Real estate crowdfunding has become a very attractive way for people to invest in property without really holding any property in their name. By pooling resources together with the other investors, one could invest in large-scale projects that once required the participation of institutional investors. The practice opens exciting avenues for investors but brings a host of risks along with it. Here’s a rundown on the pros and cons to help you decide if real estate crowdfunding fits your investment portfolio.
1. What Is Real Estate Crowdfunding?
Real estate crowdfunding is when multiple investors pool small sums of money toward a real estate project. These projects could range in size from small residential, commercial projects, to large industrial property projects. The platforms that connect you with vetted real estate deals include the likes of Fundrise, RealtyMogul, and CrowdStreet.
The projects can be funded in various ways, including the following:
Equity Investments: A method whereby investors buy shares in a property or development and the return is based on how the property performs-rental income, for example, or appreciation in value.
Debt Investments: A method whereby investors loan money to a real estate developer or property owner who gives regular fixed interest payments to the investor over a fixed period of time.
2. Advantages of Real Estate Crowdfunding
Various benefits are associated with real estate crowdfunding, especially to those investors wanting to diversify their portfolios without tying up large sums of capital. The main advantages are listed below.
Reduced Barrier to Entry
Affordability of Investment: Traditional real estate investment requires a huge amount of capital to purchase a house. Crowdfunding sites can enable one to invest in as little as $500 to $1,000, thus being made affordable to a wider group of people.
Diversity Opportunity: Since you can only invest small amounts, you could diversify your investment in more projects and different geographic locations. In this case, the potential risk of a single project will be lower. High-quality deal access to large deals: Crowdfunding platforms also include institutional-level investments for high-value commercial and residential properties that are beyond the reach of any individual investor.
Curated Deals: Many platforms have already screened and vetted real estate projects before offering them to investors, reducing the burden of due diligence required from an investor.
High Return Potential
Attractive Yield: Real estate crowdfunding can be very lucrative with equity investments, especially in areas with a high demand for housing. High yields come from rental income, property appreciation, and dividends coming from equity shares.
Passive Income: Most crowdfunding investments in real estate entail regular income in the form of interest payments or dividends, especially debt deals, and thus keep cash flow fairly passive.
Less Headache with Investing
No Property Management Required: Unlike traditional real estate investment, wherein landlords must put up with all the headaches of taking care of troublesome tenants, doing repairs, and general maintenance, real estate crowdfunding does not need any hands-on management. Investors simply put in the capital and take in their share of returns.
Professional Oversight: Crowdfunding usually occurs with a development or operating partner experienced in the line of real estate being offered. This third-party expert will manage the project on behalf of the investors. Portfolio Diversification
Low Correlation with Stocks and Bonds: Real estate generally does not keep pace with stock market ups and downs. This is, in fact, the best avenue of diversification for your investment portfolio. Crowdfunding allows you to get into real estate at a low level of commitment compared to direct ownership.
3. Cons of Real Estate Crowdfunding
As you can see, benefits abound, yet there are downsides to real estate crowdfunding. Each one is important to consider before you embark.
Illiquidity
Long-term investment: Real estate crowdfunding is normally a long-term deal. It takes a number of years before the property would have been developed, or sold, or rented out. Investors may not be able to get their capital until the project is completed.
No Secondary Market: There is rarely a secondary market to sell shares in a real estate crowdfunding deal, unless the deal involves stocks or mutual funds. You are generally locked in for the term when you put in your money.
Platform and Project Risks
Platform Dependence: Real estate crowdfunding platforms are still relatively new; their success is not assured in the long term. If a platform were to go bust or get into financial problem, this could affect an investment you made through it.
Project Risks: Not every real estate project will be successful, so there is always the possibility that a property underperforms, the market fluctuates, or any similar scenario, leading to returns lower than one had hoped for or even the loss of capital.
Fees and Costs
High Fees: Crowdfunding platforms normally come in with a variety of fees, such as management, asset management, and profit sharing. All these could eat into your overall returns and consequently decrease profitability.
Hidden Costs: Other platforms may contain added administrative or performance fees that surprise investors if you are not reading between the lines.
Lack of Investment Control
Passive Role: In investing in the crowdfunding of a project, you really have little or no control or say in how a project is managed or developed. The implication here is that lack of control places you fully at the mercy of the platform and the real estate developer for the success of the project.
Underperformance: In case of poor project management by a developer or other external factors, such as market shrinkage, influencing the value of the house, there is very little investors can do to minimize their losses or even alter the course of the project.
Regulation and Rule of Law
Unregulated Markets: Real estate crowdfunding is a recent form of investment. In some countries, regulations have barely been put in place. This may result in scams, projects that are not pre-screened, and provision of misleading information to investors.
Complex legal structure: In nature, real estate crowdfunding may involve very complex legal structures, depending on the type of investment, which an individual investor may find difficult to fully comprehend without professional advice.
Economic Sensitivity
Market Cycles: Real estate investment is highly sensitive to economic conditions. A slump in the housing market can take a nosedive and plunge your investment into oblivion. Even apparently lucrative projects are likely to run into unexpected snags during economic recession, high-interest rates, and reduced consumer demand.
Interest Rate Risks: Generally, a rise in interest rates has a negative impact on the real estate industry, especially for debt-based crowdfunding. Since it means higher borrowing costs, developers may struggle to obtain loans, or increased mortgage rates may lower demand for properties.
4. Things to Consider Before Investing
After weighing the pros and cons, there are a number of factors one must consider before investing in real estate crowdfunding.
Your financial goals: Determine whether real estate crowdfunding aligns with your overall financial goals, such as long-term growth, passive income, or diversification.
Platform Credibility: Learn about the history of the platform, its reputation in the market, and any additional hidden fees towards investments.
Project Due Diligence: Evaluate the specific property or development in which you will be investing. Consider project location, experience of the developer, and potential risk.
Risk Tolerance: Understand that with attractive returns, there may come a lot of risk in the real estate market. Your risk tolerance will have to be commensurate with a scope of gains and losses.
