Beginner’s Guide to Real Estate Crowdfunding

Michael QuanEducation, Income, Investment, Misc, Real Estate23 Comments

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I’ve been asked by a few of readers to dive a little deeper into my experience with real estate crowdfunding.  So, I thought it’d be helpful to start out with a post on what it is, and why I like it so much.

As an early retiree, I have some added pressure to make my current nest egg work for me.  This means I’m constantly scouring investment opportunities looking for places to make my dollars grow and return to me quicker.

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Don’t Save… Invest!

With current savings rates so low and trailing inflation, it actually costs you money to keep your cash liquid!  Not only that, but the measly interest income is then taxed on top of that.  So, one of my biggest problems is trying to find suitable investment vehicles to grow our assets with healthy returns, but simultaneously minimizing risks.

My approach to this problem is simple.  Use diversification and sound financial knowledge to mitigate risk.  I then follow-up by focusing my discretionary investment capital into “active markets” (markets that are moving up at a faster pace) to extract a better return.

NWA Calc

As you may have seen from my net worth allocation, I diversify our assets into several areas with a higher preference towards real estate.  Don’t get me wrong, I still like the stock market, but parking my assets into index funds is like watching paint dry.  That’s why I also have discretionary investments where I can be more active if I choose.

As an active real estate investor, I’m always keeping my ear to the ground to get a sense of where particular markets are headed.  A few years ago, I saw some opportunities to purchase homes that would cash flow healthy returns of 15% or more.  I purchased a couple of them and they’ve since performed very well.

HOWEVER, this took a ton of work just for these two investment homes.  Once my children were born, I needed to focus on their needs and I wasn’t able to spend as much time looking for deals.  Yet, I still attended my local REI (real estate investment) club and continued to learn as much as I could.  One day while I was reading their forums, someone mentioned real estate crowdfunding.  I was like, “what the heck is that?”

 

What is Crowdfunding?

So, what exactly is crowdfunding first of all?  Well, I’ll be honest, I’m a techie and it still took me awhile to grasp the concept.  So don’t feel bad if it takes awhile.

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Basically, crowdfunding is using the Internet to raise money for a specific project or investment.  With the Internet nowadays, people looking to find money can appeal to a mass online audience (the “crowd”) incredibly fast.  Their raised capital can then be used as an alternative financing option (this didn’t exist until recently!).

Real Estate Crowdfunding

To better understand how this specifically applies to real estate investing, I’ll illustrate with an example.

DEVELOPER: A real estate professional that purchases distressed properties, tears them down, puts up a new building, and sells it at a profit.

INVESTOR: An accredited investor looking to put up cash in exchange for a good return on investment (ROI) – target of 9% to 18%  (this is where I like participating currently)

As a DEVELOPER you may be able to get traditional financing for your first few projects, but after a certain point, a “normal” bank won’t give you any more money because he views you as too leveraged (even though your properties may be incredible deals).  So, without a traditional bank’s money, you’d need to find a partner to put up the money, or find a hard money lender who will provide funds (usually at a significantly higher cost).

Crowdfunding help to creates a more efficient market!

A crowdfunding company, like RealtyShares, can help the DEVELOPER gets access to better rates over the traditional hard money lender.  Likewise, the INVESTOR gets a strong rate of return on his/her investment and is able to hedge risk by pooling his/her money with other investors.  Furthermore the investor can spread risk across different DEVELOPER projects instead of putting his/her eggs all in one basket.

Crowd Funded Real Estate Investing

In my illustration above, you’ll notice the Real Estate Investor DEVELOPER is trying to raise $25,000 (FYI, this is just an arbitrary number for the example, it could be $25M!) to fund his latest real estate deal.  However, he’s already tapped out with conventional mortgages and will not be able to get any further financing from a traditional bank.

He now has the option to borrow money from a hard money lender at 14% (interest only), but luckily for him, he found another option through RealtyShares who will lend him $25,000 at a lower rate of 10%!  After getting approved by RealtyShares (he needs to prove that his project is worthwhile), RealtyShares will create an investment profile page for INVESTORS to view.

From here the INVESTOR can do his own due diligence on the opportunity, ask questions, decide if he wants to move forward with an investment.  An investment could be a little as $5000.

Invest With The Best

What I really love about Real Estate Crowdfunding is my ability to invest alongside other real estate investors.  Having knowledge of real estate already gives me an additional edge to evaluate the project and figure out the probability of its success.  In fact, once you find a developer with a great track record, stick with them (just remember, never blindly invest into anything… always do your research)!  statistics-76197_640

Knock on wood, but I’ve been able to pull down some incredible returns thus far on RealtyShares… 9%-19% on the capital I’ve invested and had returned to me.  I love it!

Now that I’ve given you the basic premise of a real estate crowdfunding, I am going to work on creating a post to do a deep dive into RealtyShare’s platform that I have used for the past 2 years and discuss different types of investments you may see there.  Please note that I have an affiliate relationship with RealtyShares and I receive compensation if you sign up with my link (I’d really appreciate it!), but my opinions are completely my own… remember I will only recommend products or services that I believe can help you, my readers.

Real estate crowdfunding sites (*I’m sure there are probably others now, but were the ones that come to mind):

Readers, were you familiar with real estate crowdfunding before?  Have you ever tried a real estate crowdfunding site before?  Do you see it as a viable investment option in the future (especially if they lift the accredited investor requirement)?  

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23 Comments on “Beginner’s Guide to Real Estate Crowdfunding”

  1. Michael,it is really a wonderful talk on the subject. Last evening I was going on the same subject here http://crowdfund.co/real-estate/ , but they have mentioned that people are now not investing in purchasing the properties but they are investing in the start up real estate projects, as returns are better . Here they have also mentioned that investing in this sector is full of risks as sometimes investors have to wait for years for receiving returns and sometimes if the project get fails, they have to lose their investment amount also. But still it is the first preference of investors.

  2. This is a fascinating alternative once you get to the accredited investor level. Thanks for explaining it so clearly.

  3. Hi Michael! I learned something new today through your post, didn’t think that would happen! I’m wondering how you feel about the risk of investing in crowdfunding. From investing in REITs, physical properties, and helping someone develop real estate, don’t you feel that it’s significantly riskier when you’re giving money to develop a completely new building rather than investing in an already completed one?

    This looks to be a great way to diversify away my risk, as the only real estate investments I have are in ETFs as you’ve mentioned (I like watching paint dry! 🙂 ). Still need to do my due diligence though as bad news from lending club are happening but looks promising!

    1. Hey FS, I’m glad you were able to learn something new here!

      They way I view risk is relative… relative to your knowledge of an investment opportunity and it’s probability of being successful. With real estate investing that projects, I look to invest when I see market trends with upward momentum. Also, I’m specifically looking at a developer’s overall cost estimates and purchase price for a property. I also want to know that he’s got enough skin the game to ensure he’s committed to the investment as much as I am too. Finally, I’m also looking for a track record of success with prior projects.

      If I’m able to answer all of these questions with confidence, then I’m much more likely to invest. Of course, you can never take away risk completely, so that’s why I diversify also. If one or two investments go belly up, then I”ll still be okay.

  4. Great info here Michael. I’ve heard about this platform before but never looked into it too much. Very intriguing.

    What are the requirements to be an accredited investor? I’m assuming the Average Joe making a median American income would not be able to qualify for an investment like this. Thanks!

    1. Hi Syed, the qualifications to be an accredited investor are noted here. So, you are correct that not all investors can meet the requirements. However, there is a lot of legislation in the works to allow other non-accredited investors to participate as well.

      1. Thanks for the info Michael. It seems like the vast majority of Americans would not be considered accredited investors. It would be interesting to see what type of legislation is introduced.

        1. Some legislation has already been approved to allow non-accredited investors to participate, however, it remains to be seen if Title III of the 2012 Jumpstart Our Business Starts Up Act (“JOBS Act”) will apply to real estate crowdfunding.

  5. Helpful information indeed.

    Mr. MMM recently wrote an article,on Peer Street.
    Naive question, what, if any, are the key differences between this one and the others you mention?

    1. Mr. PIE, I wish I could tell you specifics, but I’m most familiar with RealtyShares. I do know that a few of them are similar in concept, but they vary in their approach in terms of the projects they bring to investors (some may focus more on commercial vs. residential projects) as well as their specific web platforms.

      For me, I was most interested in the quality of the deals and two years ago I felt RealtyShares had the best. For example, they had some developers that had 100 projects under their belt and multiple projects underway. I liked the ones that were going into high-end neighborhoods like Beverly Hills, knocking down an old house, and putting up a new structure that really increased the value of the property.

  6. Thanks for this post! This is an area where I’m hoping to become a little more familiar with to see if it fits for my portfolio.

    Looking forward to the post you mentioned to Mr. Tako about taxation.

    — Jim

    1. I’m glad it helped to shed a little light, Jim! I may not be an investment for everyone, but it certainly is worth looking into. I look forward to writing the follow up post! 🙂

  7. I like the idea of real estate investing in a less risky/more diversified way – and one that doesn’t involve me flipping the property myself.

    I find investing really interesting – it’s actually one of the things that keeps me motivated to pay off debt. Once the debt gets paid off, I get to start doing the really fun stuff!

    1. Thanks for the comment, Pia. Yeah, it’s a great way to start learning about deal structure if nothing else as RealtyShares does a pretty good job to vet the developers they allow onto their platform. Hence, we can learn alongside them and see how they structure a win/win deal.

  8. While I see the intrigue with real estate crowdfunding sites, I am still hesitant to invest in them. While I understand it gives you a way to diversify your holdings across many projects, I still feel like the risk can be high on these sorts of projects. Does RealityShares force the developers to have separate LLCs for each project? Otherwise, I’d be nervous that they would try and group multiple together and that a project I am not invested in could go wrong and destroy my investment as well.

    1. Thias, I suspect you’re not alone in your hesitancy to participate in real estate crowdfunding. It took me quite awhile myself to jump in for some of the same reasons you mentioned. However, if you check out the comment by Biglaw Investor, I replied with a link explaining how the LLCs are separated to protect investors. Even then, you are correct that this is a speculative investment. This is why I use my discretionary funds here, and I also try to mitigate some risk with my personal knowledge of real estate investing.

  9. Michael,

    Do you know where the LLCs that you invest in are bankruptcy-remote from RealtyShares or whether you’re also taking on bankruptcy risk from RealtyShares? One of the odd things about LendingClub is that from what I’ve read it appears you are actually making the investment through LendingClub and therefore running a risk that if LendingClub goes bankrupt, you may not get paid. I’d only be comfortable investing in a real estate deal if I knew that the LLCs they set up were separate for each deal and would NOT be considered part of RealtyShares’s estate in a bankruptcy.

  10. Michael, I appreciate the explanation of the basics on real estate crowdfunding. Anyone who is looking into it for themselves would be wise to read your post.

    At this time, I am researching Fundrise from a number of perspectives: for an upcoming post, recommendations for a friend, and possible discretionary investment myself in the next few months.

    1. Thanks for the comment, FSH! I’d be interested to hear about your experience with fundrise. Back when I was doing my initial research a couple years ago, I signed up with a few different platforms. RealtyShares had the best one back then, and more importantly, I like their deals better. I should probably get out again to see what types of deals are available on other sites.

  11. Hi Michael. From a taxation point of view, is the return considered income or cap gains? If it’s a cap gain, is that short or long term type gain?

    As I’m sure you know, any real estate investor needs to understand the taxation situation before they can make a proper comparison between investments.

    1. Hi Mr. Tako, excellent question! Unfortunately, the answer to that question is – it depends. In my next post, I’ll try to cover some of the possible scenarios. To give you a basic idea though, when I participate in an equity deal at RealtyShares, I’m investing as a fractional owner of the LLC. LLCs are typically pass-through tax entities meaning that it’s not taxed at the entity level and simply passed through to the members. So, in my particular case, I get a K1 at the end of the year showing passive income (or a loss). This also gets more complicated if you invest outside your own home state, so I’ve been trying to stick with CA deals thus far. Hope that helps!

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