Crowdfunded real estate is a relatively high-risk, high-reward investment. However, it can be difficult to understand the returns generated by crowdfunding deals, especially compared with more straightforward investment vehicles like stocks and investment properties.
With that in mind, here's a rundown of what investors should know about:
- the types of returns a crowdfunded real estate investment can generate,
- some of the return metrics you'll see when researching investment opportunities, and
- how to calculate the returns generated by your crowdfunded real estate investments.
There are two main components of crowdfunded real estate returns
Most (but not all) crowdfunded real estate deals aim to produce some level of income for their investors. However, it's important to realize that the income isn't guaranteed, and in many cases, it's not likely to come in a linear fashion.
For example, if a crowdfunding investment aims to buy an old apartment complex and renovate the property, it can be several years before the property generates enough income to pay out to investors. We'll discuss what this means in a bit, but many deal sponsors set a targeted "average cash yield" that they anticipate paying out to investors over the duration of the holding period. Just know that this doesn't mean your income stream is going to begin right away.
The second way that crowdfunded real estate investments produce returns is through a profitable exit. If you haven't started browsing crowdfunding platforms yet, each deal is typically listed with a target holding period (anywhere from 3–10 years is normal). This is because these deals generally plan on an "exit." This usually means selling the property, and investors are entitled to their share of the proceeds.
Depending on the deal, the bulk of investor returns could come from either one of these sources or a healthy combination of both.
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A few important crowdfunding return concepts to understand
Before you start browsing crowdfunded real estate opportunities, it's important to speak the language. There are a few return-related terms you'll typically see in crowdfunded investment opportunity listings that are important to understand before you put your money in.
- Target internal rate of return (IRR): This is the main return metric you'll see listed in crowdfunded real estate. IRR is complex, but the main idea is that this is an annualized return metric that spreads your cash flows and equity return over the course of your holding period. If you know your investment's cash flow each year, as well as the lump-sum distribution you'll get at the end, you can use a spreadsheet or an online IRR calculator to figure out your investment's IRR.
- Average cash yield: Most crowdfunded real estate investments have some sort of income component, but it's not necessarily going to start right away or be the same every year. Deal sponsors often list a target average cash yield, with average being the keyword. For example, one deal currently listed on a major platform is targeting a 13.9% average cash yield over an expected five-year holding period, but this ranges from a target of 6.8% in the first year to 18.5% in the fifth year. If you're looking for a minimum level of income from your investment, you need to know how much the sponsor plans to distribute each year.
- Equity multiple: While IRR is a great metric for breaking down your returns on an annualized basis, equity multiple is a metric that tells you the total return (or expected return) of an investment. For example, if you invest $25,000 and achieve an equity multiple of 2.0x over five years, that means the cumulative money that's been distributed to you over the entire holding period would be $50,000.
- Target holding period: Most crowdfunded deals have a planned sale, or exit, that will take place at some point in the future. The target holding period in crowdfunded real estate listings refers to the time from the initial funding to the expected closing of the sale. The keyword here is "target." There's no guarantee that the holding period will be what the deal states. It could be shorter if the market heats up and the sponsor sees an opportunity to profitably sell the property -- some crowdfunding deals have lasted for less than a year. There was one deal on the CrowdStreet platform that targeted a four-year holding period but ended up wrapping in just over a year with a juicy 66.5% IRR for investors. Conversely, if there's a recession going on or the sponsor thinks it's in investors' best interests to wait, the actual holding period could be longer than expected.
An example of calculating your crowdfunding returns
Here's a simplified example just to show how this works. Let's say you invest $50,000 into a hypothetical crowdfunding investment and the investment is held for five years. Over that time period, you receive the following cash flows:
|Year||Cash Received||Annual Cash Flow (%)|
In addition, you receive a check for $70,000 at the end of five years when the property sells. In all, you've received a total of $87,500, which translates to an equity multiple of 1.75 times your original investment. During the holding period, the deal produced an average cash yield of 7%. And using an IRR calculator shows that you achieved a 12.6% internal rate of return on your investment.
Of course, this is a simplified example -- your actual returns aren't likely to be such round, even numbers, and your holding period likely won't be an exact number of years, but you can still use the same basic method to calculate your returns.
Real-world results: What kind of returns are people actually seeing?
The crowdfunded real estate investment industry is still very young, and because of this, most deals that have been funded are still active. However, the early results are certainly promising.
Popular crowdfunding platform CrowdStreet publishes the results of all the deals realized through its site (as of July 2019, there have been 17). Here's a rundown of the numbers:
- The average IRR achieved by investors on the 17 completed investments was 23%, although there have been a few outliers.
- Four of the 17 investments generated IRR of more than 40%, although all four finished far earlier than expected.
- 10 of the 17 investments achieved an IRR of 18% or higher, and 13 of the 17 achieved an IRR of 14% or higher.
- Only one deal that has been realized through CrowdStreet so far has resulted in a loss for investors, and the deal lost about 70% of investors' money.
That last statistic highlights the increased risk involved with crowdfunded real estate, but even considering that, these results have been impressive. It's still very early and actual results are limited, but it's clear that there's money to be made in crowdfunding if you have the appetite for risk.