Although Crowdfunding is a relatively newer subject in Real estate, it has quickly gained popularity in the mainstream investment arena. Hence, its growing demand has led crowdfunding investment vehicles to be further branched into subdomains. The ‘perfect crowdfunding scheme’ is an investment myth. So, the method that aligns with one’s risk tolerance and returns expectations generally works the best in the long run. Predominantly, there are three types of real estate crowdfunding investments that we are going to discuss here:
- Equity Crowdfunding
- Preferred Equity Crowdfunding
- Debt Crowdfunding
Read Lilypads’ blog on Real estate Crowdfunding here.
The three types of Crowdfunding investments
1. What is Equity Crowdfunding?
Equity Crowdfunding is often considered the most reliable type of real estate crowdfunding investment. They are most prevalent in commercial real estate projects. It is also known as Investment crowdfunding or Crowd-investing equity crowdfunding.
Equity Crowdfunding entitles individual investors of stakes and profits in a proportionate amount to what they invested in the crowd-funded project. It is similar to the workings of the stock market. Here, as real estate professionals invest in a deal, they become shareholders in the specific property.
For example, say an experienced real estate sponsor secures a profitable deal but lacks the adequate capital to invest in the property. Therefore, the sponsor can take the deal to an equity crowdfunding platform. As a result, they can advertise their projects to the general public. They can also raise capital from other private investors for funding said purchase.
So, say, the crowdfunded equity investment deal requires $5 million in total funding and an investor invests $50000 (1% of the total). Subsequently, the equity investor will receive 1% of the general profits that the deal generates.
Hence equity crowdfunding investments enable the investors to receive real estate crowdfunding returns in the form of stable rental income. Furthermore, these investors also receive appreciation gains from the sale of the subject asset.
In addition to this, equity investors also benefit from depreciation expense deductions. Therefore, the investors receive distributions in proportion to their equity in the project and the deal structure.
Potential investors can utilize equity crowdfunding to invest in startups and small businesses via real estate investment platforms. A non-conventional form of raising the required capital, this crowdfunding scheme is often restricted to just the accredited angel investors. This is because most platforms want to minimize the risk of losses. However, most platforms also allow non-accredited investors to partake in sophisticated projects.
Benefits of Equity Crowdfunding
The advantages of investing in real estate Equity Crowdfunding include:
- High returns:
Equity investors can easily receive crowdfunding returns and distributions double their initial investment through appreciation or disposition. The investors earn annualized returns ranging from 18% to 25% with no cap on returns.
- More tax deductions:
Equity investors can benefit from depreciation deductions. As a result, they can reduce their tax liability on a yearly basis.
- Lower fees:
In real estate equity crowdfunding investments, the investors pay a single annual fee ranging from 1% to 2% of the total amount invested.
2. What is Preferred Equity Crowdfunding?
The additional term ‘preferred’ in Preferred Equity Crowdfunding defines the additional allowances and rights that the investors receive in return for investing. Therefore most Angel investors and venture capitalists prefer to invest in preferred equity crowdfunding as opposed to general equity crowdfunding.
In this type of real estate crowdfunding, the dividends out of the company’s profits are paid out to the preferred equity investors. Subsequently, common stockholders receive the remaining dividend payments after the preferred investors are repaid. As a result, if the crowdfunded project succeeds, the preferred equity investors receive a steady income.
In addition to this preferred equity investors also receive preemptive rights. as a result they can choose to invest in future rounds of financing. Hence they can prevent the dilution of their shares and convert some of their preferred stocks into common stocks. Again, this depends on the type of preference shares the investors opted for.
Although the fees are slightly higher in Preferred equity, such investors are cushioned in the event of business liquidation. In risky crowdfunding ventures that carry higher chances of losses and underperformance, the sponsor focuses on protecting the investors. Hence, when the project shuts down, the proceeds from the sale will be first given to the preferred shareholders.
Benefits of Preferred Equity crowdfunding
The advantages of investing in real estate Preferred Equity Crowdfunding include:
- Stable stream of income:
Preferred Equity Crowdfunding investors receive a stable income flow if the crowdfunded project is successful.
- Dividend Preference:
Preferred equity crowdfunding holders are given first preference at the time of the payment of dividends out of the profits from the crowdfunding deal. Generally, preferred equity investments receive a dividend of a certain percentage of their share value.
- Liquidation Preference:
When a business is liquidated either due to poor performance or mismanagement, the preferred equity shareholders are safeguarded from the risk of losses. This is because they are first in line to receive the proceeds from the sale.
- Favourable tax treatment:
In a similar way to equity crowdfunding investments the preferred equity investments can benefit from tax advantages in the form of depreciation deductions.
3. What is Debt Crowdfunding investment?
Debt Crowdfunding investors act as a lender to the deal sponsor for the property owner. Such investments are actually a loan or investment in mortgages that are secured by the property itself. Therefore, the investors receive a fixed rate of return and fixed interests on a quarterly or monthly basis.
The debt-based crowdfunding investors are at the bottom of the capital stack. Therefore, they receive a prior claim to the proceeds of the project. Even if the property is liquidated or fails to earn its projected profits, the debt investors must still receive their predetermined payments.
Benefits of Debt Crowdfunding
- Shorter holding time:
Unlike the other two types of real estate crowdfunding investments, those investments have a shorter holding period ranging from 6 to 24 months.
- Stable income:
Real estate debt crowdfunding investment generates a study and frequent stream of returns. Here, real estate investors can earn a fixed income ranging from 8 to 12% annually.
- Lower risk:
Being at the bottom of the capital stack debt investors in a crowdfunding project are exposed to fewer risks. Even if the project sponsors the property owner defaults, debt investors get paid first. In addition to this, they can initiate foreclosure action to recover the losses from the investment.
Types of Real estate Crowdfunding investment – which one is the best choice for you?
In the end, it is entirely the call of the investor to determine which among the three types of real estate crowdfunding investments is the best for them. They must analyze their risk tolerance and liquidity preference when opting for crowdfunding investments in real estate.
Preferred equity and Equity investments balance certain amounts of risks with long-term profits. On the other hand, debt investments ensure a stable income flow and predictable yields with lesser risks. Therefore, real estate investments through the best crowdfunding option can help in wealth creation at a fraction of the cost.