GowerCrowd

The Ultimate Guide to Crowdfunding Real Estate Development

By Adam Gower Ph.D.

The Ultimate Guide to Crowdfunding Real Estate Development - COMPRESSED

For many investors, the rarefied world of real estate development is attractive and a bit daunting. Most of us have little experience in the real estate sphere outside of our home mortgages or dealings with landlords. There is also a widespread perception, right or wrong that the real estate industry is full of sharks, many of whom will do their utmost to separate a fool from their money. However, like many aspects of life and business, things are not always as they seem. A sea change in how real estate projects are financed has developed, in the form of crowdfunding real estate finance, is giving investors across the country the ability to participate in and benefit from the flourishing commercial real estate sector like never before. 

What is Real Estate Crowdfunding, and How Does It Work?

 

Real estate crowdfunding is an investment avenue that uses crowdfunding or sourcing capital from a “crowd” of investors, to raise money for investments in real estate assets like multifamily apartment buildings, retail centers, office buildings, and other types of real estate. 

Through crowdfunding, investors can deploy capital in a wide range of properties, without having to purchase or manage real estate directly themselves. They do this by investing in a real estate syndicate set up by a developer, sometimes also called a ‘sponsor’ or ‘operator,’ and it is the developer who takes on the day to day responsibilities for managing the property..

How does it work?

 

To Investors in a syndicated property receive rental income distributions from the deal sponsor on a monthly or quarterly basis, depending on the terms of the deal. As many real properties appreciate in value over time, investors are also entitled to a share of the growth in appreciation value upon the sale of the property.

Requirements to Become an Accredited Investor

 

To prevent novice investors from taking significant financial risks they may not truly understand, the US Securities and Exchange Commission (SEC), by the use of the accredited designation standard, has set up a firewall to prevent unsophisticated or investors without high enough capital resources from investing in “high risk” investments. This is primarily to ensure that investors who deploy capital in riskier investments have the financial wherewithal to weather declines in the investment and that the investor will be less likely to go bankrupt from excessive risk-taking with their portfolio.

The SEC guidelines for an accredited investor are as follows:

The investor has earned income more than $200,000 in each of the past two years, or $300,000 together with their partner- the investor must also expect to make the same amount of more in the upcoming year.

OR

The investor has a net worth of 1 million dollars or more, either as a single individual or combined with their partner. The value of one’s primary residence does not count towards this requirement.

OR

The investor is an executive officer, general partner, or director working in concert with the issuers of the offered security.

Accredited investor status is required to invest in many real estate crowdfunding platforms, but not all. Let’s take a look at some of the different types of crowdfunding options available to investors.

Need help with your marketing strategy to grow your real estate business? Check out Gower Crowd today.

Different Types of Real Estate Crowdfunding

 

As is the case with many other investment types, real estate crowdfunding deals can be divided into different subcategories, each of which offers different risk profiles, payment schedules, and return potential.

There is no “one size fits all” option, so before investing in a real estate crowdfunding deal, you must understand the differences between the three types of opportunities most common in the industry, like preferred equity, common equity, and debt crowdfunding.

Type #1: Equity Crowdfunding

 

Quick Takeaway: Equity crowdfunding investments generate regular returns via rental income from tenants, as well as appreciation gains upon sale of the subject property. Equity investors may also benefit from depreciation expense deductions.

 

Equity investing is the most common form of crowdfunded real estate deal. With this investment type, investors are shareholders in a specific property or property portfolio, with their stake in the project being proportional to the amount of capital they’ve invested in the crowdfunded property/portfolio. Returns come in the form of a regular share of rental income generated minus any expenses, fees, or other charges related to managing and running the property.

 

If the property is sold, investors may also receive a share of the appreciation value. For example, if a crowdfunded property is initially worth $100,000, but appreciates to $200,000 throughout the investment, stakeholders will be entitled to a percentage of that $100,000 increase in value, less any share of it owed to the sponsor.

Type #2: Preferred Equity Crowdfunding

 

Quick Takeaway: Preferred equity works like equity crowdfunding, with one key difference that preferred equity investors are first in line to be paid,  which is ahead of common equity investors. 

 

Through preferred equity crowdfunding, investors acquire an ownership stake in a property or property portfolio. However, the difference between equity and preferred equity crowdfunding comes down to the advantage that preferred equity has over common equity. Preferred equity entitles investors to more rights/benefits and preferential treatment in several critical aspects of a crowdfunding deal.

 

The term ‘preferred equity’ has taken on a second meaning in recent years. It can also be used as a form of debt to a project (even though it is called ‘equity’) where investors are paid an interest rate with no share of the profits, just as a regular bank loan might, but retain extensive control rights should the property fall into default on payments.

Preferential Liquidation Terms

 

Possibly the most valuable aspect of being a preferred equity investor is the preferential liquidation terms they receive. In the case of a business liquidation event, where for whatever reason the company and assets must be sold due to poor performance or mismanagement, preferred equity shareholders receive preference when the proceeds from the sale are distributed to investors.

Leaders of The Crowd

Conversations with Crowdfunding Visionaries and How Real Estate Stole the Show

Discover how laws that gave us crowdfunding were solely meant to finance small companies and yet inadvertently opened the doors to allow you to invest in real estate like never before.

Read the book and listen to the actual conversations.

Preferential Dividend Payout Terms

 

In a similar vein to liquidation terms, preferred equity holders are paid first when it comes time to pay dividends from profits from the crowdfunding deal. Once preferred equity holders are paid, the dividends to which they are entitled to will go to the common equity holders that will receive the remainder of the proceeds.

Favorable Tax Treatment

 

Real estate is considered to be among the most tax-advantaged classes of real estate for a good reason. There are several benefits offered to real estate investors by the IRS, and one that comes into play in a big way with equity crowdfunding is depreciation.

 

In most cases, investors can claim a portion of their investment on their taxes through the depreciation schedule set forth by the IRS. This holds true for both preferred equity and common equity holders, but not for debt crowdfunding holders, as they do not become “owners” of the property, but lenders to the sponsor.

 

Want to invest in online syndicated real estate deals? Gower Crowd can help you establish wealth preservation and long term growth

Type #3: Debt Crowdfunding

 

Get Paid First

 

Similar to preferred equity investors, debt investors get paid first if the loan should go into default. Your investment in the crowdfunding deal is secured either by the property itself or by a promissory note which is held by the entity that owns the property.

 

Shorter Hold Periods

 

When compared to equity investments, debt investments usually have shorter hold periods. They have pre-set payoff dates, which typically range anywhere from 6 to 24 months.

 

Set Payback Schedule

 

Since debt crowdfunding is essentially a loan, investors are entitled to payments on a regular payback schedule, in the same way, mortgage holders receive payments. These interest and principal payments usually come quarterly or monthly, and a set schedule allows investors to know when and how much they will be getting paid for their investment.

 

Related: How to Invest in Real Estate Syndications

FREE Real estate syndication education and insight newsletter. Subscribe now.

Real Estate Crowdfunding Terms You Should Know

 

New investors often have trouble making sense of the jargon that comes along with discussions about crowdfunded real estate deals. Like many other avenues of finance, these terms can be daunting or confusing at first, but they represent simple concepts that you should have little to no trouble understanding. For now, let’s take a look at a few of the real estate crowdfunding terms you should know before getting involved in a crowdfunded deal.

1. Sponsor

 

The crowdfunding sponsor is the person or organization/company that finds, organizes, and manages the crowdfunding investment. The sponsor of the deal works to facilitate the acquisition of the asset or assets, works with contractors and builders, lines up financing, and is responsible for selling the property if and when the time comes. 

 

In most cases, deal sponsors put up some of the initial funding for the project and are entitled to an agreed-upon share of any profits generated as a result of the deal. The term ‘sponsor,’ as mentioned earlier, is synonymously used with the word ‘developer’ and other terms like ‘operator’ or ‘manager.’

2. Crowdfunding Platform

 

A crowdfunding platform is a website or app where the sponsor connects with investors to raise capital for a real estate crowdfunding project. The platform exists as a digital exchange where sponsors can advertise to investors, and the platform managers work to confirm that any posted deals follow legal and financial regulations. They also act as a filter to ensure that any potential investors meet the requirements for the investment, and the platform is sometimes responsible for collecting any invested funds for the deal sponsor, depending on the platform’s business model.

3. Real Estate Developer

 

Real estate developers are people who develop and sell/lease properties for residential or commercial use. Their duties include coordinating the project and working with architects, builders, finance personnel, and others involved in the development process. Within the crowdfunded real estate space, this person is also known as the sponsor, as mentioned above.

4. Rental Income

 

Rental income is the income collected from tenants via rent payments from leases and is one of the two ways that investors generate returns from crowdfunded real estate. Rental income is either expressed as gross or net income, with gross rental income referring to the total amount of rents collected, while net income refers to the leftover profit after expenses have been paid.

5. Property Appreciation

 

Property appreciation is another way that returns are generated for real estate crowdfunding investors. As properties can and often do appreciate in value, shareholders in equity deals are entitled to a percentage of that appreciation value upon the sale of a property or properties.

6. IRR (Internal Rate of Return)

The IRR or Internal Rate of Return for a property or portfolio is an estimate of the appreciation in value that either will generate while owned by an investor or investors on an annualized basis over the lifetime of the project. In simple terms, the internal rate of return is the yearly return that investors earn on each dollar they’ve invested in a property/portfolio during the entire holding period, whether that be six months or six years.

 

Related: What's Happening Right Now

Benefits of Real Estate Crowdfunding

 

As an investment avenue, real estate crowdfunding offers benefits not available with traditional real estate, stocks, bonds, and other asset classes, and in essence, combines many of the best qualities of these investments. Some specific advantages include:

Low Investment Requirements

 

Traditional property investments carry high acquisition costs, often in the hundreds of thousands, millions, or even tens or hundreds of millions of dollars. Even if you finance a property through a lender, you are looking at putting a minimum of 20% down payment to receive an acceptable interest rate on borrowed capital. The fractional ownership model of crowdfunded deals allows investors to invest as little as $500, which is substantially less than almost all other forms of property investment.

Ease of Access/Research

 

In a similar vein to the information mentioned above, low minimum investment requirements, crowdfunding platforms are much more accessible than direct investments in real estate. Crowdfunding platforms are just a click or tap away via PC or mobile device and sign up shouldn’t take more than a few minutes. 

 

Once you’re on the platform, searching for potential opportunities is as easy as a Google search, and the platform itself will provide a fair amount of research and information that you can use to perform the due diligence required of any investment. 

Gower Crowd  builds best-of-class digital marketing platforms for real estate developers

Professional Management

 

Many proponents of real estate refer to the sector as one where you can deploy capital and “make your money work for you while you sleep.”

 

This is true for some real estate investments, but it is not a universal truth. For instance, when you own a multifamily building, you are either handing over a significant percentage to a manager, or spending your own sweat equity to make sure tenant issues are solved, repairs and maintenance are taken care of, taxes and insurance are paid, and the day to day duties you need to focus on to keep your asset generating returns.

 

With crowdfunded real estate, your sponsor takes on most or all of those duties, while you can sit back and collect rent and appreciation payments.

For more information and to gain access to:

  1. Guided tour of 8 real estate crowdfunding websites
  2. FREE: Complete list of every real estate syndication website
  3. FREE: 10 things to look for in real estate contracts
  4. Access to advanced real estate investment training

Real Estate Offers Higher Returns than the Stock Market

 

Comparing two asset classes that encompass so many subcategories of investments, like stocks and real estate, is an inexact science. With that being said, we can look at common performance metrics, like market tracking funds or stock indexes to see how asset classes perform over long periods of time. 

 

While stocks have performed admirably over the past few decades, when you compare the S&P 500 Total Return to the Vanguard Real Estate ETF Total Return over the past 25 years, you will see that returns in commercial real estate outperformed the S&P 500 by more than 200%, with Vanguard’s real estate ETF coming in at 865.3%, while the same number for the S&P 500 is 621.8%. 

 

Now, this does not mean that real estate assets will always outperform stocks, but it shows that as an asset class, commercial real estate is no slouch.

Plentiful Diversification Options

The most significant issues faced by new real estate investors is the lack of portfolio diversity that comes with the purchase of a commercial property. While some of us are lucky enough to have portfolios where a few million dollars represents a small allocation, the rest of us would be treading in dangerous territory by putting such a large amount of capital into a single investment. 

Real estate crowdfunding allows for fractional ownership in properties, which gives you the ability to benefit from phenomenal growth in the commercial real estate markets while maintaining a sound long-term investment or retirement strategy.

 

Related: Podcast

Risks of Real Estate Crowdfunding

 

If you’ve made it to this point, and you weren’t born yesterday, you’ve probably had one nagging thought in your head – what’s the catch? 

 

As with any investment opportunity, real estate crowdfunding has its share of drawbacks. As an investor, you need to weigh these risks with the potential rewards, all the while keeping in mind your personal tolerance for risk and your desired return on investment. 

Let’s take a quick look at some of the risks inherent to real estate crowdfunding investments.

 

More Risk than Other Investment Avenues

 

As many of us remember from the dark days following the housing crash in 2008 and the turmoil surrounding the Coronavirus pandemic, investing in real estate is not currently, and never was a way to generate returns without risk. Like any investment not guaranteed by the federal government, such as bonds, there is always the chance that things could go sour on a macro or micro level, and you could be left holding the bag, and taking substantial or even total losses on your invested capital. 

Keep in mind that you can reduce your risk in crowdfunded investments by employing tried and true strategies, like creating a diverse portfolio and performing rigorous due diligence on any potential investment.

 

Crowdfunded Real Estate is an Unsecured Investment, and May Suffer from Platform Failure

 

In the United States, the Securities Investors Protection Corporation, or SIPC, protects investors from the failure of a bank or brokerage, as explained on the FDIC website:

 

“The Securities Investors Protection Corporation (SIPC), a nongovernment entity, replaces missing stocks and other securities in customer accounts held by its members up to $500,000, including up to $250,000 in cash, if a member brokerage or bank brokerage subsidiary fails.”

 

Crowdfunding investments are not protected under the same terms, and this exposes investors to risks from the platform closing, or the crowdfunding sponsor mismanaging investor funds. Of course, similar risks are also present with securities – just ask Enron or WorldCom investors. 

 

Like many of the other risks listed here, you can take steps to protect yourself from failure, including properly vetting your sponsor and doing business on an established, well-respected crowdfunding platform.

 

New Real Estate Investors May Have Trouble With Crowdfunding Investments

 

Crowdfunding is a relatively new way to invest in real estate, but the old fundamentals of the real estate business still hold true. The ease of access and digital nature of crowdfunded real estate may draw in investors who are unfamiliar with tried and true strategies for building wealth with real estate. Unfortunately, there is not much you can do to prevent this; it happens with any type of investment that gains widespread popularity, including stocks, tech startups, precious metals, and other commodities. 

 

You can protect yourself from risk by being deliberate with your investments and putting in the sweat equity and research to ensure that you know how and why that investment is going to generate returns for your portfolio.

 

Related: About Gower Crowd

Some Aspects of Due Diligence May be Challenging/Lack of Analyst Reports

 

Digital platforms make it easier than ever to research a potential investment, and to connect with crowdfunding sponsors. Unfortunately, the financial research and analysis industry has not yet caught up to this new way of funding development projects. Resources for vetting potential projects are limited, especially when compared to the countless reports and analysis pieces crafted for equity and commodity investments. This is a blessing and a curse. 

 

For those of us that are reluctant to trust someone else’s opinion or analysis, it gives us the chance to delve deeper and research a project on our own. However, this kind of deep-dive is not ideal for every investor, some of us simply do not have the time or desire to dig into financials, market reports, and other data points that would provide us insights on making an informed decision. 

 

Real Estate Crowdfunding is Treading New Regulatory Ground

 

Anytime you have a radical paradigm shift in finance, tech, and many other sectors of the economy, it always seems like regulators and authorities are rushing to catch up. While the lack of clearly defined rules and regulations can be a boon to growth and creative thinking, it can also lead to many of the problems we’ve discussed above. 

Additionally, when the government eventually does step up to the plate, it can present significant problems for existing players, who have to adapt to new rules or ways of doing things. This may also introduce risks into the crowdfunding space, which savvy investors, like you, should be aware of.

How Much Should You Invest in Real Estate Crowdfunding?

 

At this point, you may be wondering how much of an investment you should make in real estate crowdfunding deals?

 

The answer is simple: as much as you can comfortably invest while still falling in line with the same principles you use to balance risk and reward with traditional assets like stocks and bonds. In most cases, this means a higher risk tolerance for younger workers and less tolerance for those edging closer to retirement.

 

The beauty of the crowdfunded real estate is that you can alter your risk level by picking and choosing individual projects and real estate types to match your personal needs and goals. 

 

Keep in mind that investing in real estate crowdfunded syndications means that your investment will likely be tied up for some years before you will get the principal returned, although there may be distributions along the way depending on how the deal is structured. 

The golden rule for any real estate investment is not to invest anything you may need for other purposes during the lifecycle of the deal, and certainly, no more than you can comfortably afford to lose completely.

For more information and to gain access to:

  1. Guided tour of 8 real estate crowdfunding websites
  2. FREE: Complete list of every real estate syndication website
  3. FREE: 10 things to look for in real estate contracts
  4. Access to advanced real estate investment training

Best Real Estate Crowdfunding Platforms

Once you’ve decided to invest, you’ll need to find a platform. As we mentioned earlier, this is a mission-critical step in reducing risk and finding the right investment opportunity.

 

Listed below are 11 of the most popular crowdfunding options, most of which we’ve worked with here at GowerCrowd:

  • Fundrise
  • Crowdstreet
  • RealtyMogul
  • RealCrowd
  • PeerStreet
  • Zeus Crowdfunding
  • GroundFloor
  • EquityMultiple
  • Patch of Land
  • Small Change
  • Fund That Flip

Conclusion/Go Forth and Conquer

 

After completing this brief crash course, you will have all the tools you need to get started with crowdfunded real estate. Your mission, should you choose to accept it, is to take this knowledge, add some hard work and due diligence, and take advantage of the immense possibilities provided by real estate crowdfunding investments, while also remaining cognizant of the pitfalls and risks that come with this unique form of investing.

 

You won’t get anywhere by sitting on the sidelines, so get out there, go forth and conquer. 


Related: Leader of the Crowd.

FREE Real estate syndication education and insight newsletter. Subscribe now.

RELATED ARTICLES

Receiverships, Restructures and Turnarounds: What You Need to Know During the Coronavirus Crisis

Receiverships, Restructures and Turnarounds: What You Need to Know During the Coronavirus Crisis This article written based on a conversation with attorney Richard Ormond that you can listen to here. The Coronavirus crisis has created uncertainty in the commercial real estate industry. Transactions have ground to a halt. An estimated 30% of tenants failed to…

READ MORE >

Real Estate Investing Explained – NOI

Real Estate Investing Explained With Support from SmallChange NET OPERATING INCOME – NOI   In this episode you will learn about the NET OPERATING INCOME which is probably the most important number of any that you’re going to find in a real estate deal. Why? Because it effectively defines ongoing profits that come from a…

READ MORE >

Your Guide to Crisis Communications During Coronavirus

[Download] Crisis Communications: A Guide for Commercial Real Estate Professionals  (and for everyone else too) With Adam Gower Ph.D. Copyright 2019 – ADAM GOWER PH.D. – All Rights Reserved

READ MORE >

Copyright 2018 - ADAM GOWER PH.D. - All Rights Reserved

Website Disclaimer:  All Content contained on this website is intended for informational purposes only and does not purport to be complete or accurate. No recommendations are made or intended to be made regarding investment in real estate of any kind. For further information on any investment opportunity contained in any content of this website, you should visit the respective crowdfunding portal or site where such investment opportunity is published. None of the content presented on this website has been prepared with any reference to any particular user’s investment requirements or financial situation, and you are encouraged to consult with professional tax, legal and financial advisors before making any investment decisions or including the decision to invest at all. GowerCrowd makes no representations or warranties as to the accuracy of any information and accepts no liability or fiduciary responsibility whatsoever. Offers to sell, or the solicitations of offers to buy, any security can only be made through official offering documents through registered portals outside of this website. Investors should conduct their own due diligence, not rely on the financial assumptions or estimates displayed on this website, and are encouraged to consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks associated with any investment opportunity. Neither Adam Gower nor GowerCrowd or any related entities are a registered broker-dealer, funding portal, or investment advisor and does not conduct any activity that would require any registration as such.