Ultimate Guide to Real Estate Crowdfunding

 


Not sure where to begin with real estate crowdfunding? This guide breaks down the basics of crowdfunding, how it works, and how you can leverage it for success.


Contents 

Introduction 

Thinking of getting involved in real estate crowdfunding? Not sure where to begin or how to find reliable platforms? 

This guide will teach you all the essential information you need to know to get started in real estate crowdfunding, including the history of crowdfunding, how it works today, the types of real estate crowdfunding, the best platforms, how to succeed, and our favorite tips from the pros. 


What is Real Estate Crowdfunding? 

Crowdfunding is a way for people, businesses, charities, and other organizations to raise money. Let’s say a company wants to raise money. To crowdfund, they would typically pitch the project, business, or idea, usually on a crowdfunding website. In doing so, they collect funds from outside investors to work toward a common goal. 

The premise is simple: when a lot of people are willing to invest a small amount, their contributions add up. 

Real estate crowdfunding follows the same basic principle. A lot of people come together to invest in a shared goal, and in doing so become shareholders in a company or real estate property. 

For organizations and individuals, this grants access to capital they might never access otherwise--without the need to go through the banks. For investors, it’s a chance to gain otherwise inaccessible equity. 


History of Crowdfunding 

While crowdfunding is often called a new fad, that’s not actually the case for real estate. Believe it or not, real estate crowdfunding has been around for years, though it’s come a long way since the early days of four people splitting the down payment for a house. 

What’s novel about crowdfunding isn’t the idea of multiple investors, but rather in the technology and mindset giving crowdfunding renewed momentum. 

Based on this metric, crowdfunding as we understand it today began between the late 90s and early 2000s. This is when the earliest Internet campaigns and crowdfunding platforms hit the web, as well as early social networking technology that made modern crowdfunding possible. 

Things kicked off properly in 2005. That was when KIVA launched as the first platform to allow entrepreneurs to invest money in the developing world. It remains one of the most successful micro-lending platforms on the market today. 

The KIVA model, combining familiar social media features with personalization to allow investors to see where their money goes, expanded into peer-to-peer lending as an alternative to traditional bank lending, creating a direct line from investors to borrowers. 

In 2008, IndieGoGo was founded to democratize fundraising. In 2009, Kickstarter launched in the U.S. as a new way to fund creative ventures. You probably recognize the names--these remain two of the most popular crowdfunding sites in the world. 

In more recent times, two recent developments have changed the face of real estate crowdfunding in particular: the Jumpstart Our Business Startups Act (JOBS Act) and over $50 million from venture capitalists and strategic partners into leading real estate websites. The JOBS Act changed provisions in securities law to allow investors to raise capital from the general public utilizing broad-based advertising. 


How Does it Work? 

The basics of crowdfunding go something like this. 

Let’s say you want to invest in a property. Instead of saving up the money yourself and investing only your own money, you would get other small investors on board to help raise the necessary capital for the project. These investors would then become shareholders in the property or company. 

However, keep in mind that real estate crowdfunding is an umbrella term, not a single model. A single definition undercuts how complex real estate investing really is. 


Different Types of Real Estate Crowdfunding 

The easiest way to understand real estate crowdfunding is to examine the different types. 

There are four general types of crowdfunding

  • Loan-based crowdfunding, as the name implies, is when you loan money in return for a set interest rate, similarly to how a bank might give a loan. 

  • Equity-based crowdfunding, especially commercial equity-based investing, is perhaps the closest to the original concept of real estate crowdfunding. It is also a recent addition to the list made possible by the JOBS Act. Basically, you invest in a business and receive a stake in the returns, often in the form of shares. 

  • Reward-based crowdfunding is the simplest of the bunch. You give money in exchange for a reward linked to the project you’re supporting, independent of the project completion itself. This is also known as non-equity-based crowdfunding. 

  • Debt-based crowdfunding, more commonly known as peer-to-peer lending, is when borrowers create a campaign for their project and lenders contribute to the financial goal for an interest. 

For real estate, there are also real estate investment trusts, or REITs, a company that owns income-producing real estate, with the goal of developing properties to operate them as part of an investment portfolio. 

It can also be helpful to think of real estate crowdfunding in terms of platform types. There are two broad types: listing platforms like RealCrowd and Crowdstreet, and the middleman model, sometimes using SPV or feeder fund models, which is used by RealtyShares and RealtyMogul. 

Listing platforms, as the name implies, are sites where you can list your project to gather investors. SPVs, or special purpose vehicles, are subsidiaries created by a parent company to isolate financial risk. Similarly, feeder funds are smaller investment funds that pool investor money which is then aggregated in a single centralized master fund. 


What to Look For in a Real Estate Crowdfunding Platform 

The good news about there being so many different real estate crowdfunding options is that you have several different crowdfunding platforms to choose from, based on what best suits your risk tolerance and preferred investment style. 

That said, regardless of your preferred investing style or investment portal, all investors should look for these key qualities in an investment portal: 

  • Types of companies and deals

  • Quality of deals

  • Quantity of deals

  • Early-stage vs. later-stage startups

  • Investor fees

  • Due diligence

  • Types of securities offered

  • Secondary market options (for increased liquidity)

  • Payment forms accepted

Crowdfunding sites specializing in real estate are useful for investors who want to know that the platform is well-versed in such deals. There are several niche portals worth considering, like RealtyMogul, though that particular platform requires investors with the patience to thoroughly review the fine print. 

Another good avenue is to look at our complete list of crowdfunding platforms. The list includes ratings and reviews for real users so you can make sure you’re choosing the right platform for you. 


Potential Risks / How to Succeed 

As with any form of investing, there are certain risks attached to it--and certain tricks that will help you succeed. 

Finding the Right Sponsor

Finding the right sponsor is a challenge for any investor. Crowdfunding makes it more and less challenging. On one hand, you won’t invest huge sums at once, so your risk is comparatively lower. On the other hand, risk works differently in crowdfunding, so you need to make sure you’re making the right call. 

Once you’ve found the right platform based on the qualities outlined above, spend some time investigating your potential sponsor options on the platform. Once you find promising ones, you should have a list of questions ready. These include: 

  • What is the business’s background?

  • What is their experience with the product type, market, and business plan?

  • Ask for a sample quarterly report--how thorough is it? Does its performance match their expertise?

  • What’s their competitive advantage?

  • What can you find out about them online?

  • What are the risks attached to this sponsor?

  • Are they clearly outlining the risks upfront?

  • What does their campaign timeline look like? What are their goals? Are they realistic?

  • What reward are they offering for your investment? Is it worth it?

  • How much money is the business contributing? Look for 5% to 10% of equity contribution (you want a partner with skin in the game).

  • Why did the sponsor opt for crowdfunding over other investment options?

  • Can you meet in person or through video to discuss the details?

Don’t be afraid to ask questions and do thorough due diligence. You want a business that has more than just a cool idea. You want someone with a plan, experience, a realistic outlook, and a promising track record.  

Finding the Right Deal

For investors, the art of finding the right deal is ultimately the art of knowing what you’re getting into. Everything else being equal, you should spend time thinking about what investment vehicle and platform are the best fit for your unique needs. 

For a start, you have to know what kind of investor you are. For example, what’s your level of past experience with real estate investing? If the answer is, “Not much,” you’ll have to decide how much time you’re willing to sink into learning the ropes. Some platforms are more beginner-friendly, while others require a more hands-on, involved approach. 

Similarly, you have to spend some time getting acquainted with various investment tools. This is for two reasons: 1) you have to be able to recognize and understand the tools a platform offers, and 2) you have to know what tools you’re comfortable using. 

From there, think about what you want from a real estate campaign. Are you looking for a long-term investment? Are you looking for a campaign to buy investment properties and flip them? This will help narrow down the pool of options and ensure you find a campaign you’re comfortable with. 

Finally, it pays to do your homework on platforms. Platforms have come a long way over the years, but finding a platform that vets campaigns thoroughly while also providing options that you’re comfortable with will help ensure that you’re happy with the end result of your crowdfunding. 


Tips from the Pros 

Not sure where to begin? Here are a few essential tips from the pros. 

One of the most essential tips is to know the difference between early-stage and late-stage funds. Joining a fund early can provide benefits like lower minimums and more favorable splits. On the other hand, getting into a fund relatively late gives you far more visibility into what you’re investing in, making it easier to reduce risk and have confidence in the big picture. 

Another key tip is learning how to navigate risk. All investing involves some degree of risk, and real estate crowdfunding is no different. However, there are ways to be smart about risk so that you can minimize losses and maximize profits. 

Take sequence risk, for example, which is the risk of a major market correction in the early years of your retirement. This creates a reduction in your portfolio so significant that your portfolio may never recover if you continue to withdraw from it. 

The key to avoiding sequence risk is to craft a well-balanced portfolio. Real estate in general is a good investment vehicle to offset sequence risk since real estate markets don’t run in sync with larger markets, but you should still have a diverse enough portfolio that you won’t suffer unrecoverable consequences. 


Conclusion 

Real estate crowdfunding isn’t a new idea, but it is certainly a useful investment avenue. For many investors, it’s one of the most accessible ways to get started with real estate investment. 

Unfortunately, there’s no one-size-fits-all approach to real estate crowdfunding, mostly because there are several approaches you can choose from. The key is doing your homework on investment options and platforms in advance so that you know exactly what you’re looking for, where to find it, and how to set yourself up for success. 

References:

Jumpstart Our Business Startups Act, Pub. L. No. 112–106, 306 126 (2012).
https://www.congress.gov/112/plaws/publ106/PLAW-112publ106.pdf

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Castrataro, D. (2011, December 12). A social history of crowdfunding. Social Media Week.
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FINRA. (n.d.). Funding Portals We Regulate | FINRA.org. FINRA. Retrieved February 17, 2021, from
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Frost, B. (2020, April 2). What is Peer-to-Peer Lending? Business.Org.
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https://www.realestateinvesting.org/sequence-risk/

Partners, U. L. (2020, February 3). 5 Most Popular Types of Crowdfunding for Startups. University Lab Partners.
https://www.universitylabpartners.org/blog/5-most-popular-types-of-crowdfunding-for-startups

Real Estate Crowdfunding More Accessible Than Ever. (2020, October 6). Fintech News.
https://www.fintechnews.org/real-estate-crowdfunding-becomes-more-accessible-to-retail-investors-globally/

The Beginners Guide To Crowdfunding. (n.d.). Milaap. Retrieved February 17, 2021, from
https://milaap.org/stories/crowdfunding

U.S. Securities and Exchange Commission. (n.d.). Real Estate Investment Trusts (REITs). Investor.Gov. Retrieved February 17, 2021, from https://www.investor.gov/introduction-investing/investing-basics/investment-products/real-estate-investment-trusts-reits

Vogel, J., & Moll, B. (2014). Crowdfunding for Real EState. Dartmouth University.
http://tuck-fac-cen.dartmouth.edu/images/uploads/faculty/john-vogel/crowdfunding_real_estate.pdf


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