What is Crowdfunding?
Crowdfunding is the process of raising funds from the public to provide capital for a specific project. You have seen this type of funding to raise money to build a specific product (as in Kickstarter projects for example). In a Kickstarter project, a specific product concept is floated out to potential buyers. If buyers are interested, they pre-purchase the product before production begins. If the project reaches its funding goal, the product is built and the buyers receive the product once produced. Other types of crowdfunding include social projects (GoFundMe), company equity, oil and gas exploration and real estate projects (the subject of this article).
What is Crowdfunding for Real Estate?
Historically, real estate investing has been limited to two types of opportunities for the retail investor.
Direct Investment
Direct Investment is the purchase of the property directly by the investor. This is a “hands-on” investment where the investor purchases the entire property and deals with the loan process and management of the investment real estate property. Direct investment typically provides higher returns and tax benefits.
Real Estate Investment Trusts (REITs)
A REIT acts similarly to a real estate mutual fund as they invest in multiple real estate properties. The REIT management handles all aspects of identifying, purchasing managing and disposing of investment properties. REITs can be publicly traded on a stock exchange or can be private REITs that are not publicly traded. Some real estate mutual funds (like VNQ from Vanguard Funds for example) purchase a basket of individual REITs as their portfolio. Publicly-traded REIT investing offers much better diversification and much better liquidity than direct investing.
Due to recent changes in securities laws, crowdfunding investments (including real estate investments) have emerged as another avenue for investors to acquire individual properties in smaller groups. This crowdfunding of investment capital opens up access to properties retail investors have been excluded from in the past. Retail investors can identify an individual property and group together with other investors on crowdfunding platforms to acquire the property. The investment sponsor manages all aspects of the property for the investor.
Why Invest in Crowdfunded Real Estate?
This new crowdfunded real estate investment access neatly bisects the historical wide divide between direct investments and REIT investments, giving the investor the opportunity to isolate specific real estate investment projects (similar to direct investments), while spreading out the risk and management headaches associated with direct investments. Instead of buying one $500,000 property and managing it yourself, you could invest $50,000 as a portion of each of ten separate crowdfunded real estate investment properties. The goal of real estate crowdfunding is to give the benefits of direct investing (higher returns, individual property ownership, different deal structures, more transparency) while reducing the drawbacks (property management, transaction complexity, deal flow).
These new real estate crowdfunding platforms source potential investments and allow you to directly invest in projects via the platforms. Typically due diligence documents for the investments are available on the platform, as well as a dashboard for tracking and monitoring your investments. Real estate crowdfunding platforms have several different types of deal structures including equity investments (stock in the specific real estate venture), hybrid investments (a hybrid of equity with some fixed return characteristics) and debt instruments (my favorite since the investment is secured by the property itself).
How does Crowdfunding for Real Estate Work Specifically?
To answer the question “What is Crowdfunding for Real Estate?”, let’s take a look at a specific example of one of the crowdfunding platforms I used to use for my crowdfunded real estate investments, Peerstreet. Note that Peerstreet declared bankruptcy in June of 2023, and is not operating any longer.
Peerstreet is open to accredited investors only. This real estate crowdfunding platform is focused on high quality real estate loan investments. In the past, if I wanted to invest in real estate notes, I would need to buy the entire mortgage. This would add overhead, in that I would need to service the loan (ie collect payments, make sure the property was insured, foreclose, etc.).
When I signed up for my Peerstreet account (and was verified as an accredited investor), I attached my Peerstreet account to my bank account to fund potential investments. I researched different investments in the platform and then invested in the ones I selected. Each month my portion of the loan payment was credited into my Peerstreet account. If the mortgage was paid off, the principal also was deposited back into my Peerstreet account. If someone defaults on a note, Peerstreet forecloses on the property and then returns my portion of the collected principal from the foreclosure sale of the property.
With the Peerstreet platform, I crowdfund the loan with other investors, putting in as little as $1,000 per loan. Additionally, Peerstreet services the loan so I don’t have the headaches associated dealing with borrowers directly. So if I allocate $250,000 of my real estate-focused portfolio to debt instruments (real estate-backed loans), I could in effect invest $10,000 into 25 separate loans, diversified by location, investment type (commercial, multifamily, residential, etc.) and borrower. All of these benefits combine to reduce the risk of holding one $250,000 mortgage on one property in one location.
What is Crowd Funding for Real Estate- Final Thoughts
So, what is crowdfunding for real estate? It is a potential option versus physical real estate, but it doesn’t have enough advantages to outweigh the illiquidity. I give real estate crowdfunding a Lever Rank of 40 compared to the other business income levers I currently cover.
I arrived at this number considering all of the factors, including:
The cost of using the different crowdfunding platforms
(low for the platform itself – high to acquire the capital in the first place)
Risk of capital
(variable depending on the location in the capital stack and the specific project)
Time allocated to reviewing the investment opportunities
(Moderate as the platforms aggregate due diligence documents for you)
Effort to run and maintain the business model
(Minimal)
Longevity of the business model
(Variable depending on the specific investment)
Growth of the business model
(Variable depending on the specific investment)
In later articles I will dive into the different real estate crowdfunding platforms that I use and how they have worked for me. I will also detail the pros and cons of crowdfunding real estate investments, as well as things that I look for in a platform, and things I try to avoid.
As an individual investor, it is up to you to do your own research and make your own investment decisions. I do not provide any form of investment advice and am only reviewing tools, platforms and other business ventures that I use, and sharing my experiences with these platforms along the way.
