What is Real Estate Crowdfunding?
Learn how to build wealth and earn passive income in real estate while someone else does all the work.
Real Estate Crowdfunding in 2020
Real estate crowdfunding was already on the rise in 2020, but industry insiders predict it to gather even more attention as a result of the COVID-19 crisis. As traditional sources of capital – banks, pension funds and the like – move to the sidelines, real estate sponsors are looking for alternative ways to aggregate funds for their projects.
Real estate crowdfunding is proving to be a viable alternative for many commercial real estate developers.
One of the reasons for the newfound interest in real estate crowdfunding in 2020 is that, leading up to this global pandemic, there were many investors with cash burning a hole in their pockets. The economy was good, and they had money to spend, but had otherwise been priced out of the real estate market. The tide is starting to turn. Real estate values are expected to decline in some sectors in the months and years to come, creating an opportunity for individuals to invest in commercial real estate deals via crowdfunding. This is a trend that bodes well for sponsors and investors alike, and one that we continue to monitor closely.
Real Estate Crowdfunding Benefits
There are several benefits to real estate crowdfunding, including:
- Low barriers to entry. Many platforms allow people to invest in commercial real estate deals with as little as $10 (to be sure, there are many deals that require at least $10,000 to $25,000 or more). The relatively low threshold means that real estate crowdfunding is accessible to everyday investors. This makes real estate crowdfunding a great alternative for those looking to add real estate to their portfolios but who would otherwise be unable to afford direct ownership given the steep up-front capital costs. For example, buying a $500,000 investment property would typically require a minimum 20% down payment, or $100,000 up front – something most individual investors cannot afford. Real estate crowdfunding provides another way to own a fractional share of the same kinds of real estate deals.
- Asset and geographic diversification. Let’s say someone does have $100,000 to invest in real estate: they can buy a single $500,000 commercial property or they can invest $20,000 in five different types of real estate deals via real estate crowdfunding. Doing the latter provides individuals with greater asset and geographic diversification. They are no longer reliant upon a single property’s performance. For example, if that single property had been a retail building, the investor may be finding themselves underwater during the COVID crisis given the beating the retail sector has taken. Instead, someone who had diversified across commercial real estate product types (e.g., office, retail, multifamily, industrial) and in different geographies would have more insulation against potential downturns.
- Little day-to-day management. People often talk about commercial real estate investing as a great way to earn passive income. But direct ownership is far from passive. In fact, owning commercial real estate outright requires robust day-to-day management, either by the investor or by a third-party property manager hired on behalf of the owner. This requires significant time, resources and capital. When someone invests via real estate crowdfunding, they can truly take a backseat, passive role – the ongoing operations and management is left to the project sponsor. The sponsor takes a fee for this responsibility, but it otherwise frees up the investors’ time.
- Speed and efficiency. Buying a commercial property has a long lead time. Most investors will engage in a robust due diligence process, scouring dozens (if not hundreds) of deals before making an offer. Once the offer is accepted, there is still a lengthy due diligence process that takes place (e.g., property inspections, title searches and the like) before closing. Many commercial properties are held in LLCs, so there’s robust paperwork that needs to be completed, usually in conjunction with an attorney. The process of owning commercial real estate is both lengthy, costly and potentially burdensome for some. Real estate crowdfunding allows people to invest in commercial property with ease: the legwork has already been done by the sponsor on behalf of the investors. Often, investing in real estate crowdfunding can be as simple as linking a bank account and clicking a button – a process that can be accomplished in just minutes.
Real Estate Crowdfunding Facts You Didn’t Know
The concept of real estate crowdfunding, in which a sponsor pools capital from an array of individual investors, has been around for ages. However, the ability to appeal to hundreds of thousands of prospective investors online, without having a preexisting relationship, is still a relatively novel concept to most.
Real estate crowdfunding works similarly.
A proponent, usually a real estate developer, will launch a campaign usually with a target “raise” in mind. The crowdfunding page will include pertinent information about the real estate deal (or in some cases, the real estate fund), including projected returns. The proponent then advertises the campaign using various media to try to get people to invest in their deal. Unlike charitable crowdfunding campaigns, which will usually allow people to donate as little as $1, most real estate crowdfunding campaigns have a minimum investment requirement of at least $10 – though in practice, the minimum investment is usually more like $5,000 or more.
Interested in real estate crowdfunding? We have aggregated some of the most interesting facts about real estate crowdfunding that most people don’t know. Read on for more.
Crowdfunding is Another Word for ‘Syndication’
A ‘syndicate’ is a group of people, historically significantly above average wealthy people, who come together as a group to finance a project. Syndications are usually formed by the person or people who wish to develop a project or otherwise intend to be those with primary responsibility for executing on the project’s business plan.
Historically, syndicate managers typically identified projects they wanted to develop or buy and improve and, not having enough personal capital to finance them, would seek additional investment capital from high net worth investors in their immediate circles.
They were prohibited from seeking investors from outside of their personal networks by regulations set down in the 1933 Securities Act which restricted fund raising to one of two ways; either an IPO where the general public could be invited to join an offering, or through private networks. To do an IPO, however, was a very costly and time consuming process and so real estate developers elected to restrict their capital formation only to networks of people with whom they had close relations.
Their syndicates were, in effect, crowdfunded from small groups of wealthy individuals with whom they had pre-existing relationship.
Crowdfunding is Nothing New
Crowdfunding syndications go back far further than even the 1933 Securities Act. The 1933 Act prohibited syndications from soliciting the general public without making considerable disclosures (hence the cost and time involved), but prior to that anything was permissible.
Indeed the entire railroad infrastructure of America was built and financed on crowdfunded syndications that go back to the end of the Civil War. Projects and railroads were financed through open advertisement and anyone could invest in them almost without restriction.
Sponsors would form syndicates, issue shares, offer dividends and discounts, and create financial structures that were, by today’s terminology, entirely crowdfunded.
The 2012 JOBS Act Was Never Intended for Real Estate
As noted above, real estate has always been ‘crowdfunded’ in one way or another, but more importantly, the 2012 JOBS Act was negotiated, lobbied for, and passed without a single nod to the real estate industry. It was passed exclusively to benefit small and startup companies as a way to stimulate the economy and create jobs; it was the ‘Jumpstart Our Business Startups’ Act, not the ‘Finance Real Estate’ Act.
The real estate industry is an accidental beneficiary of the passing of the Act – an unintended consequence.
Real Estate Crowdfunding is On Pace to be an $869 Billion Industry by 2027
Despite the serendipitous impact of the JOBS Act on real estate, the growth of the real estate crowdfunding marketplace has been staggering and has dominated all other industries as beneficiaries of JOBS Act regulations. In 2014, the real estate crowdfunding industry was estimated to be worth about $1 billion. Just two years later, in 2016, that had more than tripled to $3.5 billion. By 2017, it had reached a $5.5 billion valuation. The industry’s growth continues its upward trajectory at rapid speed and some companies, notably CrowdStreet as the first, have raised over $1 billion in equity capital representing several billion of real estate projects on their own.
In terms of revenue, the U.S. real estate crowdfunding market is expected to reach $869 billion by 2027 – growth that experts attribute to the lack of other avenues available for individuals to invest in commercial real estate deals. In other words, a growing number of people want to invest in commercial property and will rely on real estate crowdfunding for their entry into the industry.
You Can Invest in Institutional-Quality Real Estate via Crowdfunding
Most people think of real estate crowdfunding as a tool used by novice or small-time real estate developers. That’s far the case! There are many major players who have entered the real estate crowdfunding realm in recent years – including major commercial real estate sponsors and funds. As these bigger players have entered the marketplace, they’ve created more opportunities for individuals to invest in institutional-quality real estate.
For example, it’s becoming more common to see a sponsor utilize crowdfunding to amass the capital needed to renovate a 30-story downtown office building. Historically, the opportunities to invest in properties like these were limited to traditional banks, life insurance companies, pension funds, and high-net-worth individuals. Real estate crowdfunding has opened the door to individuals interested in investing a smaller amount of capital in an otherwise institutional-quality real estate product.
Some of the biggest institutional players to utilize crowdfunding regulations and marketing techniques include KBSDirect, one of the world’s largest office owner in the world, Jamestown Invest, another multi-billion dollar company, and others.
You Can Invest in Both Debt and Equity with Crowdfunding
People generally understand that real estate crowdfunding is a tool that can be used to raise equity for a deal. What many don’t know is that it can also be used to raise debt for projects. In other words, as an investor, you can invest in either debt or equity depending on the platform, the sponsor and the project’s needs.
This is significant for a few reasons.
First, a debt investment generally carries a lower risk profile. Those who invest in debt are usually repaid before equity investors recoup their investments. Second, in most cases, debt is secured by the real estate asset itself. Therefore, if the deal goes sideways, the “lenders” have a tangible asset to make a claim against, which isn’t always the case for equity investors. Finally, debt investments are usually structured for a shorter-term compared to equity investments, which allows an investor to be repaid sooner – a benefit to anyone who is looking for liquidity sooner rather than later.
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Crowdfunding Real Estate Doesn’t Take a Lot of Money
A longtime knock on commercial real estate is that the asset class, by and large, has higher barriers to entry. Only the elite, or those with significant resources, could invest in the asset class.
Real estate crowdfunding has the potential to spin the industry on its head by allowing everyday investors to invest in both commercial real estate debt and equity with far less capital. In fact, that’s one of the primary benefits to real estate crowdfunding – it doesn’t take a lot of money to invest. As we mentioned above, some platforms allow people to invest with as little as $10 – GROUNDFLOOR for example, have a minimum investment level of $10. This makes it an asset class that is much more accessible to individuals wanting to add commercial real estate to their portfolios. It’s no longer an industry limited to the “old boys’ club” the way it was in decades past.
Related: 6 Keys to Crowdfunding Real Estate
74% of Crowdfunding Investors are Between the Ages 25 and 49
When you think of the typical real estate investor, you might think of someone who’s in their 50s or 60s – someone who has an established career and has already done well for themselves. You might also be picturing men, particularly white men.
The profile of those investing in real estate crowdfunding is much different.
According to Adam Hooper and Roman Rosario, the co-founders of real estate crowdfunding platform RealCrowd, an estimated 74% of those investing in their deals are between the ages of 25 and 49. A substantial share of these investors are women, relative to traditional real estate investor demographics. In some respects, this comes as no surprise. Younger investors are more tech savvy, more willing to invest via an online platform, and are willing to invest smaller shares of capital in more diversified asset classes like commercial real estate.
You Can Invest at Any Time of the Cycle
Real estate cycles generally last for about 10-12 years, on average, though some can certainly be longer than others – Phil Anderson claims that the cycle is exactly 18.6 years long and predictably so. Predictable or not, during any given real estate cycle, there are four periods: expansion, contraction, recession and recovery. Real estate crowdfunding allows people to invest at any time during the real estate cycle.
In fact, some of the best “deals” to be had are at the bottom of the real estate cycle when other investors are sitting on the sidelines, waiting to see when the market will start to grow again.
That said, it remains to be seen how real estate crowdfunding will fair over multiple real estate cycles. The last real estate recession was in 2008-2010. Online real estate crowdfunding, and its associated platforms like Fundrise, Crowdstreet and others, didn’t start to emerge until a couple of years after the 2012 JOBS Act was passed and only once associated laws were promulgated by the SEC. Therefore, many of these platforms have only operated during periods of economic growth.
The coronavirus crisis is expected to cause the commercial real estate market to taper off somewhat, which will be the first true test faced by real estate crowdfunding: will people invest in real estate crowdfunding during periods of contraction? We think so, especially given the underlying strength of the economy heading into this potential recession. There are many investors sitting on the sidelines who are eager to invest, and many will turn to crowdfunding as a way of deploying that capital in the months and years to come.
Real estate crowdfunding presents an exciting new way for individuals to invest in commercial property. Real estate campaigns can range from as little as $100,000 to well over $25 million, which shows the diversity of projects raising capital using this vehicle – KBSDirect are raising $1 billion by crowdfunding. This also translates into diverse investment opportunities for people with budgets of all sizes, risk tolerances, and investment horizons.
To be sure, although crowdfunding makes it easier than ever to invest in real estate, that doesn’t mean individuals should skip out on doing their homework:
there are many legit sponsors offering deals online; there are also many first-time real estate developers out there using this as a tool to raise capital for projects that they are unqualified to deliver. It’s always important to research who the sponsor is before investing in real estate crowdfunding, just as you would vet any other investment opportunity.
Interested in learning more about real estate crowdfunding? Take a look at the resources available to you here at GowerCrowd, below.
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