Crowdfunding is a relatively new way to invest in real estate. While crowdfunding certainly has the potential to deliver some pretty impressive returns, there’s a lot that investors should know before getting started.
With that in mind, here are eight basic concepts investors should know before they start shopping around for crowdfunded real estate deals.
1. There are three parties involved in a crowdfunding real estate deal
To make a crowdfunding real estate deal come together, there are three main parties:
- Sponsor: This is the individual or company that plans and executes the investment opportunity. The deal sponsor will negotiate the purchase of the property, hire contractors, supervise the progress, and eventually sell the property. The sponsor is also responsible for distributing income and profits to investors.
- Crowdfunding platform: A crowdfunding platform acts as the middleman between sponsors and investors. The platform will vet prospective deals, advertise them to investors, and deal with regulatory requirements.
- Investor: A deal’s sponsor generally contributes some of the capital required to complete the investment opportunity and seeks outside investors to provide the rest.
2. Crowdfunded real estate deals usually have a targeted time frame
You’ll typically see some sort of an investment time frame when it comes to crowdfunded real estate investment opportunities. For example, you might see a three-year targeted hold period.
In most cases, there’s some sort of exit strategy involved with crowdfunded real estate deals. For example, a deal sponsor might plan to acquire an office building, add some amenities, rent the vacant units, and then sell the property at a profit three years later.
3. Within that time frame, investments are highly illiquid
A liquid investment is one that you can readily sell, and for its full market value. For example, you can sell your shares in a real estate investment trust, or REIT, anytime you want with a click of the mouse. And you’ll sell it for the full market value of the stock.
Crowdfunded real estate investments are perhaps the most illiquid way to invest in real estate. You’re generally locked in for the entire duration of the investment. Plus, there’s no guarantee that the deal will be exited within the targeted time frame. For example, if you invest in a crowdfunded real estate deal with a five-year target time frame and there happens to be a recession going on in five years, the deal sponsor might decide to wait to sell.
For this reason, it’s generally not a good idea to invest in crowdfunded real estate with any money you’ll need within the targeted time frame plus a couple of years.
4. Crowdfunded real estate deals have a target investor return
You’ll also notice that each crowdfunding deal lists a target internal rate of return, or IRR, for investors. The mathematics of IRR aren’t terribly important for investors to understand, but what is important to know is that IRR is an annualized return metric that combines any income investors are expected to receive from the deal, as well as the profits when the property is ultimately sold.
It’s also important to keep in mind that the IRR target is just an estimate -- the investment’s actual return is likely to be somewhat higher or lower than the projected amount.
5. There is a lot of money to be made in successful crowdfunding deals
The main reason to invest in crowdfunded real estate deals, despite the lack of liquidity, is for superior return potential when compared with other types of real estate investments.
Since crowdfunding is a relatively new way to invest in real estate and most deals have a multi-year target holding period, there is little data available about their success rates. However, the data that does exist is promising. For instance, there have been 17 deals with realized investor returns completed on the CrowdStreet platform as of August 2019:
- 14 (82%) have produced IRRs of more than 14% annualized.
- 10 (59%) have produced IRRs greater than 18%.
- Six (35%) have produced IRRs greater than 22%.
- Only one has produced a negative return for investors.
6. However, there is also an elevated level of risk
Generally speaking, higher reward potential means higher risk, and that’s certainly the case when it comes to real estate crowdfunding.
There are two main reasons crowdfunded real estate investing is riskier than, say, real estate investment trusts:
First, most crowdfunding deals are backed by a single asset, such as one hotel or one office building. In contrast, REITs generally own hundreds of properties, which spreads investors’ risk out.
Second, crowdfunding deals typically include some sort of value-adding strategy, such as a renovation. This creates an element of execution risk, especially when combined with the single-asset nature of these opportunities. In other words, if your crowdfunding deal aims to acquire and renovate a hotel, and the renovations take a year longer than planned or end up costing more than expected, it can be devastating to the investment’s returns.
Having said that, it’s important to point out that there’s a wide range when it comes to risk. For example, a crowdfunding deal that aims to acquire a hotel and complete a full-scale renovation is inherently riskier than one that aims to acquire a fully occupied shopping center and just plans to add value by making relatively minor upgrades.
7. Crowdfunded real estate deals can provide you with income, but …
Unlike some other types of real estate investments like REITs and residential investment properties, crowdfunded real estate opportunities are not always the best choices for income-seeking investors.
Most crowdfunded opportunities have some type of targeted income for investors, but there are a few things to know. First, the income might not start right away. Many crowdfunding deals are designed to acquire a property and renovate it, which can mean a few years before the property generates enough income to pay out. Second, income from a crowdfunded real estate investment can be unpredictable.
8. You probably need to be an accredited investor to take advantage
There are some crowdfunded real estate investment opportunities that welcome all investors, but these are the exception, not the rule. And many of them are fund-type investments as opposed to single crowdfunding deals.
For the most part, if you want to participate in a crowdfunded real estate investment, you’ll need to be an accredited investor. There are two ways you can qualify:
- You have at least $1 million in net assets, excluding the value of your primary home.
- You have at least $200,000 in annual income (or $300,000 combined with a spouse) for each of the previous two years, and an expectation of the same this year.
It’s important to know what you’re getting into
Crowdfunded real estate investing is a relatively new concept, and like any high-risk, high-reward investment opportunity, it’s important to understand exactly what you’re getting into. Knowing these eight concepts is a good start, but also be sure to check out our crowdfunded real estate homepage to learn even more before you make your first investment.