““I am a firm believer in the people. If given the truth, they can be depended upon to meet any [situation]. The great point is to bring them the real facts, and beer.” – Abraham Lincoln
Crowdfunding – the involvement of a broad audience in financially supporting a project – has caught on wildly in markets ranging from consumer loans, to global micro-finance, startup support and the arts. It’s now the focus of nearly a dozen crowdfund websites for real estate investing, with the primary benefit being a low dollar minimum, typically $1,000 to $10,000 to hold your very own slice of an income- and equity-generating property.
Exactly how does real estate crowdfunding work, and what are the benefits and risks? This post will give you an introduction, with future posts diving into the details including my crowdfunded deal experiences, and interviews with crowdfund CEOs, developers and legal/financial experts.
Crowdfunding has become an increasingly acceptance mode of business in a variety of markets. For consumer lending, Prosper and LendingClub allow individuals to back loans for home purchase, debt consolidation, education, etc, at interest rates of 5-15% (this is after accounting for write-downs). Google is a backer of LendingClub while the huge hedge fund Blackrock invests in Prosper. This sector was on pace to fund $2bn to $3bn in loans in 2013. Elsewhere,
- Circle Up and and Grow VC provide access to early-stage venture capital deals;
- Mosaic funds large-scale solar panel installations in return for an interest rate backed by those projects’ profits.
- Kickstarter and Indiegogo crowdfund projects ranging from new technology and business ideas, to charities and musical/artistic creations. Kickstarter has raised nearly $400m so far.
RE Crowdfund Sites
In real estate, crowdfunding websites I’ve researched include: FundRise, Patch of Land, PRIMARQ, RealCrowd, RealtyShares, and Realty Mogul, and I’ve invested through several of these so far. There are another half-dozen companies in beta or beyond.
This hyper-growth was kicked-off by the Jumpstart Our Business Startups (JOBS) Act, which in 2013 first allowed companies to promote their private securities offerings to accredited investors. Accredited investors have minimum income requirements in the six figures or minimum liquid assets of a million of more. Next, rules have been proposed for unaccredited investors to participate in crowdfunding, though with limits on invested amounts. While there’s debate over whether the law properly balances ease of access to opportunities for investors and offerers, against investor protections, so far over $2bn has been raised through this process. Read more at VentureBeat.
What are the benefits for real estate investors? To begin with,
- Far more individuals are likely to gain access to a range of RE deal opportunities, without having to know the ‘right people’.
- Returns are attractive on paper, ranging from 8-13% on a home refurbishment loan, to 12-20% internal rate of return on a commercial/rental property. This certainly beats average bond/stock returns, and compared to non-real estate crowdfund, investments are both better rewarded on average and better secured, via the property and developer guarantees.
- Minimum investments for accredited individuals are relatively low, range from $1000 to $10K on many sites.
- The crowdfund sites provide much of the due diligence, easing somewhat the need for the investor to be fully versed in real estate.
- In sum, more individuals can incorporate real estate into their financial portfolio, without having to resort to the volatility and lack of transparency in REITs.
Risks are ever-present and need to be carefully evaluated by anyone getting involved. At a high level, these include:
- The traditional risks with real estate remain: that these are ‘living’ properties, whose profits are affected by their developers, tenants, trends in the economy, issues in the neighborhood, etc. Your principal investment is by no means guaranteed and, in the end, you can only look to yourself and your lawyer for responsibility to be comfortable with the due diligence.
- Your capital is locked up in a deal from 6 months to 6 years or more. You choose the types of deals to be involved with, and all else being equal, longer lockups usually target higher return rate.
- With some crowdfund sites and deals, the site operator has a stake in the deal or facilitates distribution of interest payments. If the site were to go out of business – far from rare in the web startup world – you need to ask what happens to your investment. (In many deals, though, you strike an arrangement directly with the RE developer and have no obligations from the website itself)..
- There are multiple parties involved in a deal, much like a traditional RE syndication. While the developer usually is the sole operating member of the deal’s corporate structure, in a worst case all the parties may tangle in voting or legal proceedings.
With all these considerations and more, real estate crowdfunding can be attractive in a number of situations: allocating a modest portion of savings to real estate; gaining access to a diversified set of properties, geographically and by property type; and learning more about real estate investing while preparing to serve as prime lender on your own deals.
There will be much more to follow as we look at individual crowdfund sites and the risk-reward considerations. Meanwhile, I recommend the real estate community discussions at Bigger Pockets to get a flavor of investors’ thinking.