Over the last few years, real estate crowdfunding has emerged as an alternate source of capital that promotes access for the general public to invest in commercial real estate projects. Prospective investors participate by contributing to a consolidated pool of capital, which is sourced collectively from other investors. This pooled capital serves as a financial support system for present or potential real estate ventures.
While the concept of real estate crowdfunding has existed for several years, its recent surge in popularity can be attributed largely to the widespread availability of online crowdfunding platforms. There are several crowdfunding platforms for individuals to invest through, such as Fundrise, EquityMultiple, Yieldstreet, and Crowdstreet. Within these platforms, there are opportunities to filter for specific asset classes, such as residential or commercial properties, which encompasses new housing development, retail, office, or partial ownership stakes in existing properties(1).
Through this online fundraising method, open calls to potential investors are disseminated on the platforms alongside an investment prospectus, which contains information such as anticipated returns. Within the platforms, the account minimums and fees vary from as little as a $10 minimum and 1% fee at Fundrise, all the way up to a $10,000 minimum and 0.25% fee at Yieldstreet. From the developer’s perspective, crowdfunding provides access to networks of colleagues, friends, family, and the general public.
This new avenue creates unique opportunities for individuals to participate in real estate that did not previously exist. However, there are drawbacks that potential investors should be aware of as well.
The Pros
- Removing barriers to entry: the traditional approach calls for a significant volume of upfront capital, typically in the hundreds of thousands. This high investment threshold has made conventional investing difficult for the non one-percenters. Crowdfuding makes property investment more accessible with lower starting capital required(3).
- Community engagement: Local residents can now directly invest in projects within their communities, fostering a sense of ownership and accountability. A developer can garner public support by allowing the local community to participate in the investment process. Ultimately, the community can have a stake in the projects happening in their neighborhood and share in some of the potential returns, garnering public support.
- Portfolio diversification: Investors are able to diversify their investments both financially and geographically. This essentially minimizes the risk that comes with making a singular investment in a single location or asset by spreading the risk across numerous investments. Also, crowdfunding real estate investments are not limited to any location or market. Investors have the freedom/ability to choose a growing sector or market that they believe will yield strong returns.
The Cons
- Due diligence limitations: Individual investors interested in real estate crowdfunding may not be experts in commercial real estate investing. They likely do not understand the full extent of risks or terms associated with a deal. For instance, understanding the structure of a deal, repayment terms, payment methods, and anticipated return metrics are all critical factors. Also, the inability to properly background check the sponsor who is raising capital may put prospective investors at risk. A lack of understanding regarding these intricate nuances of a deal is undeniably an added risk(5).
- Risk of uncertainty: If a crowdfunding platform goes out of business, investors could lose their invested capital. This makes the investment less secure because it is then dependent on the success of both the real estate investment and the platform itself. Government regulation acts in the best interest of the consumer to reduce risk and fraud, however, additional regulation could change the dynamics of who can be defined as an accredited investor.
- Lack of control: Real estate crowdfunding investments generally lack liquidity, implying that they cannot be readily converted into cash. This illiquid nature may pose challenges for investors seeking to access their capital promptly. Furthermore, exit options may be constrained, and the timeframe for realizing returns can be protracted. Hence, investors need to meticulously evaluate their investment objectives and timeframes.
Conclusion
Real estate crowdfunding creates investment opportunities in a wide variety of asset classes for investors to participate in a traditionally exclusive environment. While this is a promising proposition, the relatively new concept comes with risks, such as a limited understanding and overall uncertainty. As we move into a more tech centered society, the future and potential of real estate crowdfunding is something we can all look forward to.
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