Real Estate Crowdfunding: A Smart Choice for Investors?

Crowdfunding, the use of small amounts of capital from a large number of individuals, has become a popular way of financing everything from personal emergencies to new business ventures.

Through social networks and websites such as Kickstarter and GoFundMe, crowdfunding allows investors to select from hundreds of causes and projects, sometimes investing as little as $10. The global amount raised by crowdfunding is $34 billion (according to fundraising platform Fundly) and experts predict that global total will nearly triple by 2025.

You’ve seen the effectiveness of crowdfunding; maybe you’ve already participated in a few projects for a favorite charity or someone’s hospital expenses. You also may have participated in a friend’s crowdfunding project for a start-up.

But what about crowdfunded real estate? Is it a smart choice for you as an investor?

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How Does REI Crowdfunding Work?

Before 2012, real estate investing was primarily the exclusive domain of career pros with plenty of capital. However, legislative changes that year allowed the option of crowdfunded real estate investing.

The process works the same way as other crowdfunding projects. Investors pool their money to fund a project or a company in the expectation of future profit. Some people even raise enough money to cover the purchase of a home through crowdfunded mortgages.

Real Estate Crowdfunding Returns: Two Ways To Earn

Crowdfunded real estate investments offer two primary ways investors can see returns -- income and equity appreciation. Most deals offer some income potential, but it is not guaranteed, and it can take several years for an investment property to generate much of an income stream.

Most crowdfunding projects list terms of a profitable exit through equity appreciation. When you browse through different real estate projects, you’ll notice that most list a target holding period ranging from three to 10 years. After this holding period, the property will be sold, and investors will receive a share of the proceeds.

Here are some other terms you need to know as you determine if real estate crowdfunding is right for you.

Crowdfunding Terms For Investors

Target internal rate of return (IRR): This metric spreads your cash flow and equity return over the course of the holding period on an annualized basis. If you know your investment's yearly cash flow and the lump-sum distribution you'll receive at the end, you can use an online calculator to figure out your investment's IRR.

Equity multiple: This metric tells you the expected return of an investment over the entire holding period.

Average cash yield: Sponsors of these projects often list a target average cash yield over the holding period. If you seek a minimum level of income from this investment, you’ll need to look carefully at the annual amount the sponsor plans to distribute.

Next, let’s examine the pros and cons of real estate crowdfunding.

Advantages of Real Estate Crowdfunding

1. Affordability. Investors can gain access to the real estate market with small amounts of money. The entry price can be as low as $500 and is usually around $5,000.
2. Convenience. The crowdfunding platform you use does most of the legwork for you. You can study the research, make comparisons, and then make an informed decision. You are a passive investor with no responsibility for managing the property.
3. Transparency. Since real estate crowdfunding is done via online platforms, you have unlimited access to information regarding assets and potential risks.
4. Predictability. Crowdfunded properties are not publicly traded, so unlike stocks, currencies and commodities, their prices cannot fluctuate along with the market.
5. Flexibility. Real estate crowdfunding allows you to diversify your portfolio with different types of assets, spreading out your wealth and creating a financial safety net.

Disadvantages of Real Estate Crowdfunding 

1. Low Liquidity. If you seek regular income from dividends, crowdfunding may not be the best choice for you. You’ll find it nearly impossible to cash out on this illiquid investment, and, as we have discussed, you may encounter lengthy holding periods.
2. Insecurity. Plans to renovate and resell a commercial property may not go as planned, limiting your potential returns. The risk of investment default is higher for crowdfunding compared with other forms of real estate investment funding.
3. Fees. The platform you choose may charge annual fees ranging from 1 percent to 2.5 percent (or even higher) of your managed assets. Also, be sure to read the fine print for hidden construction or management fees.
4. Lack of control. When you invest in real estate via crowdfunding, you are not an owner of the property and therefore have no say in how the property is managed. If you like to be hands-on with property decisions, real estate crowdfunding is not for you.

The pandemic and the resulting economic turmoil have severely tested real estate crowdfunding platforms. In a recent article for Forbes, Adam Kaufman of the Arbor Crowd crowdfunding platform, writes that the real estate crowdfunding industry is at an inflection point.

“If platforms want to continue to share in the upside of the global real estate crowdfunding market, which in 2019 was projected to reach $9 billion by 2021, we must prioritize the end-user over all else,” Kaufman writes.

So, is crowdfunded real estate investing right for you? After carefully weighing the pros and cons, your answer comes down to your investable assets, your investment timetable, your risk tolerance and your portfolio diversification preferences. Do your homework, research the top real estate crowdfunding sites and develop a strategy that works for your financial future.