I’m a real estate junkie, and I know you (probably) are too. If you’re like me, you also have money in the stock market because it’s a good thing to do in addition to your real estate investments. But what if you can put some of that diversification into real estate in a more limited-risk way?
Read on, reader, for my take on crowdfunding.
OK, so what is crowdfunding?
Basically, crowdfunding is a way of raising capital that asks many investors to contribute a smaller amount rather than asking one or two investors to contribute substantial amounts. This allows investors who may not have a large amount of capital (or who may not be willing to risk that large amount) to participate in real estate investing by purchasing a small share of the holding.
Many platforms like Fundrise, EquityMultiple, YieldStreet, and more help connect an investor looking for capital with investors looking to place capital. Crowdfunding can also include widely advertised syndications.
Investors participate in these offerings through several different security regulations:
- Regulation Crowdfunding (Reg CF) allows up to $5 million in fundraising annually per sponsor but comes with stringent reporting demands. Contributions must be made through a registered platform or a broker/dealer.
- Regulation A+ allows up to $75 million in annual fundraising but requires detailed upfront disclosures and an SEC-qualified statement.
- Rule 506 (C) sponsors can advertise widely and there is no cap on investments from participants, but all participants must be accredited investors.
How is crowdfunding any different than REITs?
While both REITs and crowdfunding offer investors the ability to purchase smaller fractional shares of real estate ownership, the risk profiles can differ significantly.
REITS
Pros:
- Provide investors with stable income
- Average return is 10-11%
- Easy to buy and sell, like stocks
- Often come with a long track record
Cons:
- High expenses can eat into investors’ returns
- Returns are more in line with stock market returns than traditional real estate
- Dividends are subject to ordinary income tax
Crowdfunding
Pros:
- Possible to invest in real estate with a relatively small amount of cash
- Potential for substantial gains with equity investments
- CrowdStreet reports an average realized IRR of 17.9%
- Ability to see and understand the specific real estate investment
Cons:
- No guarantee the venture will deliver on its promise
- Many sites charge fundraiser fees, donor fees, and processing fees
- Some options may only be open to accredited investors
- Depending on the structure, the tax implications may be similar to REITS
While REITs typically invest in large, stabilized assets, crowdfunded assets may be more volatile. As such, the risk is much higher. Investors should carefully consider the risks associated with their investments.
So, why should you invest in crowdfunding?
Reason 1: Invest on Either Side
There are two main options for crowdfunding: equity investments and debt investments.
Equity investors can see higher returns, and you can deduct expenses come tax season. However, equity investments are also riskier, and their holding periods typically range from 5-10 years.
Debt investors make a lower ROI than their equity counterparts, but they also assume less risk. Since debt investments are usually for development projects, they have shorter holding periods. You may be subject to higher fees, however, and your returns are capped.
Reason 2: Target Markets
Let’s say you want to bank on Austin TX continuing to be a hot market. If you’re participating in crowdfunding, you can just select a property in that market, making tailored decisions based on your research and preferred strategy.
In a REIT, the fund’s managers make all of the investing decisions for the group, which doesn’t allow you to target specific properties you’re interested in. Certain REITs may focus on a broad area, like the Southwest, or a property type, like retail. But mostly, you’re a small fish in their big pond.
Reason 3: Retirement
Placing retirement funds in crowdfunded real estate is a great way to have passive control over your portfolio if you have a self-directed retirement account.
What risks do you need to know about?
Risk 1: Low Liquidity
Crowdfunding investments often function more like syndications – they’re much harder to exit during the lifecycle of the investment.
Risk 2: High Risk Profile
Because many deals are “value add”, the risk profile is higher than stabilized, long-term investments that you could hold.
Risk 3: Investment Limits
If you’re not an accredited investor, you have limits on how much you can contribute. The JOBS Act broke down barriers, but also set up limits for nonaccredited investors.
Due to the risks involved, the law states that you can only invest up to $2,200 or 5% of the lesser of your annual income or net worth during a 12-month period if either is less than $107,000. If both are more than $107,000, you can invest up to 10% of whichever is less during a 12-month period, but you still can’t invest more than $107,000.
For example, if your annual income is $120,000 and your net worth is $100,000, your maximum investment is $5,000 during a 12-month period. The lesser number between your annual income and net worth is $100,000, and you are capped at 5% of that number because it’s under the $107,000 threshold. 5% of $100,000 is $5,000.
Accredited investors aren’t bound by these limitations.
Conclusion
The global crowdfunding market size is estimated to grow by $310.07 billion from 2024-2028 according to Technavio. This is the total for all crowdfunding uses, which primarily include business funding and other capital uses outside of real estate. However, with the total market size expected to grow, and the ability crowdfunding provides investors to participate in real estate investments on a smaller scale, expect real estate crowdfunding to grow significantly in the coming years.
Our advisors proactively pursue a multi-faceted approach when working with you to grow your long-term wealth. Contact us today to plan your strategy.
Sources
https://www.biggerpockets.com/blog/real-estate-crowdfunding
https://www.sec.gov/resources-small-businesses/exempt-offerings/regulation-crowdfunding
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