Real estate crowdfunding is an emerging investment model that enables real estate investors to get excellent returns from property deals. For a long time, real estate has been the playground of the rich. However, with the rise of crowdfunding in real estate, the barriers to investment have come down.
Therefore, smaller investors are aiming to partake in institutional quality deals in real estate alongside accredited investors. So, this blog aims to discuss real estate crowdfunding pros and cons. Hence, if you are keen on investing in crowdfunded real estate deals, identifying the pros and cons of crowdfunding is the first step in your investment journey.
What is Real Estate Crowdfunding and how does it work?
Real Estate Crowdfunding allows investors to raise money from a ‘crowd’ of potential investors for investing in sophisticated real estate deals. This helps in cases where a single profitable property deal or project is too expensive for one investment entity. In exchange for their minimum investment amount in real estate crowdfunding deals, the investors receive monthly rental income distributions from the deal.
An experienced real estate developer operates as a ‘Sponsor’ or a ‘General Partner’ of the Crowdfunding Syndicate. This entity is responsible for identifying lucrative investment opportunities and managing the properties on a day-to-day basis.
Through crowdfunding, real estate investors can diversify their portfolios with a broad range of properties. These include multifamily, retail, office, and hospitality properties among others. Furthermore, crowdfunding investors can avoid the burden of direct property management.
Read Lilypads’ blog on Real estate crowdfunding here.
Pros and Cons of Real Estate Crowdfunding:-
Although the jobs act and crowdfunding investments are rapidly transforming the real estate industry, such investments are not without their advantages and downsides.
Advantages of Crowdfunding
1. Portfolio diversification –
Real estate crowdfunding allows investors to diversify their portfolios and minimize the risks of losses of a single investment. When you distribute your wealth across numerous investments, you widen your portfolio with greater diversification. Therefore, in the event of market crashes and volatility, investors can benefit from a natural hedge.
Besides portfolio diversification, real estate crowdfunding investments also allow greater geographic diversification. With numerous online investment platforms on the rise, real estate investors can transcontinental reach and eventually expand the boundaries of their portfolio on a global scale.
As a result, investors operate in various markets at the same time. So, if the market in one city is declining, another market is flourishing. Therefore, investors can protect their investments and generate higher returns even when the market is declining.
2. Minimum investment requirements –
Crowdfunded real estate investments through Special Purpose Vehicles (SPVs) raise capital from a pool of investors. As a result, each investor can invest as little as $500. Therefore this is considerably lower than the high acquisition rate of traditional property investments that require millions of dollars and greater down payments. Therefore, crowdfunding has lowered the bars of entry into real estate.
3. Accessibility –
Earlier only accredited investors with a net worth of over $1 million and an annual income of over $200,000 were allowed to invest. However, the emergence of real estate crowdfunding platforms after the JOBS Act of 2012 has made real estate investment accessible to individual, non-accredited investors.
4. High dividends
Most crowdfunded real estate platforms work through Real Estate Investment Trusts (REITs). Legally both public and non-traded REITs must distribute 90% of their taxable income to their investors in the form of dividends. Therefore, income investors can receive consistent dividends or distributions from their investments.
5. Passive investment vehicle –
Traditional investments subject an inexperienced investor to the burdens of property management and other associated risks. Moreover, professional managers charge hefty fees for day-to-day asset maintenance. However real estate crowdfunding is essentially a passive investment vehicle.
Therefore, the Sponsor or General Partner of the Special Purpose Vehicle is responsible for the overall property management. Hence, crowdfunded real estate investors can administer their investments remotely. Furthermore, they can simply collect all appreciation payments without the hassle of property management.
6. Easy to Access –
Crowdfunding platforms are much more accessible than direct investments in real estate. The use of technology in real estate has fundamentally changed the way of traditional property investments. Most crowdfunding platforms today have mobile versions of their websites or apps.
Therefore, once an investor is on such websites, they can easily access all relevant information ranging from market trends to Sponsor experience. So an average investor can educate themselves from their mobile device without any third-party real estate agents or fund managers. Hence, such transparent information enables them to make informed decisions and invest diligently in those deals that align with their investment goals.
Real estate crowdfunding is a high-risk, illiquid type of investment. But if the investors are willing to take more risk for superior returns, crowdfunding real estate deals is the smartest investment mode to broaden your portfolio.
Disadvantages of Crowdfunding
1. Lower Relative Returns –
Generally, a crowdfunded property generates lower returns than traditional investments. That includes sponsor fees, management fees, advisory fees, and individual fund fees. Depending on whether you choose equity investing or debt crowdfunding investment, the returns you receive may vary.
Besides, crowdfunding investments are generally illiquid. This implies that the investors must tie up their money for longer periods (6 months to 10 years) until the sale of the asset. Therefore the investors cannot cash out their investment anytime they want which also affects the value of the property.
So, real estate crowdfunding is only suitable for those investors who are comfortable locking their money for longer investment horizons.
2. Lack of control –
If you want full control over your investment then real estate crowdfunding is not for you. Once the investment is made with crowdfunding the property, the Special Purpose Vehicle and the General Partner oversee the management entirely. will be managed by someone else entirely.
3. New Investment Avenue –
Being a relatively newer investment vehicle, Crowdfunding operations often lack proper regulations. Moreover, real estate fund investments are not protected by the securities investor protection corporation. Therefore, new investors face the risk of platform failure or mismanagement of the investor funds.
Furthermore, the short track records of certain crowdfunding Syndicates and Sponsors hinder thorough due diligence in their industry experience. In addition to this, it is noteworthy that crowdfunded real estate platforms are not registered with the SEC. So, it is suggested that investors associate with established, well-respected crowdfunding platforms.
Is Real Estate Crowdfunding the right choice for you?
Real estate crowdfunding might not be the right choice for everyone. But if you are willing to take on risks and start investing with minimal amounts, then Crowdfunded real estate deals are your best option. But before pursuing Crowdfunding opportunities in real estate, ask yourself the following questions:
- Do I need anybody else to manage my investments or can I do it myself?
- Do I have less amount of money to invest?
- Do I want to invest for a short period of time or do I want to hold the property for decades?
- Do I want consistent cash flow from my investment?
If most of your answers to the questions are affirmative, you might prefer crowdfunding investment over traditional real estate investments. Crowdfunding offers almost all the benefits of real estate investment without a lot of limitations. Therefore, it is easily accessible to regular, non-wealthy investors.
The Lilypads Bottomline
Real estate crowdfunding investments are steadily disrupting the real estate market. Albeit new, it has moved to the mainstream investment arena due to its low investment requirements and steady cash flow. However, investors keen on entering the real estate domain must gauge the real estate crowdfunding pros and cons. Therefore, by analyzing their investment goals and risk assessment, investors can explore this property investment tool.
Read Lilypads’ blog on