Real Estate Crowdfunding: is it a Good Idea?

Folks don’t often think of real estate investing when they think about crowd funding; however, nowadays there are a number of investment “crowdfunding” groups popping up all over the place.

Crowdfunding traditionally attracts smaller investments in startup businesses that produce products or services, usually via social media. The Internet has increased access to potential investors anywhere in the world. The question of whether it’s a good idea for real estate is a complicated one. The short answer is that it depends, not only on whether you are a developer or an investor, but also on the property, the project and the state of the market.

Crowdfunding works similarly to real estate investment trusts (REITs) to source capital for smaller and more specific projects—developments, a specific piece of commercial real estate, as well as fix-and-flip residential properties. However, REIT investors buy shares in the trust without direct control over the selection and management of those investments.

The upside

As mentioned, crowdfunding increases investor access, giving the developer a more broadly based financial resource. Developers do not have to look for deep pockets to raise capital. Using social media, individual developers have access to friends, family and colleagues, as well as to their networks of friends, family and colleagues, for his investor pool.

For a smaller real estate investor, it can be easier to invest and potentially reap a larger return on that investment, on average 5 to 20 percent. In addition, there are more properties and opportunities to choose from that fit an investor’s financial resources. Typically, investors have a direct link to the developer, giving them a voice in the development project.

Use caution

Real estate crowdfunding is a new phenomenon and it’s experiencing rapid growth, almost none of it regulated. Officially, the 2012 Jumpstart our Business Startups Act, allows SEC-accredited investors to put money into SEC-registered business entities. An accredited investor must demonstrate a minimum net worth ($1 million) or a minimum income ($200,000). Regulation D/506(c) allows an unlimited number of investors to invest an unlimited amount of capital, a loophole that may not be available long. The SEC is proposing new regulations.

As with any new trend, there’s no record of accomplishment to draw on to determine the viability of real estate crowd funding over the long haul. It appears to work well at the moment, especially in the commercial real estate sector—a complicated business indeed. What’s to say it will?

With crowdfunding, liquidity is an issue. Investors won’t see any returns on their investments until the project is complete. There are no secondary markets to allow investors to hedge their bets. In addition, investment information and reliable advice can be hard to find. Investment standards to measure against have yet to be developed and adopted.

Due diligence

Careful investors, regardless of the investment vehicle, do their homework before parting with their money. With crowdfunding, look for:

Transparency: Is the project clearly defined, what type of property, what’s the budget; investor education materials should be available.

Capitalization: Are company founders well capitalized; are their platforms well developed; know whom you are dealing with.

Experience: Do the founders or company managers have experience in real estate, finance, technology; avoid enthusiastic novices.

The bottom line

Real estate investment is not without risk, regardless of the vehicle. Crowdfunding investors stand to gain reasonable returns on their smaller investments. Developers can gain easier access to a larger investor pool.