The Basics of Real Estate Crowdfunding

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How is crowdfunding beneficial? Can you apply it to your everyday business operations? Crowdfunding is a new way of gathering large amounts of money by calling to action a wide group of investors. By investing as little or as much as they wish, the investors can benefit from the same features that stock and other market investors benefit from.

Just the Nuggets

  • Crowdfunding has found its way into the art of real estate. It has proven itself as equally beneficial for both large real estate developers and smaller investors. But just like any other endeavor, there are also downsides to it.
  • The JOBS Act from 2012 is a result of crowdfunding and has also introduced peer-to-peer lending (P2P)—today’s number one method of crowdfunding.
  • The process of becoming an investor through crowdfunding is aimed to make you and your funds safe. It includes steps such as research, becoming a shareholder, watching out for limits, and risk management.
  • The types of real estate crowdfunding are debt investments, preferred equity investments, and common equity investments. What’s best for you among these three depends on your goal, time, and money to be invested.

What is Crowdfunding?

In its core, crowdfunding is an innovative and efficient way for companies to raise capital by utilizing the advantages of modern-day business ventures. Particularly by using social media platforms such as Facebook, Twitter, and LinkedIn, the companies are able to reach a whole new group of clients and investors. As a result, this method has become one of the key elements of successful business plans across the financial sector.

Developers of larger properties can use real estate crowdfunding to get their hands on capital by engaging with a huge group of investors who are willing to put their funds toward good use. On the other hand, more modest developers can take advantage of their social media presence to generate a whole new source of funding for their real estate endeavors.

Crowdfunding Through History

Since this type of acquiring profit was first introduced, it was mostly used by wealthy investors who are more easily adaptable to the many changes in the market. 

According to iFunding, New York’s top spot for crowdfunding, the revenue for this market accounts for around $11 trillion. This is just another example of how beneficial crowdfunding is for many different parts of the business structure, and the investors are looking to it more and more to achieve their goals.

As for the US market, the regulators have made significant efforts over the years to make this type of fund-gathering more accessible and in accordance with the market standards. As a result, we have the JOBS Act today. This acronym stands for Jumpstart Our Business Startups, and it is related to the US Government Act from 2012. This Act was introduced by the former US President Barack Obama, and it represents a revolution in the world of real estate crowdfunding.

JOBS Act is focused on encouraging the funding of smaller businesses, which is the first effort towards inclusivity in the US market. The bases of this Act are eased security regulations and the newly established balance between average and wealthy investors. 

The Act was later enhanced by receiving the title equity crowdfunding, which is applicable to many sectors of businesses including real estate. This Act is one of the most beneficial solutions to the world’s economy since the 2008 global financial crisis.

Crowdfunding vs. Peer-to-Peer Lending

JOBS Act includes two of the biggest groups influencing the real estate sector today. One is the above-mentioned wealthy investors, while the other is different types of investment markets. 

Lending and gathering funds across multiple markets can be tricky since it takes into consideration a lot of different factors, trends, and patterns. As a result, this Act has introduced peer-to-peer lending (P2P)

As the name suggests, P2P is a new and efficient way of lending funds between individuals by cutting out the middlemen—in this case, the many financial institutions you can come across while investing. P2P was introduced back in 2005 and is only recently becoming the number one method of crowdfunding.

How is Real Estate Crowdfunding Different?

Real estate crowdfunding is peaking as a result of the immense presence of social media platforms in our everyday lives, not to mention businesses. Crowdfunding has a unique ability to generate and engage with a whole new group of potential investors—from individuals to well-established companies. As a result, real estate crowdfunding has taken a crucial position in the business structure as an innovative way of acquiring capital.

The real estate groups are using crowdfunding to learn about different types of investors that could significantly contribute to their business goals. This does not only include big investment firms or high-rollers. Rather, crowdfunding is a way to reach your peers, relatives, and friends with whom you share connections on social media. Here, you can use crowdfunding to introduce them to your business venture, and therefore engage them in something they would find suitable and useful for their own personal experience.

Crowdfunding started as a beneficial solution for big investors. However, it is evident that the real estate investment landscape is changing towards welcomeness and inclusivity for all types of investors out there. Today, as a result, we have access to a unique and efficient way of acquiring money and contributing to the business goal we are a part of.

Advantages of Real Estate Crowdfunding

There are many great things we could list about real estate crowdfunding. 

1. Accessibility

This doesn’t just mean access to the funds. This type of gathering funds also makes it easier to keep up with the latest trends in the world of finance. Not to mention the efficiency, too, since you can access all the relevant platforms, sign legal documents, and finish other documentation online and completely safe.

2. Marketing skills into good use

Another big advantage is the marketing dimension. While you go through your crowdfunding plan, you are also using those same tools to market your business and its benefits. What makes you stand out from the crowd? The crowdfunding world serves as a show-and-tell solution for this, as well.

3. Good news travel fast

First impression counts, right? The same goes for real estate crowdfunding. As you polish your image to attract more investors through crowdfunding, you are also presenting to the world your business goals in their full glory. This way, you can get some extra points from the investors that will then serve as a helpful guide for the clients. This is a lesser-known but quite important advantage of real estate crowdfunding. It has proven itself as a great way to establish and keep a clean reputation on the business market which can never hurt.

4. Time and money are key

Taking a shortcut now and then is a helpful way to get you where you need to go. In addition, it is also a beneficial trait to show your future clients. In other words, anything your competitors can do, you can do better. And by better, we mean in less time and with fewer costs. Crowdfunding helps you do exactly that, by allowing you to utilize the many advantages of social media platforms and their accessibility to a greater selection of potential investors.

5. Building from the ground up

Real estate crowdfunding is the area of business that can provide you access to solutions that are especially useful and important for developing companies. With the combination of lower costs and broader reach online, real estate companies are taking advantage of this benefit today more than ever before.

What About the Downsides?

In every business, there are downsides and traits that could derail you from the path of success. The same goes for real estate crowdfunding but the good thing here is, we can easily detect and name them. That way, you can try and manage your game plan in order to avoid downsides affecting your investment portfolio.

1. Absence of liquidity

The real estate investment market works a bit differently from other financial markets. One of the best examples for that is the clear absence of substantial liquidity during investing. Here, there is no secondary market the entire network of investments could fall onto in case of any trouble. This is one of the most relevant features of the real estate crowdfunding you should keep in mind.

2. Unguaranteed return on investment

With everything in real estate, things take time. This is especially applicable to your return on investment (ROI). It’s simple—when you decide on investing in real estate, you can never predict if the investment will be profitable or not. In addition, the ROI usually takes around five to seven years, which requires quite a lot of patience and dedication. On the other hand, that also implies a great amount of long-term profit you can acquire through real estate crowdfunding.

3. Uncertainty

One of the most important things that come to mind is the uncertainty of the outcome. After all, there is only so much you can do to present yourself on the market and attract clients, right? The same goes for the investors—you can never fully be aware of the image of the company and how reliable it would be to invest in it. It’s just the way things go with investing, the same as any other business sector.

The Process

If you wish to indulge in real estate crowdfunding, you’ll be pleased to learn that the minimum amount for investors to get into the game is only $1,000. This is a great advantage for both companies and investors. You can join in on the action by investing a relatively small amount of money. After that, a whole new window of opportunity will be opening for you in the investment sector. On the one hand, if you are a company looking to acquire additional profits for your business, can you imagine how many investors are willing to contribute with at least $1K?

1. Do your research

From the investors’ perspective, crowdfunding requires you to do your research and get acquainted with the latest trends. Also, you should keep updated with the news about the real estate company you’re looking to contribute to—that is a given. Unfortunately, there are a lot of companies out there who are unreliable and just want to scam their investors before they disappear from the radar completely. This is why it is important to keep your eyes open and look out for the red flags about the company’s practices. 

Furthermore, the process of crowdfunding has made it easier for you to keep up with this area, as well. Namely, the well-established crowdfunding platforms have curated lists of reputable real estate companies currently holding top-spots on the market. These lists are also regularly updated, so you don’t have to worry about missing out on anything.

2. Become a real estate shareholder

A way to do this is to acquire a property. As a result, you’ll have many abilities and advantages at your disposal. The best part of this type of funding is the fact that you don’t even need to buy the entire property. Rather, you can earn profits from any portion of the real estate investment over time, depending on the revenue, rental income, and other factors attached to the real estate and its success.

3. Watch out for the investing limits

The Security Exchange Commission (SEC) proposes several limitations in the world of crowdfunding, and you should keep them in mind if you are a non-accredited investor. These are standards for any type of investment and are set around the symbolic amount of $107,000.

For example, if your annual income is less than $107,000, you can invest up to 5% of your income at any time during the 12-month investment period. Similarly, in case your annual income is above $107,000, you can invest up to 10% of the net worth. This way, the SEC makes sure that the investors are taken care of within the regulatory frame of this activity.

4. Transparency and risk management

In any area of investing, transparency is a crucial trait that can help you distinguish the relevant and trustworthy names from the ones you should steer clear of. The majority of reputable platforms today do not permit any suspicious companies to approach them, so this is a good sign for you as an investor. Furthermore, transparency is a crucial part of the art of risk management which can be quite challenging at times.

Risk management is an important dimension of your investing process that can help you make a smart decision for the long haul. In other words, you should always know where your investment is going and what is it used for, right? The company’s transparency is quite evident here and can help you learn to notice a clear distinction between reliable and unreliable names. This is definitely one of the most important traits you should look out for during your research!

Types of Real Estate Crowdfunding

In the world of finance, there is a status quo about three types of real estate crowdfunding investments, and each one comes with a specific set of upsides and tricky parts you should pay attention to.

Debt Investments

Debt investments are based on collateral that comes with the property you’re willing to take a chance with. In other words, your investment is secured by the same property you’re investing in, and the risk here is generally quite low. The return potential is fixed and based on interest-rate payments, so there isn’t a lot of room for variables of unexpected turns of events. 

The shortest waiting period for payouts is with this type of investment, so debt investors are the first ones to get paid. This period can vary from six to 24 months, while the other types typically have to wait much longer. The payments are also divided equally between months or quarters.

On the other hand, fees are a lot higher here than with equity investments. In addition, the clear absence of tax benefits of any kind is usually the reason why investors look further for their portfolio.

Preferred Equity Investments

Preferred equity investments are a bit riskier due to the fact that you’re investing through the equity attached to the company owning the property. The return potential is fixed here, as well, but the fees are somewhat lower due to ordinary income rates—which can significantly affect your investment portfolio.

This type of investment comes with a unique combination of lower fees and a wider selection of investment opportunities unavailable for debt investors. Also, the return potential is much higher here.

Common Equity Investments

Lastly, common equity investments are the type of investments attached to the entity investing in the company itself. The properties can be anything from family homes and student housing to storages and hotels. However, the risk is the highest here since your return on investment depends on a variety of different factors—from mortgage to depreciation expense deductions.

The main downside with common equity investments is, you’re not first in line to get paid out in case the deal falls through. As mentioned above, the very first ones to get paid are always debt investors.

Which is Better?

As you can see, there are a lot of advantages to each one of these types of investments. The most suitable choice for you depends on the goal you want to achieve and how much money and time you’re willing to invest. Do you appreciate the safety and quick access to your funds? Then debt investments may be the perfect choice for you. Meanwhile, if you wish to take advantage of the extra benefits and are not afraid of the risk, you should go for common or preferred equity investments.

Closing Notes

In the unpredictable world of finance, real estate crowdfunding is emerging as the newest solution for both businesses and investors. It brings a whole new dimension into the world of financial markets, especially when it comes to new investors who are looking to get in on the action. Real estate crowdfunding is inclusive and welcoming, but at the same time, competitive and with great potential on the return on investment. Though there are some downsides to it, too, real estate crowdfunding is definitely the next big thing to watch out for in the rich financial landscape.

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