Real estate crowdfunding is on the rise thanks to recent technological and legal developments, and it’s redefining the way commercial real estate (CRE) assets are bought, managed, and sold today.
Also known as ‘online real estate’, it allows individual investors access to CRE assets that have long been beyond their reach due to the six-figure price tag attached to the average investment minimum. Online real estate platforms act as loan originators between campaign sponsors – i.e. property managers and developers – and investors, providing a venue where the latter can tap into an extremely attractive asset class with low minimums, while the former can get funding for CRE development and management without relying on traditional funding vehicles.
It can work on two levels, loans or equity. Property developers can choose to borrow money from a crowd on pre-set interest repayment terms, or they could sell equity in a short-term company that exists for the duration of the development. In the equity structure the investors and developer more closely share the rewards and risks. In both instances the value of the property in question can be used as an asset to guarantee repayment of the loans or investments in the event that the developer ceases trading, or for any other reason is unable to make payments on time.
As online real estate picks up steam, its range of investors gets broader by the day. This growth, however, comes with challenges, risks, and, of course, rewards that are unique to this industry. The novelty of real estate crowdfunding makes it challenging to realise the full breadth of its repercussions on individual portfolios and on the real estate market itself.
There are, however, well-documented benefits and risks that can be easily identified with some research and with due diligence. If you’re looking into investing in this lucrative industry, you will do well to be aware of the following core risks and rewards of real estate crowdfunding:
Core Risks
- Bad Actors and Misleading Marketing. Perhaps one of the most cited problems with online real estate crowdfunding is the sheer amount of fraudsters and misleading marketing. By doing away with the VC-led vetting system present in primary and secondary markets, this seems to be a natural consequence of lowering the bar of entry for both investors and sponsors.
It would be a mistake, however, to assume that this is unique to real estate crowdfunding. Bad actors and misleading marketing plague almost every new industry that arises, until they are dealt with by legal developments that happen as the industry matures. Until then, it is incumbent upon everyone who wishes to invest in real estate crowdfunding to perform their due diligence and do research on the companies they partner with. - High Default Rates. Another consequence of lowering the bar of entry. As such, not every company that advertises itself on a crowdfunding platform can or will follow through with their campaign promises. Investment default is generally higher in online real estate than direct real estate investments or P2P lending, making it the riskier alternative.
- Investment Illiquidity. Due to the absence of stock exchange indices for crowdfunding platforms in general, trading stock isn’t a real option at the moment. Many find that the only way to sell shares is to actively seek out other people interested in them through online forums where interest in those stocks is expressed. If you wish to invest in online real estate, you ought to be prepared for illiquidity.
- Less or No Control Over a Project. This is more of a case-to-case basis type of scenario. Platforms under a direct investing model allow users to directly partner with property managers, which means they get a say on what happens to a property. Ones under an indirect investing model, on the other hand, manage the investments directly and so disallow for direct partnerships between sponsors and investors.
Core Rewards
- Lower Minimums and Attractive ROIs. For many, this is the primary reason for investing in online real estate. Real estate crowdfunding campaigns have high risk-reward ratios and guarantee significant returns if all goes well with the properties in question. With interest rates easily in the double digits for nearly every campaign, rewards from crowdfunded properties are genuinely rewarding.
- Property Management-Free. If you have managed CRE assets in the past, you’ll be very familiar with the amount of work, time, and money that go into managing, maintaining, and developing those properties. On top of that, you will have to deal with tenants and collecting rent, which could be a terrible hassle if things go wrong enough for you. Real estate crowdfunding gives you all the upsides of owning CRE assets without all the trouble of direct ownership or management.
- Broad Range of Investment Options. If you have a substantial amount to invest, finding diversification opportunities is easier when CF platforms do all the work of finding and vetting potential sponsors for your investment. This means less work on your end and more profit potential in the long run.
- Opportunities for Geographic Diversification. The availability of more investment options comes with another upside, and that is more opportunities for geographic diversification. Before, finding enough opportunities for one market – say residential real estate – is difficult enough; it was virtually impossible to chance upon multiple opportunities from different markets simultaneously. That is no longer the case with real estate crowdfunding, and you can easily diversify your risk profile by venturing into different markets across the entire country to offset any potential losses.
Have you some real estate crowdfunding experience you’d like to share with us? Or maybe you think something is missing from this article. Please let us know.
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