How Crowdfunding Real Estate Works
Crowdfunding has long been a resourceful way for investors to pool money and go in on an investment together. Today, with the ease and ability to both find people, and then even initiate investments online, real estate crowdfunding may just have become the biggest and greatest disruptor to the real estate industry in centuries.
What is real estate crowdfunding, exactly? And what are the pros and cons to this investment strategy? Learn all this and more, including how to gauge and analyze which investments are the best, and what tax implications you should be aware of, in our guide on how real estate crowdfunding works.
What is Real Estate Crowdfunding
Real estate crowdsourcing is the concept of using the Internet (and yes, sometimes even social media) to connect like-minded investors looking for opportunities in the world of real estate. Real estate crowdfunding platforms will pool money from individual investors, and then invest in large-scale real estate trusts or developments. At that point, investors become shareholders and can start earning dividends on a project.
If you’re looking to diversify your portfolio, crowdfunding real estate opportunities may be able to offer you access to a whole new level of investing. While traditionally large-scale real estate ventures have been cost prohibitive for many investors, crowdfunded real estate is changing the scope of the investment landscape through smaller, individual investment thresholds.
Benefits of Real Estate Crowdfunding
Real estate crowdfunding is proving to be wildly popular with investors looking for opportunities outside the stock market. There are many benefits to this newfangled type of investing.
- Diversification: Real estate is a great way to diversify your portfolio.
- High Dividends: Crowdfunding real estate investments like Real Estate Investment Trusts (REITs) can offer higher dividends than some other more traditional real estate investments. REITs are required to pay 90% of their taxable income to their investors.
- Low Minimums: It’s easier than ever to get in on real estate these days. Real estate crowdfunding can offer low investment minimums, sometimes even just $500-$1000 per deal.
- Professional Property Management: Being a landlord is time consuming and often frustrating. Crowdfunded real estate investment opportunities mean you enjoy the benefits of property ownership, but without the hassle of property management.
Limitations to Real Estate Crowdfunding
Of course, there are some drawbacks to real estate crowdfunding investments, too.
- Illiquidity/Rate of Return: Maintaining a diversified and balanced portfolio means holding both liquid and illiquid assets. While it is important to have some of each, too much illiquidity means all your money is tied up and untouchable. Real estate crowdfunding investment opportunities typically are illiquid.
- Fees: Although there are fees with almost every investment opportunity, be sure to do your due diligence when it comes to understanding the fees associated with a crowdfunding deal. Annual fees on real estate crowdfunding investments could range anywhere from 1% to 2.5%, or sometimes even higher. It’s extremely important that you closely read the fine print on any investment you’re considering, be it real estate or anything else.
- Tax Implications: Of course the goal of any investment is getting the greatest return on your money possible. But keep in mind that real estate crowdfunding pays back in dividends, which will likely have a tax implication. Be sure to carefully look at the tax form you receive from any real estate platform you’re considering. They should be outlining what tax will result from qualified dividends vs ordinary dividends, as well as the tax on the return of capital - each of these is taxed at individual rates.
- Accreditation: In the past, real estate investment platforms have been limited to accredited investors, which are high net-worth individuals (usually worth $1m+). Newer platforms have set out to disrupt the industry though, making REITs more accessible, with lower minimum investment requirements.
How to Judge Crowdfunded Real Estate Investments
Any time you’re considering a new investment opportunity, it’s critical that you fully understand all the potential rewards, as well as any risk you’ll be assuming. Particularly if you’re interested in a crowdfunding real estate deal, the following criteria are important to research.
Risk
You always want to know what you have to lose before you put money toward an investment. Make sure you look at how complex a project is, and you must be comfortable with how much reward you’re expecting when compared to the risk.
Debt
Reviewing a project will let you assess the debt-reliance of the deal you’re looking at. Watch out for excessive debt - and while there isn’t really a firm, hard number on what that would be, some experts say no more than 70% of the total capital stack should be debt.
Fees
There will be fees associated with any investment opportunity you take advantage of. You should know up front and before you sign on the dotted line what those fees will be and how and when they will be collected.
Target Return
Target return can be calculated based on your initial investment plus the profit you hope to get in return. That number needs to be adjusted based on the time value of money.
Payment Schedule
Real estate crowdfunding investment deals typically payout quarterly through dividend distributions. Some investment opportunities will payout monthly. Remember, REITs legally need to pay out at least 90% of their income to their shareholders.
Crowdfunded Real Estate Investing Requirements
Crowdfunding platforms will have various investor requirements. For example, some sites have requirements specifically for accredited investors (who have a net worth of $1m+).
But even for investors just starting out, or for those who haven't quite built up their net worth past that 7 figure mark, there are alternative funding options out there.
Tax Implications
As noted earlier, there are tax implications on crowdfunding real estate dividends. Certain factors will come into play when determining exactly how much tax you’ll owe. Non-accredited investors (who have a net worth of less than $1m) and accredited investors will be taxed differently based on their deal. And, if you’re not in that $1m+ camp, it’s important to remember that even though it’ll be easier for you to file, if you’re in a very profitable deal, you could potentially face a hefty tax liability.
Is Crowdfunding Worth It
Crowdfunding for real estate can be a smart investment, depending on a few factors, including:
- Your goals
- Your risk tolerance
- Your other investments in your portfolio
Average returns on real estate crowdfunding deals can range between 9% - 15%, so if your goal is to invest for diversification, and you’re comfortable with that rate of return, it may just be a route worth exploring further. Crowdfunding isn’t for everyone, but it can be a great opportunity with huge potential.
Crowdfunding Real Estate with Connect Invest
Real estate crowdfunding has exploded in recent years, and there’s no sign of it slowing down any time soon. To be a part of this exciting new(ish) investment opportunity and start building your wealth and diversifying your portfolio, check out the real estate opportunities available on Connect Invest today!