To invest in real estate, you can do it the old-fashioned way, buying a property with a loan or cash, then collecting rent or fixing it up to sell. Or you could invest in a real estate investment trust, a kind of fund that buys residential, commercial or industrial properties.
Or you could do it the 21st century way, with a real estate crowdfunding company, which pools investors’ funds to make loans to home flippers or to buy residential and commercial properties. Interest and rent earned on those deals is passed back to those who supplied the money.
It’s an alternative to lending directly to an individual or small firm, with the crowdfunding site doing most of the work, checking out the borrower and judging the loan’s risk – and chasing the borrower for payments if necessary. And it’s different from a REIT, where decisions are left to the fund manager. With crowdfunding you decide which properties or loans should go into your portfolio.
Industry insiders say investors can expect annual returns of 8 to 12 percent, but critics warn of high risks as some firms may cut corners in their scramble for market share.
One of the industry’s big names, RealtyShares, currently offers a number of opportunities with handsome projected returns if all goes as planned, such as 9.5 percent on a Church’s Chicken restaurant in Huntsville, Alabama, 11 percent on a single-family home in Jacksonville, Florida, and 14 percent on a home being built in Los Altos Hills, California.
Other prominent platforms include LendingHome and PeerStreet.
The crowdfunding industry started to mushroom after the 2013 federal JOBS act relaxed regulations, and with new rules issued by the Securities and Exchange Commission about a year ago. Investors typically can get in with just a few thousand dollars.
Investments generally fall into two broad categories: equity investments which own properties and pass to investors the rental income and capital gains from sales; debt investments which lend to property owners and pass on borrowers’ interest payments.
Most platforms have been limited to “accredited investors” – people with at least $1 million in liquid assets or annual income of at least $200,000. But rules are changing fast, so stay tuned if you don’t qualify now. Realty Mogul and Fundrise allow non-accredited investors.
“Some platforms allow non-accredited investors to participate in real estate investing for as little as a hundred dollars,” says Richard Swart, chief strategy officer for NextGen Crowdfunding, an information site for investors.
“For a retail investor, the opportunity to own an income stream through ownership of a portfolio of properties has never been available before,” Swart says. “However, equity transactions into large commercial real estate require that investors be patient. The fix and flip financing models offer high rates of return, but also higher risk as their returns depend on the ability of the developer to profitably rehabilitate a property.”
Though the doors are open, not everyone should walk through, Swart adds. “Real estate has been a stable asset class, but should only be a portion of a well-diversified portfolio,” he says. “If investors aren’t actively diversifying, they aren’t ready to invest in alternative assets.”
Investors in equity projects should plan to commit for three to five years, Swart says, though debt investments may pay off much sooner.
Since this is a new industry, platforms don’t have long track records, and some may skimp on due diligence in their eagerness to grow, some experts warn.
“Crowdfunding as a whole is really in its infancy, and doubly so for real estate crowdfunding. At this stage, the crowdfunders are not necessarily looking at what is in investors’ best interests,” says Adham Sbeih, the CEO of Socotra Capital, a lending and investment firm that finances residential and commercial real estate purchases.
“This may sound a little cynical, but we live in an era where the goal isn’t to create a lasting product. Instead, they are looking to create a platform that quickly takes the industry lead. There is a huge push to get the most transactions completed as possible, take up the largest market share, so that these platforms can then be sold off for billions.”
Investors are wise to investigate how much due diligence the platform performs, says Dan Mulcahy, director of equity at Northstar Commercial Partners, a commercial real estate investment firm in Denver.
“It is also important to distinguish whether the site is an Amazon.com (ticker: AMZN) of real estate, wherein anyone who pays a fee can list their opportunities and no material due diligence has been conducted, or a website that is operated by broker-dealer or sponsors themselves,” he says.
A licensed brokerage is likely to have done meaningful due diligence, and a sponsor to have its own money at risk, he says.
Experts say investors should proceed with caution:
Know the rules. Most experts urge investors to consider real estate crowdfunding to be a long-term investment, since real estate holdings and debt are not as liquid as stocks, bonds or mutual funds. Equity real estate investments are considered long-term holdings, while debt investments may produce returns more quickly, but pay less in the long run.
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