Real Estate Crowdfunding for Beginners

Many novice real estate investors spend time attending seminars and reading how-to books, which often emphasize investing in residential rental properties. Investors who are interested in pursuing commercial real estate investing may assume there are no opportunities in that space for beginners, but they are wrong; they should investigate real estate crowdfunding.

Crowdfunding, or raising capital from large numbers of people via the internet, has revolutionized investing and capital sourcing, especially for real estate. Real estate crowdfunding is essentially real estate private equity investment or mortgage lending conducted online, via websites called “crowdfunding platforms.” Over one hundred real estate crowdfunding platforms have launched in the past few years. Real estate crowdfunding is on an upward trajectory and will remain that way for the foreseeable future. According to crowdfunding data provider Massolution, over $1 billion was raised on these platforms for real estate developments in 2014; in 2015 that amount climbed to $2.5 billion and in 2016 to $3.6 billion. Several real estate crowdfunding platforms have raised in excess of $200 million individually.

Some real estate crowdfunding platforms only offer equity investments, some only offer debt investments, and some offer both. Equity platforms usually offer commercial properties, while debt platforms often specialize in “fix-and-flip” or other residential projects. Equity investors own a piece of the underlying property and participate in that property’s operating income and eventual proceeds from sale. Debt investors are lenders; their investments are pooled with funds from other investors and loaned out to sponsors. Debt investors receive periodic interest payments at a stated rate. Debt investments generally carry less risk than equity investments, but also usually have less upside potential. In other words, you are less likely to lose your investment if you invest in a debt offering, but you have a greater opportunity to earn a larger return if you invest in an equity offering. Debt holders almost always have priority over equity investors in the event that a deal goes bad. Regardless of the type of offering, investors cannot lose more than they have invested.

It is very important to investigate all deals thoroughly before making an investment; this cannot be emphasized enough. Prospective investors should begin by vetting the platform, and considering their own risk tolerance. Investors should carefully read all information provided by the crowdfunding platform, including the private placement memorandum and other documents. Investors should also vet the sponsor and the principals in charge of the sponsor, by learning all they can about the other deals they have been involved in and how successful these projects have been. Have there been any disasters? Understanding the financial structure of the deal is critical; investors should ask a financial professional for assistance if there is something they don’t understand. Investors should also perform research on the market in which the property is located.

Investors need to make sure they understand what fees, if any, the platform will charge them. Some platforms simply charge sponsors a flat fee to list deals; these platforms typically do not pass on additional fees to investors. However, other platforms pre-fund or otherwise invest in offerings; these platforms usually include fees that are born by investors.

It is crucial to note that private placement offerings, whether conducted through crowdfunding platforms or offline, are still mostly limited to “accredited investors” (a legal term of art that essentially means “high net worth individual”). Accredited investors are theoretically financially able to sustain a loss, and savvy enough to conduct thorough due diligence. Title III of the JOBS Act authorized a type of crowdfunding that is open to almost everyone, regardless of income or net worth. It has not yet been used extensively to fund real estate developments, but that will change as more sponsors learn how to use it to fund smaller projects.

Real estate crowdfunding is an excellent way to become involved in commercial real estate investing. As with any other type of investment, all investors should conduct extensive due diligence before deciding to participate in a real estate crowdfunding offering. With that in mind, the opportunities presented by real estate crowdfunding make it well worth considering for novice investors.

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