Real estate crowdfunding is a new way to invest in commercial properties. It allows everyday investors to put their money to work in ways that have been the domain of the wealthy. Specifically, that's single-asset commercial real estate. Few people could invest in a high-rise apartment community before crowdfunding came along.
Crowdfunded real estate deals have the potential for excellent returns, but there’s a lot you should know before considering them for your portfolio.
Here’s a brief overview of what real estate crowdfunding is and the pros and cons to be aware of.
What is real estate crowdfunding?
Real estate crowdfunding lets individual investors invest in single-asset commercial real estate deals. Here's the quick version:
A developer or real estate company (the deal sponsor) presents a commercial real estate opportunity. Investors contribute money to the project in exchange for a proportional share of some of the returns.
For example, a deal sponsor may aim to buy a run-down apartment complex and renovate it over the course of the next few years. The goal is to raise rental income and the property’s value and eventually sell it. Or a sponsor may identify an office property with a high vacancy rate and buy it, aiming to lease the empty space.
These are simplified examples. But they're the types of deals you can invest in through real estate crowdfunding. Mid-market commercial properties have delivered high returns. But, like any investment, putting your money into crowdfunded real estate deals has its pros and cons.
Advantages of investing in crowdfunded real estate deals
There are several benefits to investing in real estate through crowdfunding:
Crowdfunded real estate deals let you invest in properties that you otherwise wouldn’t be able to access. For example, not too many people could go out and buy a 500-room hotel. But real estate crowdfunding lets you put your money to work in this way. You can find crowdfunding deals that let you put relatively small amounts of capital to work. In general, that means $25,000 or less per deal.
Unlike real estate investment trusts, or REITs, crowdfunded real estate deals let you invest in a specific property. Because of the single-property nature, sponsors are able to focus all their expertise on the deal.
Real estate has a long track record of making people wealthy. In fact, nine out of 10 millionaires primarily created their wealth through real estate.
Crowdfunded real estate deals have high profit potential. Many crowdfunded deals achieve annualized returns of 15% or more. It’s not uncommon for investors to double their investment in five years or less in a successful crowdfunding deal.
These deals have high return potential, but many also offer a combination of steady income and equity appreciation. Imagine that you participate in a crowdfunded deal to buy an apartment community. You'll get a share of the rental income as well as a nice profit when the deal sponsor sells the property.
Crowdfunded real estate deals let you add diversification to your portfolio. Real estate (particularly commercial real estate) is not heavily correlated to the stock market. So it's a good way to diversify while still focusing on assets with high return potential.
Crowdfunding is a great way to invest in individual properties without the headaches that come with them. For example, if you buy a duplex to rent out, you’ll need to deal with maintenance issues, tenant problems, and more. With a crowdfunded real estate deal, you write a check to the deal sponsor and they do the rest.
Drawbacks of crowdfunded real estate
There’s no such thing as a perfect investment, and real estate crowdfunding isn’t a good fit for everyone. Here are some of the potential drawbacks to consider before investing in your first deal.
The first thing to know is that crowdfunded real estate deals can be much riskier than other types of equity investments. Most crowdfunded real estate deals are backed by a single asset, and there’s a fair amount of execution risk involved in most strategies. Let's say a developer plans to renovate an apartment building and increase rents. An economic downturn or oversupply problem in the market could cause returns to drop.
Perhaps the biggest drawback of crowdfunded real estate deals is that they aren’t liquid investments. They cannot be readily sold if you need the money. Most crowdfunded real estate deals have target investment periods of at least three years. Five-to-seven-year expected holding periods are common.
It can be a long time before investors see any income from their crowdfunded real estate investments. Imagine a deal to renovate an outdated hotel. Distributions may not start until renovations are complete and the property makes a profit. On the other hand, you can invest in a real estate investment trust (REIT) or a tenant-occupied investment property and see cash flow right away.
While the JOBS Act opened up private equity investment to everyday investors, most crowdfunded real estate deals are still restricted to accredited investors. That typically means you need to have at least $1 million in assets or $200,000 in annual income ($300,000 with a spouse) to access most deals. You can find crowdfunded real estate deals that welcome non-accredited investors, but you’ll be rather limited.
Is real estate crowdfunding right for you?
There’s no perfect answer to this question. Crowdfunded real estate is a high-risk, illiquid type of investment. Do you have a low risk tolerance? Do you need the ability to cash out of your investment whenever you want? Investing in crowdfunded real estate deals is probably not the best idea for you.
But if you're willing to take on a bit more risk for superior returns and are comfortable having your money tied up for several years, crowdfunded real estate deals could be a smart addition to your portfolio.
Like any other type of investment, commercial real estate crowdfunding has pros and cons. Be sure to take them into consideration before investing.
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