Crowdfunding is a relatively new concept in real estate investing, which allows investors to pool their money to take advantage of commercial real estate (CRE) investment opportunities. For example, a group of investors may contribute a combined $5 million in order to acquire and renovate an apartment community.
CRE crowdfunding is particularly innovative because it allows investors to access types of investment opportunities that have historically been out of reach. Few people reading this could afford to buy a 500-room hotel and renovate it to add value. Sure, you could buy a real estate investment trust (REIT), that focuses on your desired property type, but this would spread your money out over many properties, and would be more focused on income generation. Whereas crowdfunded real estate offers you opportunities to invest in single-property, value-adding investments that in the past were only available to wealthy real estate developers.
There are some great reasons to consider crowdfunded real estate for your portfolio, and in a lot of cases the risk-reward profile of these investments can be very attractive. However, like any type of investment that can produce high returns, crowdfunded real estate has its drawbacks as well.
How does real estate crowdfunding work?
Crowdfunded real estate investments typically have a targeted timeframe, as well as a targeted income level for investors. For example, a deal may set out to buy an office building, make improvements, and sell it five years later, while paying investors a 5% yield in the meantime.
The big difference between a crowdfunded CRE investment and a REIT is that most CRE deals are focused on a single property with a value-adding plan. On the other hand, REITs are generally more income-focused, and spread your money over hundreds or even thousands of properties.
There are three parties involved in a crowdfunding deal:
The experienced real estate developer or investor: This is the person who will identify the investment opportunity. For example, they may find an apartment complex that needs $2 million in renovations and will be worth $5 million more when complete. This person (or company), known as the deal’s “sponsor,” will negotiate the purchase, hire contractors, and oversee the project, before selling the property and distributing the profits. In exchange for doing all of the work, the sponsor gets a percentage of the successful deal’s profits.
The crowdfunding platform: The sponsor needs a way to pitch opportunities to qualified investors, and that’s where the crowdfunding platform comes in. There are several reputable companies that list deals on behalf of sponsors, essentially serving as middlemen. There are several regulatory requirements that must be met in order to market an investment opportunity, and the crowdfunding platform deals with these.
The investor: That’s where you come in. Investors find crowdfunding opportunities that meet their investment goals and risk tolerance, and agree to fund a portion of the project.
Because real estate crowdfunding is still a very young industry, and most deals are held for several years, there isn’t much performance data available yet. However, crowdfunding platform CrowdStreet publishes results, and judging by the 17 completed or “realized” deals that have originated from its platform as of July 2019, the high projections are quite realistic. Of the aforementioned 17 deals, only one produced a negative return for investors, while 12 generated internal rates of return of more than 15%, and nine delivered better returns for investors than originally projected.
Potential advantages of crowdfunded real estate investment
There are several good reasons to consider adding a crowdfunded real estate deal (or a few) to your investment strategy:
- First and foremost, there’s a lot of money to be made in CRE deals. It’s not uncommon for crowdfunded CRE deals to achieve annualized returns of 15% or more. Most CRE deals list a targeted Internal Rate of Return, or IRR, to give you an idea of the project’s potential return. For example, as I write this, one deal listed on a major crowdfunding platform intends to acquire an office building, add amenities and upgrades, and sell the property after a four-year holding period at a 15.6% IRR for investors.
- Crowdfunded CRE deals allow you to invest in assets that otherwise wouldn’t be possible. For example, you probably couldn’t afford to buy an office tower and renovate it, as investors in the deal I just mentioned did. And even if you could, would you really know how to do it right? CRE lets you effectively go along for the ride with experienced real estate developers.
- Many CRE deals offer a nice combination of steady income and growth potential. Many may not start paying investors right away (such as while renovations are going on), but there’s typically some sort of income stream involved in the plan for CRE deals. For example, the office building acquisition deal I mentioned earlier in this section is targeting a 6.9% cash yield for investors as part of its overall return.
- Crowdfunded real estate deals can help you diversify your investment portfolio beyond things like stocks, bonds, and mutual funds. Even if you already invest in real estate through rental properties, commercial real estate (especially value-adding CRE deals) are a rather different type of investment.
- Crowdfunded real estate deals allow you to invest in real estate without the hassles of property ownership. I can tell you firsthand that being a landlord isn’t for everyone, and renovating properties with the intention of selling really isn’t for everyone. With a CRE deal, you can simply write a check and let someone else worry about the day-to-day operations.
Let’s be perfectly clear. No investment that’s capable of double-digit rates of return is risk-free, or even low risk. And crowdfunded real estate is no exception. Before you invest, it’s important to consider the following risk factors:
- Single-asset investments can produce excellent returns, but you’re also putting all your eggs in one basket. In other words, if a REIT owns 100 office buildings and the renovations on one take longer than expected, it’s unlikely to significantly hurt profitability. On the other hand, if it’s a crowdfunded investment in one office building and the renovations take too long, it can have a big impact.
- On a similar note, there’s typically a great deal of execution risk. Unlike REITs, which generally acquire and hold investment properties, there’s usually some sort of major value-adding project. To be fair, this is what often gives CRE deals such high return potential, but it does make those returns dependent on the sponsor’s ability to execute the plan.
- All real estate investments are illiquid, but CRE deals are really illiquid. Most deal sponsors give a target hold period (anything from three to seven years is common), and it can be next to impossible to cash out of the investment early. Also beware that the stated holding periods aren’t binding -- for example, if a CRE deal sponsor plans to sell a property after five years and there happens to be a recession going on when the time arrives, they can decide it’s in investors’ best interest to wait.
The bottom line: A high-risk, high-reward investment that isn’t right for everyone
To sum it up, crowdfunded real estate investments can be highly lucrative, and while the industry is still in its relative infancy, the early results have been quite promising. However, it’s important to realize that even the more conservative crowdfunding investments aren’t exactly low risk, and there are several drawbacks to consider. In short, while crowdfunded real estate investing isn’t right for everybody, it can be a great fit for many investors seeking strong long-term investment returns.