So, you’re a beginner at real estate investing and you want to get started purchasing properties. It sure would be great to diversify your portfolio and create extra income, but, like so many others, you don’t have huge amounts of capital sitting around. You don’t have a close friend or family member who can help out in the way of a private real estate deal. If you’re in this situation, you might have already heard of this option: crowdfunding to invest in real estate.
What is Real Estate Crowdfunding?
Crowdfunding, in a general sense, is the practice of funding a project or venture by collecting money from a large number of people. It’s similar to crowdsourcing, and it is a popular form of alternative finance—that is, it’s a financial channel that has emerged independently of traditional institutions, like banks and capital markets.
Crowdfunding isn’t exactly new, but it has definitely reached new heights in the last few years thanks to Internet platforms and social media. It’s a very cool concept: people can choose to help others financially, even if they’re complete strangers or live on opposite sides of the globe.
You have almost certainly heard of crowdfunding for medical expenses. This is a popular way for people to help each other out through the power of social media. Another popular type of crowdfunding involves entrepreneurs who need funding to bring a brand-new product to the market. Inventors use platforms like Kickstarter to ask people to support their product, and supporters will get certain perks once the product is fully funded and ready for release. People also crowdfund to support their artwork or music, to fund travel, collect money for community improvement projects, and more. These types of crowdfunding are often donation-based or reward-based.
Real estate crowdfunding is less well known, but it’s not a whole lot different than the more mainstream types of crowdfunding. It occurs when multiple investors pool their funds to invest in a real estate project. The main difference between real estate crowdfunding and other types: it’s based on equity or debt investments rather than being a simple donation.
The Two Categories: Equity Investments and Debt Investments
Equity Investments: The first type of real estate crowdfunding is equity investments. These investments can apply to commercial or residential properties. Multiple people can purchase an equity stake in the property, and in turn, each investor will obtain a portion of the income that property generates. Pretty simple. This channel is somewhat risky and usually requires a significant holding period, but the potential for returns is pretty high.
Debt Investments: When you take part in debt investment crowdfunding, you invest in a mortgage loan that’s associated with a specific property. You get a share of the interest as the loan is repaid. The profitability of this type of loan is limited by the loan’s interest rate.
The Benefits of Crowdfunding to Invest in Real Estate
You might think that this sounds pretty similar to investing in a REIT (real estate investment trust), and you are right. You might wonder what’s wrong with the traditional avenue of purchasing your own rental property. We’ll explain the benefits associated with crowdfunding below.
You can get lots of information prior to making a decision: One of the drawbacks of investing in a REIT is that you often don’t know all that much about the investment. This makes it hard to make an educated decision on whether you should put your money into it. With most real estate crowdfunding platforms, though, you can get quite a bit of information about any given deal—before you make any decisions. This allows for increased peace of mind and smarter decision-making.
It’s accessible even if you’re not rich: In the past, you had to be fairly well off in order to invest in real estate, or you at least had to be willing to make sacrifices. With real estate crowdfunding, though, you don’t have to bring tens of thousands of dollars to the table. You can spend as little as $5,000 and still take advantage of the great benefits of owning real estate. This opens new doors for all kinds of people.
You still get the benefits of regular property ownership: One of the main reasons people invest in properties is to diversify their portfolios. With crowdfunding, you still get that exposure to a new asset class. Plus, you can often still get many of the tax benefits that would normally apply to owning an investment property.
What do Crowdfunding Investors Actually Own?
It isn’t as simple as buying your own property the traditional way. You don’t exactly own a physical property. The answer to this question can differ based on the type of investment it is (equity or debt-based), the platform you use, how your investments are structured, and other variables. You will either own shares in the LLC that is set up for your investment opportunity, or you will own payment dependent notes.
Tips for Getting Started with Real Estate Crowdfunding Investments
So, you think that real estate crowdfunding is the right path for you? Here are some tips for taking advantage of all the great benefits of crowdfunding.
Realize that there is risk involved: If you have any experience whatsoever with real estate investments, you already know this. While it’s an excellent method of diversifying your portfolio, it carries inherent risks, and you need to weigh the potential returns against the possible risk involved.
Not all platforms are created equal: There are several platforms that can help you out, and they are all a bit different, with benefits and drawbacks that vary from platform to platform. As far as we can tell, none of them are necessarily “good” or “bad,” just slightly different in the ways they operate. Do your research to find out which real estate crowdfunding platform will work best for you and your situation. Some examples are RealtyShares, Patch of Land, iFunding, and RealtyMogul, with more being established all the time!