If you close your eyes and think of crowdfunding, your first association may be a friend asking for donations on Kickstarter for their independent movie or an entrepreneur soliciting pre-orders for their new invention. While this is how the industry started, so-called “donation crowdfunding” has been eclipsed by crowdfunded investing, where investors can purchase small stakes in projects ranging from tech startups to real estate developments. In fact, investment crowdfunding is now a $40 billion + industry annually and projected to grow to over $300 billion by 2025¹. This evolution began after Congress passed the JOBS (Jumpstart our Business Startups) Act in 2012, allowing businesses to broadly market formerly-private investments to individual investors for the first time since the Securities Act of 1933. The legislation was conceived as a way to help fund startups so many of the initial new crowdfunding platforms, like AngelList, focused on that. More recently, real estate has emerged as the fastest growing segment of the industry – the familiarity and tangibility of real estate, together with its unique combination of current income and potential upside has proven an easy entry point for investors looking to diversify beyond stocks and bonds. For investors, modern real estate investing sites offer the opportunity to participate in the ownership of projects that were previously available only to institutional investors and through personal connections.
Although the real estate crowdfunding industry is still young, it is already seeing consolidation and several distinct business models have evolved that offer different value propositions to investors. Depending on your definition, there are dozens to well over 100 real estate investing sites operating in the space.
Let’s take a look at the three most prominent varieties of real estate investing sites, and their pros and cons for individual investors.
Equity Real Estate Crowdfunding
Probably the closest to the original “real estate crowdfunding” concept, equity crowdfunding platforms connect individual investors with equity investments in distinct properties, allowing individual investors to participate alongside real estate companies in projects as they acquire, redevelop, or build. Investors invest passively – they don’t have any responsibility relating the the management of the property and are simply entitled to a fixed share of the profits. EQUITYMULTIPLE is one of the real estate investing sites still operating in this space.
- Lowered Barrier to Entry: For as little as $5,000, individual investors are able to invest in large, commercial real estate projects that were difficult to access prior to the JOBS Act, and enjoy the benefits of real estate investing that institutional investors have long recognized: a low degree of correlation with public markets, and historically lower volatility than stocks.
- Ease of Use: Through streamlined online platforms, investors can access real estate investments from across the country, and attain a degree of diversification that wasn’t attainable for most individuals previously.
- High Yield Potential: As equity investors, individuals can share in uncapped upside – if a project performs well, these investments often project to very high potential yield.
- Risk Remains: Though there’s great potential for yield, these investments, like any other, carry risk. Less experienced investors may not know how to properly evaluate risk factors. And, while some platforms are anchored by real estate veterans, not all have robust diligence protocols in place, and investors will need to vet this out.
- Lack of liquidity: Many of these investments entail a hold period of up to 5 years. To date, no prominent secondary markets have emerged so, unlike stocks, investors must be comfortable with their money being tied up until the project is refinanced or sold.
- It’s still early: while many platforms can tout positive aggregate return figures at this point, it’s inevitable that some projects won’t go well. It will take time for individual investors to truly validate the performance track records of the different platforms.
Syndicated Debt Real Estate Investing Sites
A fast-growing realm of the real estate crowdfunding space, “debt syndication” platforms take some or all of an existing real estate loan, secured by the underlying property, and syndicate it out to a network of individual investors in the form of notes that pay a fixed-rate annual return (APR). The originators of the loans are typically private, non-bank lenders (often referred to as “hard money lenders”), and the loans are typically short in term and issued at relatively high interest rates, making room for the platform to take a small piece (usually 1%), while still leaving individual investors with a healthy return – usually between 8 and 12%.
- Less risky: Debt investors are entitled to repayment before equity investors earn a return (“lower in the capital stack” in industry parlance), and thus these investments carry less risk than an equity investment.
- Extra diligence: The loans upon which these investments are based are originated by professional real estate lenders, who often have a boots-on-the-ground presence and expertise in the markets where they issue loans. As such, individual investors benefit from an extra layer of diligence, providing additional risk protection.
- Short hold period: Relatively short terms (typically six months to two years) allow investor to reinvest sooner, and reduces liquidity risk.
- Less upside than equity: Though debt investments are generally more secure, they carry limited upside, as the investor’s yield is limited to the interest rate of the loan, and they do not share in additional profits from the income, refinance or sale of the property (as equity investors do).
- An extra middleman: While the syndication model brings in an experienced real estate lender, and thus an additional layer of diligence, it is another party in between the individual investor and the original loan. This typically means a net APR of 0.5% to 1% lower.
Platform-Issued (“Pre-Filled”) Debt Crowdfunding
In this model, individual investors again invest in a real estate-backed loan, but in this case the platform acts as lender, doing their own diligence and issuing a loan to the borrower, thus removing the middleman. The majority of these loans are for fix-and-flips – single family homes that the borrower is planning to renovate and resell for a quick profit.
- Reduced risk: Again, debt investors are the first to be repaid, and the investment is secured by the underlying property, providing significant downside protection.
- Short hold period: Again, the term of the investment is relatively short; the individual investor typically recoups their money in six months to two years if all goes well.
- One less middleman: With the platform acting as the lender, there’s one less party that takes a fee. So, all else being equal, individual investors would realize an APR 0.5%-1.0% higher than a similar loan via a syndication platform.
- Less upside than equity: As another form of debt investing, this mode of real estate crowdfunding carries limited upside, as individual investors don’t share in the profits above the stated interest rate.
- Less diligence: Unlike syndication, the only loan underwriting is done by the platform (acting as lender). While some platforms have real estate teams led by industry veterans who practice conservative underwriting, the companies themselves may have limited operating histories and not have experience in all the markets where they are issuing loans.
NOTE: some platforms offer a hybrid of these models. EQUITYMULTIPLE, for example, offers investments of the first and second kind, while RealtyShares offers investments of the first and third variety.
“Marketplace” Real Estate Investing Sites
In this model the platform serves as an unbiased marketplace for private real estate investments, allow originators of investments (the Sponsor) to post their projects and raise capital from passive investors, allowing capital to flow to those Sponsors and investments that are most appealing to the marketplace’s investor network. These real estate investing sites operate more as a SaaS (software as a service) tool for Sponsors looking to raise equity capital.
- Smaller (or no) fees: Since the platform is providing software to connect investors and Sponsors, and doing less intermediary work, they are typically able to charge less in total fees per transaction.
- Scale: Similarly, with less diligence and investor relations work, and fewer diligence measures, these real estate investing sites are typically able to offer a higher volume of investments from a wider array of Sponsors.
- Fewer diligence measures: Since these platforms operate more as laissez-faire marketplaces, they’ll typically do less diligence on behalf of investors. For those individual investors with the time and real estate knowledge to do their own diligence, this may not be a dealbreaker. For those investors seeking a real estate investing site that will practice robust underwriting on their behalf, marketplace platforms may not be the answer.
- Less asset management: For the most part, marketplace platforms transact fundraises, then leave further communication to the Sponsor and the individual investors who contributed to their projects. This may work out fine in many cases, but may compromise timely delivery of distributions, tax documentation, or general information throughout the life of an investment.
- Are no fees a good thing?: Reduced fees is ostensibly a good thing. However, the right kind of fee structure can align a platform’s interest with yours, the investor, and incentivize the platform to surface only investments they believe in.
Even after some consolidation there are still many real estate investing sites operating in the crowdfunding space, and the options for individual investors can be overwhelming. In marketing materials, platforms (rightly) tout the new level of access and benefits of diversifying into real estate. However, the fact is that these investments, like any other, carry risk. Investors getting started in real estate crowdfunding should carefully consider the people and protocols behind each platform before they invest and review the details of reach investment. When in doubt, reach out and ask questions – an unwillingness or inability to field questions from prospective investors should raise a big red flag.
Investors should also take advantage of the opportunities for diversification: with low minimums, individuals can spread the real estate portion of their portfolio across different markets, asset classes (i.e., multifamily, office, industrial, etc), hold periods and platforms. As the industry continues to grow, and real estate investing sites amass more robust track records, investors will be able to easily include real estate as a portion of their overall investment strategy – whether that’s boosting current income or planning for retirement.
Note: a version of this article appeared in MarketWatch