An Introduction to Real Estate Crowdfunding

There are several ways to invest in real estate, such as buying investment properties or buying shares of a real estate investment trust, or REIT. A new option is to participate in a crowdfunded investment opportunity. This new and exciting way to invest in real estate has the potential for excellent returns, but there are a few things investors should know first.

In this Industry Focus: Financials clip, Fool.com and Millionacres contributor Matt Frankel, CFP, gives a brief introduction to real estate crowdfunding and why investors might want to consider it.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 7, 2019.

Jason Moser: Let's jump into real estate. Matt, as listeners remember, you are working on one of our newest initiatives here at The Motley Fool in Millionacres. You're helping bring the world of real estate investing to our members in new ways. Real estate investing is very much in line with the financial stuff that we're talking about every week. We're trying to incorporate more of this into our shows. It's a fascinating subject. It's one that I enjoy talking about. It's one that you know a lot about. This week, we wanted to talk a little bit more about crowdfunding's role in real estate, how it works, and how this plays out for everyday investors like our listeners.

Matt Frankel: Sure. I'll give you a simplified explanation of how this works. Let's say that an experienced real estate developer finds this rundown hotel in an old part of town, and can buy it and renovate it and seize the opportunity to make a big profit. Let's say that they can acquire the hotel for $10 million. A bank might be willing to fund, say, $7 million of that. If this developer, which is known as the sponsor in this, would not want $3 million of their own capital tied up, they can approach investors to raise the money from individuals. They usually put up a little bit themselves. They can use investors to raise the rest of that money in exchange for a share of the profits.

Similar to a REIT, except a few big differences. One, it's a single-asset, usually, like a hotel that they will buy and renovate and try to sell it, say, five or seven years later. That's a usual timeframe. That's the other big difference. There's usually a planned exit strategy.

There's a few reasons you would want to do something like this. No. 1, the return potential is off the charts compared to general stocks. A lot of these deals target rates of return in the 15% to 20% range. Although it's a pretty new industry, the early indicators are that it's pretty successful. On CrowdStreet, which is one of the most popular platforms, I think all but two or three of their deals that have been completed so far have beaten 14% internal rates of return. A handful have done over 20%. There's money to be made here. That 20% rate of return would double your money in roughly four years.

Moser: Not too shabby.

Frankel: No. There's a lot of money to be made here. It's a good way to add diversification to your portfolio. This is a type of real estate that, until recently, had been inaccessible to individual investors on a single-property basis. You could buy a hotel REIT, but --

Moser: That's a lot of different hotels, usually.

Frankel: Right. It's not buying one asset with some way to add immediate value and then flip it at a profit. That's been inaccessible to individual investors for most of history.

There are some drawbacks to this. Obviously, it's a riskier asset. Nothing that can produce a rate of return of 20% or so is without risk. This is certainly not an exception. Whenever you're trying to add value to an asset, there's a big element of execution risk. If you're planning to renovate a hotel and then sell it at a higher price, there's a lot of things that can go wrong in that strategy that wouldn't go wrong if it were just, say, buying hotels and renting them out, bringing in income. So, added risk is something investors want to keep in mind.

And, liquidity. Generally, when you give one of these your money, it's tied up until the deal is completely done -- until the hotel is bought, renovated, then eventually sold; or office building, or strip mall, or whatever you happen to be investing in. There's not really a secondary market for this. If you buy a REIT, you can sell it at a click of a button if you want to. If you buy, say, a rental property, you can list it whenever you want to. It might take you a couple of months to sell it, but you can sell it pretty much whatever you want to. With one of these, you really can't. You're pretty much tied up for the duration. There's no real secondary market for these. There's some interest in some of the platforms of creating some sort of market for these, but in general, if someone's targeting a seven-year holding period, be prepared to be locked in for seven years.

It has its ups and downs, but it's a really exciting new way to invest in real estate, and the early results have been very promising.

Moser: Real estate traditionally, for a long, long time, has been extremely prohibitive just because of the requirements needed to get in. You need a lot of capital. Whether you're trying to buy your own home, or whether you're trying to buy a hotel, or whether you're trying to invest in some sort of real estate consortium, it all comes down to that bottom line of you need capital, which makes it a lot more difficult. But it's really nice to see, in this crowdfunding age, options like this come online. Real estate, generally speaking, is an attractive investment. It's generally fairly reliable. Historically, more or less tracks the rate of inflation. There's some outliers there. Certainly, we can think of the early 2000s, where there was a little bit of a spike there. Real estate is a part of my investing philosophy, my strategy. My wife and I are homeowners. That equity that we build up in that home is something that we are looking at down the road as part of our strategy later on in life. But to get there, it took a little while to save up some money and actually get that home. It's nice to see that this is opening some doors for investors.

Of course, folks with more questions, you can go check out millionacres.com and all of the stuff Matt and the team are posting over there. Of course, you can always fire your questions our way. We'll be happy to take them here on the show as well.