With the rise of popular crowdfunding platforms, it has never been easier to diversify your portfolio by investing in real estate. Real estate crowdfunding has really drawn a lot of attention from investors looking for alternatives to equity investments. In many ways, real estate crowdfunding works like other investment vehicles where investors pool funds together collectively to purchase an asset. Because traditional real estate investing can often have a higher barrier to entry, real estate crowdfunding platforms can be lucrative alternatives because they address critical deficiencies of individual investors (i.e., low credit score, lack of reserves, etc.).
Similarly, some investors favor certain real estate crowdfunding investments because they get to invest in real estate without the hassle of going through the entire mortgage loan approval process or managing the subject property directly.
But while there may be several benefits to crowdfunding in real estate, there are also some slight drawbacks. If you consider investing in real estate through crowdfunding, here are a couple of things you should be aware of before you commit to anything.
How Does Real Estate Crowdfunding Work?
Much like a hedge fund pools funds from multiple investors to be used towards achieving higher returns on investment, real estate crowdfunding also pools funds from individual investors to invest specifically in real estate.
The appeal is that it allows average investors access to real estate markets that they may not have access to or the ability to invest in on their own. In fact, the yields can often be higher depending on the underlying investment and how the platform is built.
It also empowers average investors by breaking the traditional barriers to entry by allowing investors to invest at a much lower price point. For example, some platforms, such as Fundrise, may let you start investing with an initial investment as low as $500.
Real Estate Crowdfunding vs. REITs
While real estate crowdfunding may in a lot of ways seem similar to REITs or other matching real estate investment funds, the truth is that there are some distinct differences?
For starters, REITs, or real estate investment trusts, are companies that own and operate income-producing real estate assets of any kind. According to the U.S. Securities and Exchange Commission (SEC), REITs can retain a variety of real estate holdings which could include industrial buildings, healthcare facilities, or even residential housing.
Furthermore, these companies do not create new developments to resell them. Instead, the trust’s goal is to purchase or develop properties and retain them as income-producing assets (usually leasing them out to businesses or individuals).
REITs are commonly publicly traded on the stock exchange, although some are privately owned. If they are publicly traded, you can purchase shares like you would other similar equity investments. However, one of the main reasons you may choose real estate crowdfunding over publicly-traded REITs is that it can offer you access to private markets with higher returns.
Yet, the most significant difference between real estate crowdfunding and REITs boils down to how everything is structured and funds genuinely flow. Real estate crowdfunding takes pooled funds and invests directly into the underlying asset (in this case, real property).
On the other hand, when you invest in a REIT, you invest in a separate legal entity (in this case, trust or corporation), which then turns around and invests in real estate on your behalf.
A downside to investing in REITs compared to real estate crowdfunding is that REITs can invest up to 25% of their investments in assets outside of real estate3. That means if you want your money to stay strictly in real estate-related assets and only real estate-related assets, real estate crowdfunding may be a better option.
Advantages to Real Estate Crowdfunding
Outside the potential for higher leverage and higher returns, there are numerous other benefits to be had by investing through real estate crowdfunding. 1. Diversification Any good investor understands the value of a diversified portfolio. Real estate crowdfunding provides an alternative investment option that allows average investors to diversify through real estate assets. Keep in mind you still may have to pay taxes on dividends you receive like other investments.
2. Transparency and Control You might find it most alluring about real estate crowdfunding because you have more transparency and control over what your money is going towards and how it is allocated. Similarly, most platforms lean into digitizing the investing process, prioritizing streamlined user experiences and a simplified toolset.
3. Minimal Initial Investment Most real estate crowdfunding platforms offer a lower initial investment for those looking to start a new portfolio. For a few hundred dollars, you can create an account and start investing right away. Privately held REITs offer investors access to private markets but often require larger upfront investments. You also sacrifice some control over how your money is invested, narrowly speaking.
4. Disadvantages to Real Estate Crowdfunding Compared to other real estate investment options, real estate crowdfunding can be pretty lucrative. However, it also carries with it a fair share of risks and drawbacks.
5. Advisory Fees Like other proprietary investment platforms, using a real estate crowdfunding platform isn’t totally free. Depending on which platform you decide to patronize, you may have to pay an annual fee, usually expressed as a percentage of your managed assets. Typically, platforms charge between 1%-2.5% or higher. Make sure you understand the entire fee structure before investing and how it will impact your return on investment.
6. Lack of Liquidity Liquid assets are often referred to as cash or investments that can be easily converted into cash. Most equity investments, short-term bonds, and even publicly traded REITs are considered liquid assets. However, most investments offered through real estate crowdfunding have a longer time horizon and are less liquid than other investment options. If you think you may want to use your cash or sell your assets in the near future, real estate crowdfunding might not be the right investment option for you.
7. Newer Technology Although some popular real estate crowdfunding platforms have been around for nearly half a decade, the majority remain new. Up until the recent COVID-19 pandemic, none of these companies have ever experienced a significant economic downturn either. Due to the short track record of these platforms, it's understandable to have some reservations about this type of investing. Furthermore, crowdfunded real estate platforms are not required to register with the SEC. Make sure you are comfortable with the enhanced risk and speculation associated with this type of investing before you start investing.
Sources
1 Fundrise. (n.d.). What is the minimum initial investment? Retrieved July 15, 2021, from
https://fundrise.com/help/articles/360029618912-What-is-the-minimum-initial-investment
2 U.S. Securities and Exchange Commission. (n.d.). Real Estate Investment Trusts (REITs). Retrieved July 15, 2021, from
https://www.investor.gov/introduction-investing/investing-basics/investment-products/real-estate-investment-trusts-reits
3 Financial Samurai. (2021, January 23). Invest In Real Estate Crowdfunding Or REITs? Retrieved July 15, 2021, from
https://www.financialsamurai.com/why-invest-in-real-estate-crowdfunding-over-reits/
4 Benson, A. (2021, May 25). Real Estate Crowdfunding: What to Consider. Retrieved July 15, 2021, from
https://www.nerdwallet.com/article/investing/real-estate-crowdfunding-worth