Crowdfunding is not a new notion; it has already occupied its honoured place in the world of finance, investing and venture capitals.
Its popularity arises from a unique way of raising the money it uses, and it has already expanded to various spheres, including real estate.
What exactly is crowdfunding in real estate?
The definition of crowdfunding real estate according to Wikipedia is raising capital for a real estate project by attracting a large number of small investors mainly online (source: Wikipedia).
Source: Massolution Crowdfunding Industry 2015 Report
Let’s have a look at how real estate crowdfunding works.
Earlier, real estate development was grounded on investing money straight into the development company or through REITs (real estate investment trusts).
The job of the latter is to give investors an opportunity to buy stakes in real estate facilities. However, it considerably restrains access to projects for individual investors.
Crowdfunding in real estate has greatly simplified this process by greenlighting investors all around the world to take part in real estate investing via numerous online platforms.
All the truth about real estate crowdfunding
Crowdfunding for real estate development differs from other types in the means of investing, benefits and risks for investors.
In real estate crowdfunding, investors play the role of property shareholders (equity investment) or allocate funds in the loans backed by it (debt investments).
Venture investing, in contrast, only gives investors an opportunity to get a stake in the crowdfunded property which they will be able to trade when the property starts generating income.
As for loan crowdfunding, which is, by the way, the rock star on the market, it works only for debt deals without applying to any intermediaries.
The last type is reward-based crowdfunding. It preceded other types and had one distinctive feature — it doesn’t suggest any material benefits.
By and large, real estate crowdfunding successfully embodies some features of other types and gives investors more room for actions.
What to choose?
As it was stated earlier, there are two possible ways to finance property projects through crowdfunding: equity and debt instruments. One of the positive things about real estate crowdfunding is the ability to choose between these types of investments.
By making a debt deal, the investor acts as a creditor for a property owner. The collateral for a deal is property itself, and like ordinary loans, the lender gets a fixed return that corresponds to a certain interest rate. Moreover, being a lender, investors have a priority when receiving payouts.
In scenarios with equity investments, investors represent themselves as stockholders having a share proportional to the investment they have made.
The return is in the form of the income from rental premises. Also, service fees paid to the platform are insufficient.
Both investment tools have their pros and cons. Debt investments are characterised by shorter holding period, lower risks and steady income that is common to all loan instruments.
However, there’s a fly in the ointment – fixed returns and high charges.
Equity investments are more popular as they offer no upper limits on returns, give a chance to reap tax benefits and tend to be much cheaper when it comes to paying out administration fees.
For those who can’t decide what is better – debt-based or equity-based investing – there is a convertible debt as an alternative.
This type of deals has inherited the features of the earlier patterns.
It works this way: startups get funds from supporters in the form of a loan that shall be repaid later in the form of a real estate property share.
The moment of conversion coincides with the funding round or the time when a business achieves the pre-defined valuation.
A “valuation maximum supposes that investors can’t make a conversion in the event of exceeding the limit. The only return they get is loan repayments.
The method of conversion is negotiated before making a deal. As a rule, it’s funders who initiate the conversion process.
An opportunity to convert a loan at a discount rate in the next funding round can be a stimulus for conversion.
Another option is a warrant that offers to buy additional securities in the next round almost for free. If investors are not willing to convert a debt, they receive returns according to an interest rate anyway.
As a mix of the two financial models, convertible loans have a great impact on the whole crowdfunding sector. They are ideal for real estate companies who are unable to determine their valuation.
If you’re not ready to estimate the future value of your property, you can opt for a convertible loan to get funds now and protect the property later.
Legal framework for real estate crowdfunding
The breakthrough of real estate crowdfunding in recent years was caused by the adoption of JOBS Act in 2012.
Its name says for itself: the act intended to foster the financing of small businesses through crowdfunding, in particular.
The passage of the Act symbolised the start of the era of using crowdfunding for issuing securities.
Source: Massolution Crowdfunding Industry 2015 Report
Pros of making money on crowdfunded investments
Real estate crowdfunding is truly a new path for investors to gain benefits. Today nearly everyone can become a small investor even presuming that they earn less than $100,000 a year.
These venture capitalists are also called non-accredited or unaccredited investors.
Those who have larger income are known as accredited ones. In the past, only the latter were able to make investments in crowdfunded property. However, JOBS Act gave the go-ahead for everyone who is looking forward to ‘cherry-picking’.
How to become an accredited investor
Of course, being an accredited investor offers more perks than having the status of a non-accredited one. Those who earn $100,000 can make a crowdfunded investment that equals 10% of their income. For investors with a lower level of income, the limit is 5%.
To become an accredited investor, you have to earn at least $200,000 a year. If you’re married, this figure increases to $300,000. This prerequisite shows your skills, knowledge, and ability to manage funds successfully.
The anatomy of online real estate crowdfunding
Let’s imagine that you happen to be an investor.
First of all, you need to choose a professional crowdfunding site to take part in a deal.
Companies working in the real estate crowdfunding industry make proposals for potential investors to make a deal. Each proposal includes the info about forecasted returns. Usually, there are two types of proposals – conservative and aggressive ones.
Conservative deals are less risky 4yet they offer low return (less than 10%). Aggressive pitches are for those who like rolling the dice. They have the highest projected returns – more than 300%.
Investors expect to get two parts of the return – the first one comes every month and equals 5-11%, the second is gained at the very end when a company sells the property.
The duration of deals varies greatly. One can find short-term projects (6 months) more attractive while others are tempted to lengthy enterprises (over 10 years).
So, you’ve found your ideal pitch, what next? Subscribe and transfer your money to an online deposit.
When doing this, you sign the legal contract and let your money be pooled with the funds of other investors. Once the pool is formed, a project creator can use the funds for the project launch.
Crowdfunding platforms come in various forms and colours. Among them, there are those with a focal point on crowdfunding real estate projects. Some of them are accessible only to accredited investors while others allow non-accredited small capitalists.
Check out the best known in the table below.
Top real estate crowdfunding platforms
|Platform||Allowed Investors||Business model||Popularity|
|Fundrise||Both||1% asset management per annum||Medium|
|Realty Mogul||Accredited||% based Service Fees||Medium|
|Patch of Land||Accredited||0-2% on interest distributions||Emerging|
|RealtyShares||Accredited||2% of the invested amount||Emerging|
|RealCrowd||Accredited||is free for investors||N/A|
Source – crowdexpert.com
In terms of fees, crowdfunding sites for real estate are quite different.
The activity of the first cluster is based on charging companies who make proposals.
Charges can be set as fixed prices. Also, it can exist in the form of a service fee paid by entrepreneurs for signing up.
As an alternative, some of the platforms have a share in the profit generated by a project just like it works with real estate equity crowdfunding.
However, there are some “black sheep platforms who don’t get profit by charging clients at all.
Others earn revenue on investors. If you subscribe to such a portal, you will have to pay 1% at a minimum for using its services every year. Luckily, investor-friendly crowdfunding platforms also are present on the market.
The strategy of the third squad is to make their own pitches.
They don’t work for real estate companies to create their projects. Project-related things like buying and selling the property, managing and maintaining it are usually available for an extra fee.
Is real estate crowdfunding a good investment?
The nice thing here is that it brings great benefits. This way of financing projects attracts investors because it gives them unlimited access to the venture-capital industry, delivers tax benefits, represents a secure and easy way to make investments and many more other advantages.
Those who are eager to proceed with investing in crowdfunded property should know what they will get at the end.
It’s obvious that real estate crowdfunding is a unique chance for small-time and big shot investors to make a sheer profit, structurize, diversify a portfolio with minimum risks connected with property deals.
However, the process of choosing a crowdfunding platform requires substantive considerations due to the peculiarities of their operation.
How about starting your own real estate crowdfunding business?
Nowadays, many people are looking to raise seed capital for their real estate projects.
And just like them, there are investors who are looking to diversify their investment portfolio.
So why not help them connect and earn money on top of it?
Real estate crowdfunding is attractive for investors and borrowers since there are no financial intermediaries – it’s the real estate crowdfunding platform that ought to do the job instead.
If you decided to launch a real estate crowdfunding platform, the real estate developers would be able to get funding in weeks and without high overheads comparing to banks.
Platforms differ regarding fees, types of property and investments. For a borrower, the most important thing is to find the right platform that will satisfy their need. Why not build one?
Here’s what you have to do
Today, there are quite many real estate crowdfunding platforms, but that doesn’t mean you shouldn’t try making business in this niche.
- Think about the type of property you want to work with and you might find yourself in the niche with quite low competition.
- Design the platform to be user-friendly and straightforward – both investors and borrowers should get clear information from your website.
- Get regulatory approvals (FCA certification in the UK, for example).
- Work out your marketing to attract investors and borrowers.
In comparison with banks or other lenders, the process to fund real estate project is far quicker. It is hardly surprising why crowdfunding is gaining prominence in financial marketplaces and has already become a preferred source for financing real estate projects.
Is being an owner of a real estate crowdfunding platform worth it?
There is the third player in crowdfunding deals whose contribution is significant – a crowdfunding platform.
There is a great variety of platforms on the market. Before starting your own, you should decide on these points:
- Will you be serving your deals or operating as a broker? If you decide on the latter option, you will have to get the licence for being a dealer or providing brokerage services.
- Will you be dealing with equity investments, debt financing or both? Choose what kinds of debts and equities you’re going to work with. Whether it will be a secured debt or one of the three types of equity crowdfunding.
- Will you be crowdfunding for retail, commercial or industrial real estate or maybe for all? Also, think about the geography – whether you’ll be providing local services locally or internationally.
It’s vital to give the answers to these questions as it determines the legislation base you will need to get a license under.
Selling securities is not the same as a bake sale. Following the law goes without saying.
Of course, having an online business means developing and applying complicated tech solutions, which can be rather costly, by the way.
You can opt for the services of white-label crowdfunding platforms that focus on developing software for real estate crowdfunding sites. Among the leaders in the sector are GroundBreaker, Selfstarter, Launcht.
Although technical aspects are at the top of raising capital online, don’t forget that your main purpose is to make financial transactions.
What do you get as an owner of a real estate platform?
First, if you decide to create a platform for your deals, you will save on service fees demanded by other platforms.
In case you choose to work as a broker, your income will be based on the charges you set.
It’s certainly clear that your success will depend on the quality of your platform. If the number of closed deals grows, you will have your clients back for sure.
An additional plus is getting more expertise in real estate crowdfunding by gathering lots of investors together and sharing your experience with them.
Real estate crowdfunding platforms can be a great business to start.
Creating your network of investors and real estate developers can help you profit financially and benefit from sharing the experience.
So what does all that mean?
In truth, real estate crowdfunding has proved popular and works well when it comes to mobilising funds for real estate projects.
Unlike banks and other brokers, crowdfunding platforms make the whole deal easy and fast thanks to innovative tech solutions and simplified procedures.
Both investors and borrowers tend to find it as a godsend.