The Pros and Cons of Real Estate Crowdfunding

Real estate crowdfunding is a method of funding a real estate project using a small amount of funds from a large number of investors.

From the developer’s perspective, crowdfunding gives developers access to networks of colleagues, friends, family, and even the general public, through such social media sites as LinkedIn, Facebook, and Twitter and various crowdfunding platforms available online. These efforts allow the real estate developers to widen their potential investor base and capitalize projects they may have had difficulty funding through more traditional channels.

From the investor perspective, crowdfunding provides investors access to significantly more investment opportunities, and allows them to spread their investor dollars in smaller amounts across more investments, and thereby achieve greater diversification.

Though real estate crowdfunding has been around in some form for many years, it has recently begun to increase in popularity, primarily because of the proliferation of online crowdfunding opportunities and platforms.

As an investor, to be successful with real estate crowdfunding, it’s essential that you select the right crowdfunding platform. By using crowdfunding to make a real estate investment, you’ll be able to gain access to the wider real estate market with only small amounts of money. While there are dozens of crowdfunding platforms available to you, some of the more popular platforms include Fundrise, Origin Investments, and RealtyMogul.

The real estate industry is becoming more active with crowdfunding, which has facilitated the refinement of the process in recent years and the increase in viable platforms. While crowdfunding is a great way to engage in real estate investment without needing to spend a significant sum of money, there are advantages and disadvantages to the process that you should be aware of before you give it a try. The following takes a look at some of the pros and cons of real estate crowdfunding, which may help you decide if this investment vehicle is right for you.

How is Real Estate Crowdfunding Advantageous?

1. Portfolio Diversification

Among the most notable benefits of real estate crowdfunding is that it allows you to engage in portfolio diversification. By diversifying your portfolio, you are essentially minimizing the risk that comes with making a singular investment by spreading that risk across numerous investments. If one of your investments happens to fail, your investment portfolio will be spread across numerous investments. To illustrate the benefit, you could make one investment of $100,000 into investment A, or invest that same amount equally in $20,000 increments across investments A, B, C, D & E. If you only invested in investment A and that investment failed entirely, you would lose $100,000. But if you had invested that amount across five investments, and one failed, you would only lose $20,000.

2. Accessibility

Engaging in real estate investing has been made much more accessible with crowdfunding. Private real estate investments were once only available to high net-worth investors who had the capital and connections that were needed to access the investments. With changes in the law and the proliferation of online crowdfunding platforms, those are no longer barriers to entry. The entry point for the real estate investment market is now much lower than it’s ever been.

3. Geographic Diversification

While portfolio diversification is among the top advantages of making real estate investments with crowdfunding, another similar and notable benefit is that you can obtain geographic diversification with your investments. The reason that geographic diversification is important is that multiple areas of the real estate market can perform very differently from one another.

While the real estate market in one city may be healthy, it’s possible that the market in another location could experience a significant downturn. If you invest all of your money into one location, it’s possible that you could obtain a negative ROI solely because of issues specific to that market that don’t impact the broader market. When you make real estate investments via crowdfunding, you’ll have the option to choose where you invest.

4. Passive Investment Vehicle

Another attractive aspect of investing in real estate through crowdfunding is that it is a passive investment vehicle, as contrasted to more traditional real estate investment vehicles, such as direct ownership. For people who make traditional investments, they generally will need to spend considerable time managing the property to make sure that it’s developed on time and according to specifications, and bear all of the associated risks. With crowdfunded real estate investments, you are investing with a third-party real estate developer or operator who does all that work. You are trusting that the developer or operator will do all of the required work on time and on budget. As such, you don’t need to deal with the frustration of managing the property. This, in turn, frees you up to focus on your other investment ventures.

5. Small Investment Size

If you’ve never before been able to invest in real estate because of how much money is typically required with a traditional real estate investment, crowdfunding provides you with the opportunity to become a real estate investor because of the small investment size requirements. In fact, some crowdfunding platforms allow potential investors to make an investment of as little as $500. You no longer have to have the tens or hundreds of thousands of dollars that would more typically be required to purchase a property to invest in real estate. The smaller investment amount also allows you to “tip your toe in the water” if you are new to real estate investing, or achieve greater diversification.

How is Real Estate Crowdfunding Disadvantageous?

1. Lower Relative Returns

While real estate crowdfunding can be highly advantageous, there are also some disadvantages that you should be aware of before you start to invest. One potential disadvantage is that your return will typically be lower than what you would receive if you directly invested in the real estate through ownership. That is because the developer or operator with whom you are investing needs to make money too. Your investment return typically accounts for that fact. The return you do receive, however, will depend on numerous factors including, without limitation, whether it is a debt investment, equity investment, and the ultimate success of the investment. If your real estate investment proves to be a successful one, you can typically expect a return of 8-10 percent for a debt investment and 18-23 percent for an equity investment.

2. Illiquid Investments

Another disadvantage of investing with crowdfunding is that this type of investment is considered to be an illiquid investment. These investments are ones that cannot be easily sold for cash if the need arises. A buyer will need to be lined up for the property that you’ve invested in, which can take a significant amount of time and may cause the value of the property to drop over time. If ever an emergency occurs, it could be nearly impossible to cash out on the investment.

3. Lack of Control

If you want to have control over your investments, real estate crowdfunding may not be for you. Once you make the investment with crowdfunding, the development of the property will be managed by someone else entirely. However, more traditional forms of investment provide investors with the ability to manage the project.

If you have managed sizable projects before and believe that you could effectively manage a real estate project, a traditional form of investment will allow you to have more control over the development process, which can typically make it easier to get the returns you’re looking for.

How to Get Started with Real Estate Crowdfunding

If you want to start investing in real estate through crowdfunding, you will first need to select a crowdfunding platform to join, of which there are many. Each crowdfunding platform comes with different requirements and different areas of focus. One principal requirement that you need to consider when choosing from among the many crowdfunding platforms is the minimum investment amount. While some platforms come with a minimum investment amount of just $500, others require minimum investments of $100,000. The average is usually around $5,000.

Most of these platforms provide you with the ability to put your money into an equity investment or a debt investment. When making an equity investment, you will receive a direct stake in the property. Returns occur in the form of an equity share of the total rental income or profit if the project is sold. As for debt investments, you will be placing your investment directly into a loan. These loans are typically secured by the underlying real estate serving as collateral and will be repaid with interest on a monthly or quarterly basis, after which a percentage will be provided to each investor.

Once you’ve found the right platform, it’s important to understand that each works differently. You will first be required to start an account, after which you can make your investment. With a platform like Fundrise, an investment of $500-$1,000 will allow you to invest in 5-10 projects, each of which you will be able to select on your own. You can get started with most of these platforms in a matter of minutes. Keep in mind that the length of these investments can be anywhere from 1-10 years.

The Bottom Line

While real estate crowdfunding and investing may not be for everyone, it can be a great way for you to start investing in real estate without needing to spend a substantial amount of money. Placing less money into the investment means that the risk will often be lower. Before you begin to invest in real estate with crowdfunding, it’s important that you understand the many advantages and disadvantages that come with crowdfunding. With this information in hand, you’ll be able to create a risk assessment for your investment.