Before we get into the particulars of real estate crowdfunding, it’s important to make sure that you understand the basics of crowdfunding real estate investing as a concept. At its core, crowdfunding investing is a process of pooling money together from multiple investors in order to achieve a common goal. For example, today, websites like GoFundMe and Indiegogo are major contributors to the crowdfunding movement.
Similarly, real estate crowdfunding involves multiple investors pooling their money in order to purchase or operate specific properties. In most cases, the crowdfunded funds are directed towards Real Estate Investment Trusts (REITs). For those who are unaware, REITs are investment instruments that own or operate various types of real estate. While the majority of REITs are publicly traded, some are privately owned.
In the of era of covid-19, many real estate investors are wondering how they can expand their portfolios without going through the hassle of buying and selling traditional real estate. If you’re one of them, one of the options available to you is to invest in real estate crowdfunding. With that in mind, below is a guide to real estate crowdfunding, including what it is, how it works, and what you can do to get involved. Read on below to learn more.
How does crowdfunding real estate investments work?
Now that you’re aware of what crowdfunding investing is, the next step is to get clear on how the process of crowdfunding real estate works. Typically, this process involves three key players. we’ve defined each roll for you below. Read them over so that you understand how everyone works together to successfully fund each investment opportunity and where you’ll fit in.
The crowdfunding process typically starts with a sponsor. the sponsor is the person who identifies the particular investment opportunity that’s being funded and does most of the legwork of purchasing, renovating, or managing the property on an ongoing basis.
Ideally, this person will be an experienced developer or real estate investor who, for whatever reason, cannot or does not want to fund the project on their own. However, when you are thinking of investing in a crowdfunding opportunity, it is up to you to do your own research on the project itself, the key players, and their property portfolios. You’re going to want to make sure that you feel comfortable with them and their experience levels before investing your money.
Keep in mind, too, that in exchange for doing a lot of the legwork on the crowdfunding project, the sponsor is generally entitled to a larger share of the profits if the deal goes through.
Then, there’s the platform, which acts as the middleman in this arrangement. The middleman is the website where the investment deal. In essence, the platform is there to help the investor collect funds. However, rather than just acting as a banking instrument, most real estate crowdfunding sites also vet the deals that they host, advertise them to interested investors, and make sure that the deal needs certain regulatory requirements.
Lastly, there are the investors. As you might suspect, the investors are the people who invest some of their funds into the project in exchange for a share of the profits. in real estate crowdfunding, in particular, an investor might receive a monthly infusion of a share of the rental income or a one-time, lump-sum payout from the eventual sale of the property.
How do crowdfunded real estate investments differ from traditional financing?
Though, crowdfunding is certainly a viable method for financing real estate projects, it’s very different from the traditional method of financing, which involves getting a loan to buy a home or obtaining owner financing. to better illustrate the specific differences between these two financing methods, we’ve laid them out for you here.
Crowdfunding has a lower barrier to entry
One of the biggest benefits of real estate crowdfunding is the fact that it has such a low barrier to entry. While many people have dreams of investing in real estate, they often find that they are precluded from achieving them because of the high upfront cost. Although, having a 20% down payment is no longer required, between the down payment and closing cost, buying real estate in the traditional manner does cost thousands of dollars.
When it comes to crowdfunding, on the other hand, the barrier-to-entry is lower. Often, interested investors can get involved in crowdfunding projects for as little as a few thousand dollars at a time. with that said, remember that the share of the profits that investors received is commensurate with the size of their initial investment.
Crowdfunding involves less financial paperwork
Often, real estate investors need to jump through hoops in order to obtain financing from a traditional bank or lender. Usually, the process involves providing the lender with years’ worth of financial paperwork and tax documents. in addition, the lender also has to take in the value of all your other assets and debts in order to calculate your debt-to-income ratio.
In contrast, the legwork required to join a crowdfunding platform is often much less substantial. Typically, all you need to do is fill out the form to set up an ACH transfer between the platform and the bank account where your money is located. In some cases, however, certain investment opportunities are only available to accredited investors and you may have to supply more financial paperwork to prove your status.
Crowdfunding requires a longer wait for a pay off
One of the downsides about crowdfunding is that it generally takes much longer to receive a pay off. According to the most recent Origination Insight Report from Ellie Mae, a cloud-based platform provider for the mortgage finance industry, it takes an average of 45 days to finalize and fund a purchase loan. Of course, after your loan has been funded, your investment project can begin in earnest.
In contrast, this process usually takes much longer with crowdfunding platforms. As you might guess, since multiple investors are each contributing a small amount of money to the project, multiple investors need to be interested in the project in order for it to become fully funded. Since most projects need to be fully funded before they can move forward, it can take a long time to reach that goal.
The outcome of crowdfunding is less certain
Finally, the outcome of crowdfunding projects is often less certain than those that are secured with traditional funding. Put simply, with traditional fun day, though you have to go through underwriting, you also have a lender and you loan servicer who are working on your behalf to give you the best chance of getting approved for the loan.
where crowdfunding is concerned, it’s not up to you to get the project off the ground. It’s up to the sponsor to create a compelling project, the platform to advertise it well, and ultimately the other investors to decide whether or not they believe in the project enough to put their money behind it. In truth, some real estate crowdfunding projects never get off the ground at all.
How to get started crowdfunding
Now that you know how crowdfunding differs from traditional financing, the last step in this process is to learn how to get started on your crowdfunding journey. To that end, we’ve laid out the steps for you. Here’s what you need to do:
Decide on the best real estate crowdfunding platform
As you might be able to guess from the information above, the first step in participating in crowdfunding is picking the right platform for you. Ideally, as a beginner,you want to go with a site that acts as a broker-dealer instead of a site that just lists the available listings. You should also go with a site that has good reviews and reliable customer service.
Find the right investment opportunity for you
Once you find it on the right crowdfunding platform, you need to take time to browse all of the available Investments. Again, some may only be available to accredited investors, and others may be outside your area of interest, However, you’ll need to do your due diligence on any project that you are interested in before you move on to the next step.
Make your investment
After you’ve landed on a project that piques your interest and seems like a good investment, the next step is to actually invest your money. As stated above, this is usually as simple as doing the paperwork for an ACH transfer. That said, keep in mind that each crowdfunding platform will have their own procedure that you will need to follow.
The bottom line on crowdfunding
Crowdfunding for real estate is not the right fit for everyone. However, for those whom it does work, this investing opportunity can often be a great way to diversify your portfolio and to build your wealth. with that in mind, use this as your guide to the crowdfunding process. Armed with this knowledge, you should be able to take the next step and start your real estate crowdfunding journey.Best of luck on your crowdfunded real estate plans.
Cited article sources
- EllieMae. (August 2020). “August 2020 Original Insight Report.” https://static.elliemae.com/pdf/origination-insight-reports/EM_OIR_AUG2020.pdf