How Risky is Real Estate Crowdfunding?

Interested in real estate crowdfunding but not sure how risky it is? Here are the main dangers.

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There's no doubt that real estate crowdfunding holds tremendous opportunity for qualifying investors. The returns are competitive and the investment is passive. But how risky is crowdfunding? Every investment has an element of risk, and real estate crowdfunding is no exception. Understanding the potential pitfalls lets you compare the risk and reward to determine if it's the right investment for you.

Why choose real estate crowdfunding?

Crowdfunding lets accredited investors take part in commercial real estate deals for a low upfront cost. Real estate crowdfunding is an appealing investment option for several reasons:

  • The investment is minority stake, so you don't have to directly manage the property.
  • You can take part in some deals for as little as $1,000.
  • You choose the specific investment opportunity you want to participate in so you know exactly what sector, geographic market, and specific asset your money is invested compared to a REIT where your money is spread across multiple investments across often in many geographic areas and possibly sectors.
  • Many crowdfunding investments offer higher-than-average risk-adjusted yields.

It’s clear why real estate see crowdfunding is an enticing choice for investors. However, there are uncertainties that need to be understood. Let’s take a look at the risks of investing in real estate crowdfunding.

The crowdfunding platform you choose matters

Not every crowdfunding platform is considered equal. The abrupt closure of crowdfunding platform RealtyShares shook up the real estate crowdfunding scene in 2018. That closure has made people question the viability of other platforms.

Each platform has a different process for vetting the deals on their website. Their investment opportunities also work in different ways. It's imperative to know how the crowdfunding platform researches the deal sponsor. Some platforms are very selective, some are less scrutinous.

But remember: The profitability of your investment rides on the property and sponsor. It's not only up to the crowdfunding platform to decide that the investment is of high quality -- it's yours, too.

If you don't see information on the vetting process on the crowdfunding website, ask questions to find out more about it. See why the platform is better (or worse) than other options.

But remember: The profitability of your investment rides on the property and sponsor. It's not only up to the crowdfunding platform to decide that the investment is of high quality -- it's yours, too.

If you don't see information on the vetting process on the crowdfunding website, ask questions to find out more about it. See why the platform is better (or worse) than other options.

Limited due diligence

Opportunities on crowdfunding platforms include an offering memorandum (OM) and/or an executive summary of the investment.

The OM gives you an in-depth view of the property, the sponsor, financials, long-term plans, and a summary of the investment. This information is comprehensive and helpful for potential investors. But without a high level of real estate investing experience, it may still be hard to determine if it's a worthy investment or not.

Without expertise in an asset class or geographic area, the average crowdfunding investor's ability to review and assess opportunities is limited. This is another reason the crowdfunding platform you choose matters. Most investors place a large amount of trust in the platform and their ability to pick worthwhile investments.

The success of the investment is in the hands of the sponsor

The sponsor is the person or organization responsible for controlling the investment. That includes

  • negotiating the purchase price and terms,
  • managing the asset through development and construction, and
  • ultimately determining the ideal time for selling the asset.

The crowdfunding platform matters, but the sponsor matters more. The viability and profitability of the investment rely on the sponsor and their management team's ability to run the asset well.

Look at the sponsor's track record. See how many assets they own and manage. Take time to research the outcome of prior investments.

Some investors would rather know the sponsor on a personal level or have worked with them on past deals. Others may never feel comfortable with crowdfunding because the success of the investment is out of their hands.

It’s up to you and your level of comfort. Before investing, make sure you agree with the sponsor's investment plan and management strategy. If you're confident they can deliver a return, go ahead and make the investment.

There are no guaranteed returns

There are no guaranteed returns in investing -- ever. It doesn't matter if you're investing in stocks, bonds, or real estate. There are always factors that can negatively affect the performance of the investment. Market fluctuations and construction setbacks are two that are relevant in real estate crowdfunding.

Crowdfunding investments might not reach the projected return. This could reduce the dividend return to the investor providing a lower-than-anticipated yield.

There are also a few worst-case scenarios. The investment might fail. The sponsor could file for bankruptcy. The asset might go through foreclosure. Depending on the circumstances, the sponsor may not be required to return interest or principal. Many crowdfunding platforms take measures to protect investors, but that isn't always the case.

There's no guarantee you'll get the advertised return or even the return of your capital. Crowdfunding isn't litigation-, fraud-, or recession-proof. You have to be comfortable with that before investing.

Low liquidity

Liquidity is one of the most appealing parts of investing in a REIT or real estate ETF; your money can be invested or withdrawn at a moment's notice.

Real estate crowdfunding has low liquidity. Most investments require at least two years before you can have your capital returned. And if you want to get a good return on your investment, you may need to keep your money there for years; sometimes up to a decade.

The lack of liquidity is one of the reasons crowdfunding platforms often provide higher returns than REITs or real estate ETF offers. If you're concerned about liquidity, consider a more traditional form of real estate investing.

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