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Real Estate Crowdfunding: Is it Your Best Option?

Capitalism.com
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February 11, 2020
Real Estate Crowdfunding

Many of the world's wealthiest people accumulated their riches via real estate. Are you thinking about running off to do the same? Remember that following their example is more complicated than selecting the right industry. For every success story, there are many cautionary tales. This makes it essential to do your homework beforehand. One good starting point for this research is looking into the wide range of options at your disposal, including real estate crowdfunding.

Read on for a look into the various options and the ways they can serve your goals. 

Real estate crowdfunding and trusts each have their risks and advantages. Some options offer superior accessibility. This is helpful for new investors with fewer funds to deploy. Other factors worth mentioning include:

  • Rate of returns
  • Riskiness of venture
  • Investment time frame

Read on for a look into the various options and the ways they can serve your goals.  

What is Real Estate Crowdfunding? 

It begins when a developer or sponsor designates a project as open for investing. Real estate crowdfunding can mean older building renovations. It can also mean new construction. Developers need capital to fund the undertaking. They often combine bank loans and cash from crowdfunding contributors. 

Real estate crowdfunding provides opportunities for investors. Crowdfunding investors often don't wish to fund an entire enterprise on their own. They stand as limited partners in the venture. This requires that they invest money upfront along with other crowdfunding investors. They will receive payouts as the building accumulates rental or lease payments. Once the project sells, they will get back their initial investment. They will also receive a final share of the price.  

These projects offer great accessibility to lower budget investors. Of course, they also present some risks. Developers can't guarantee the property will command the rent they project. The development's value upon completion is also uncertain. After all, the real estate market has shown that it will change without warning. 

The amount of risk can fluctuate depending on the development. For example, projects like warehouses and storage facilities tend to be safer investments. As e-commerce continues to rise, the need for these places will keep them in demand. Ventures like apartment buildings are vulnerable to swings in the economy. Economic turns also affect retail locations.

crowdfunding real estate

Is Real Estate Crowdfunding a Good Investment?

Some investors might worry about the viability of real estate crowdfunding. This is most likely due to how new it is, compared to other alternatives. The JOBS Act of 2012 made it possible for crowdfunding platforms to advertise. These advertisements offered investment opportunities to large pools of funders. This contributed to surging popularity. 

If you're interested in real estate crowdfunding, you still have a decision to make. This decision is between accreditation and Regulation A. The ideal fit for you depends on the current state of your assets. Deciding on the right option between the two is difficult. It begins with assessing them to see which of the variables best lines up with your intentions. 

Option 1

Accredited investing requires you have at least $200,000 in liquid capital or a minimum of $1M in net worth. Investments begin at $25,000 and are typically attached to specific projects. The developments themselves are usually on the bigger side. They include hospitality locations and commercial renovations. 

Option 2

Regulation A investments have a minimum of just $500. They usually don't center around a single development. Your real estate crowdfunding investments would go into several projects, giving you no real control over the use of your money. If hands-off investing suits you, this avenue makes sense. 

Can You Make Money Crowdfunding Real Estate?

Being able to make a profit comes down to finding the right balance between risk and reward. The time frame is also a significant factor. One major drawback of real estate crowdfunding deals is the lack of liquidity. Since your money remains tied up in numerous ventures, you wouldn't be able to get it back if you need it in a hurry. Crowdfunded projects also tend to last for a long time. This translates to a long wait before you see returns on your investment.  

If your financial strategy doesn't require access to your funds once you've invested, this could work for you. You'll still need to consider the deal's length and all potential risks you might face from onset to completion. New construction could provide a bigger return, but simple renovations would take much less time to pay off. The longer the project, the greater the risk of economic shifts or other problems impacting the bottom line. 

Possibly the greatest advantage of real estate crowdfunding comes with the availability of projects. You get a chance to invest in properties that could otherwise fall outside your budget. Crowdfunded real estate deals usually only require small contributions. However, you never lose the potential for sizable returns.  

making money with estate crowdfunding

What are Real Estate Funds?

Real estate funds are a way for investors in the space to enjoy similar benefits to mutual funds. This includes portfolio management assistance, liquidity of funds, and diversification of investments. Most real estate funds deal with commercial developments and corporate projects. They can also cover agricultural spaces and apartment buildings. Income to investors mainly comes from an appreciation of the funds over time.  

Real estate funds come in open-end and closed-end varieties. Open-ends permit entry or departure from the fund at any point, so long as it's active. Closed-end real estate funds, on the other hand, have fixed points for entering and exiting. Real estate crowdfunding investors need to provide capital within a specific timeframe and must remain with the fund until it reaches a natural end. 

As is also the case with mutual funds, a real estate fund can be actively or passively managed. For the most part, passive strategies involve trying to replicate an underlying index's performance. Actively managed funds have managers who oversee the purchases and sales of assets. Instead of seeking to replicate an underlying index's performance, they try to beat them. 

Most types of real estate investments have limited liquidity, as it can take years to sell off pieces of property for capital. Real estate funds are different, as investors can redeem their shares in as few as three business days.  

What are real estate funds?

What Does REIT Stand for? What Exactly Are They?

REITs stand for real estate investment trusts. They are companies that either finance, own, or operate revenue-generating real estate. They offer communities the chance to reach new heights. This grants all investors the opportunity to own valuable properties. People can invest in them the same way they'd do so on the stock market -- only for real estate.  

REITs allow for investments in physical properties without the need to go out and acquire any. They are securities that can trade on the stock exchange like an ordinary stock. Mainly, they deal with investments in commercial and residential real estate. That said, they also participate in mortgages and related securities. For the most part, REITs produce revenue via rent collection on the owned properties.

REIT investments encompass a broad scope of real estate developments. These include apartment complexes, office buildings, stores, hotels, medical centers, warehouses, and even cell towers. Collectively, REITs account for over $3 trillion in gross assets in the United States.  

what does it mean to crowdfund real estate

Why REITs are Better than Stocks 

Although REITs and stocks are different from one another, they also share some similarities. Both pay their shareholders income through dividends. Both can represent a steady stream of income if you've made the right choices. However, while both are available for purchase via brokers or on stock exchanges, they do not work the same way within the market.

Stock investors buy ownership shares in publicly traded companies. REIT investors purchase shares in real estate. The trusts they invest in own and manage real estate mortgages and properties. The income they generate comes from rents. These tend to stay more reliable throughout the investment. On the other hand, success with stocks hinges on applying strategies based on market changes and projections. 

Arguably the biggest advantage of REITs over stocks is the SEC requirement. It states that REITs distribute a minimum of 90% of taxable income to shareholders. For investors with their sights set on maximizing returns as soon as possible, this is a big plus. REITs are also taxed only once at the investor level. 

Lastly, REITs offer superior capital appreciation over the long-term. This makes them a strong fit for retirement accounts and IRAs. Over 87 million Americans invest in REITs by way of their 401k or other retirement accounts. The stability of REITS is as opposed to traditional stocks, which are more susceptible to changing trends in the market. Marketwatch statistics suggest that REITs have proven to be more reliable than stocks. This is particularly true during periods of recession and economic hardship.  

What is the Difference Between REITs and Trusts? 

REITs and typical trusts mainly differ in that they're focused on different fields. REITs are strictly centered around real estate deals, while business trusts can deal with just about any other industry. Other points of contrast include the way they utilize management and the methods by which dividends payout to investors. 

Unlike with business trusts, where the entity who owns the assets also handles the management, REITs separate the two. The trustee is the asset owner, and there is also a manager who handles the actual running of the operation. In the case of a change in management, business trusts need 75% of votes for a new manager. REITs only require a majority of votes. 

Regarding dividends, investors in a REIT can usually depend on a steady income stream. This is thanks to the requirement that they payout 90% of their income via dividends every year. On the other hand, business trusts have no such requirements. They have no minimum distributions to worry about, which can be a problem for some shareholders.  

How Do REIT Managers Make Money? 

Some REITs keep their managers on payroll, while others prefer to hire managers from outside. The number of money managers earn can have a wide range. It depends on factors like agreement terms and the performance of the funds themselves.  

REIT management salaries tend to be on the higher end of the spectrum. Many earn over $250,000 annually. However, there is also room for other types of compensation, particularly cash bonuses. Sometimes the threshold will be set according to external measures, like a stock market index. 

One form of compensation that has gained popularity recently is providing managers with shares as their bonus. Shares in a successfully managed REIT will gain additional value. This helps this form of compensation align the interests of managers with those of the investors. At the same time, agreements can limit stock rewards if the fund fails to meet their desired targets.  

how do real estate investment trust managers make money?

How Do Business Trusts Work?  

A trust forms when assets are overseen by an entity or a trustee appointed to manage them. When the assets in question belong to a business corporation, it is a business trust. Trustees handle the ongoing business operations. They have the goal of creating profits for beneficiaries. These recipients can continue getting income installments for the business trust relationship. 

Using a trust for the running of your business comes with certain tax advantages. It can also serve to protect your assets from litigation or creditors. However, the disadvantage of business trusts comes with the need to distribute each year's profit to the beneficiaries. This can be a major obstacle for people hoping to cultivate growth in their business.  

Business trusts come in two variations, unit and discretionary. Discretionary trusts give trustees the option to choose the distribution of the income. Additionally, they get discounts on capital gains made upon selling assets held for at least a year.  

Unit trusts divide the income into fixed parts, known as units. The relationship between beneficiaries and units is very similar to that of shareholders and publicly traded shares. Earnings from unit trusts stem from the number of units held. If there are two unitholders, each with half of the units, they will each get 50% of the income. 

Discretionary trusts can work for companies with a family structure. This is inappropriate for the majority of companies. A family structure implies that a trustee will act in the beneficiaries' best interest.  

Parting Thoughts to Ponder

When considering different investment options, perspective is important. Some avenues will provide bigger returns. Others could be a better fit for your desired time frame. Longevity is also a concern. Many opportunities start off lucrative but they return to a more sustainable ROI over time. 

For example, real estate crowdfunding deals bring attractive returns. This is especially true compared to those provided by REITs. They haven't been around for very long. They have a short lifespan in comparison to the other options. This is a reason to believe the returns will come down.

You'll also need to be comfortable with not having access to your funds for a while if you choose to crowdfund. Most of the investments last for over a year, with some even enduring for over five. In rare cases, you'll be able to sell out ahead of schedule. Even this can take some time and will likely come saddled with a penalty. As far as control goes, your funds are out of your hands once you give up your principal. 

Whichever way you end up leaning, never forget that you have options. You also have time. New investors might feel tempted to dive headlong into real estate, but you should only do so when you're in a good place. Do your research, explore your options, and your own success story might follow. 

In the end, the most proven wealth generation vehicle in history is simply... investing in real estate.

However, when most people hear the idea of investing in real estate, they assume it means flipping houses or dedicating a full time focus to finding good deals, negotiating, or managing tenants. There are so many other options, and we discuss many of them in The One Percent.

crowdfund real estate for a balanced return on investment

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