Crowdfunding is all the rage, attracting everyone from individuals who want to get in on the next big thing to regulators who want to protect you. And one segment drawing a lot of attention of late is real estate, an investment formerly accessible mostly just to those who could afford to plunk down a large down payment on their own.
Crowdfunding will certainly face some stiffer controls in the not too distant future. Just this week, the public comment period closed on Title III of the JOBS Act, the SEC’s crowdfunding rules proposal. Among other things, the JOBS Act (short for Jumpstart Our Business Startups) enables average investors to access more complicated investment opportunities which previously were available only to “accredited investors” who earn more than $200,000 a year or who have a net worth exceeding $1 million.
“Until new SEC crowdfunding rules are finalized, the only way most Americans can invest in real estate — outside their home — is through a REIT,” says Grant Easterbrook, senior research associate at Corporate Insight, who’s been tracking these new platforms.
Purchasing a share in a REIT allows an investor to buy into a management company with a portfolio of existing investments. Real estate crowdfunding, however, pools investors together so that, with as little as $5,000 typically, they can buy small shares of individual properties.
These are generally commercial properties, such as multi-family, retail, office and industrial projects, including new developments. You can get direct ownership and, if projects are successful, increase your long-term returns by saving money on the fees many REITs charge, says Easterbrook. Investing in REITs provides indirect ownership, and fees investors pay generally go toward the management company in exchange for professional management. For engaged investors, other benefits of real estate crowdfunding include greater transparency and control over your holdings. Users can review regular progress reports and monitor each of their property investments online, including possible dividend payments.
Crowdfunding for properties
Crowdfunding in real estate comes in two flavors: tangible properties and personal mortgages.
The first is a platform where clients can browse vetted property deals, like a plan to turn an old industrial site into luxury apartments. Then, you choose what you want to invest in. Some platforms also allow you to purchase shares in existing properties and later sell your real estate ownership to other investors on the platform, providing a possible avenue for liquidity. Primarq is among the few focused solely on the residential side, enabling investors to own part of residential homes along with the actual resident of the property, and to participate in any appreciation in the home’s value.
Whereas you could spend countless hours investigating properties on your own to make a buying decision, these online platforms conduct the due diligence for you and strive to put forward quality property deals for their clients to choose from. Fees vary depending on the project and the crowdfunding firm, but typically include an upfront fee for a successful funding round with an additional annual 1% fee on your investment amount.
Some sites, like RealtyShares, charge the borrower and not the investor. Another site, GroundFloor, doesn’t currently charge any fees, but that could change. Be careful about sites that say there are no fees to join or to view investments but that may have fees once you make an investment.
Members of some sites, such as Collaperty, can write reviews. Login access or dashboards may feature performance reports and updates on your investments.
Perhaps the most intriguing aspect for those small investors is that this presents a way to get in on the ground floor. “Getting into an investment when one investment changes from one hand to another isn’t as lucrative as getting in early, on the ground floor,” Easterbrook points out.
Crowdfunding for mortgages
The other crowdfunding flavor on the real estate front features mortgages. Think of the friend who can’t get a Fannie Mae loan and instead opts to go online to get a mortgage to buy their home.
That’s right: Multiple people can invest in a person’s mortgage. And your investment can be spread across multiple mortgages, providing diversity within this investment class. These borrowers may be seeking a crowdfunding solution because they cannot get a traditional loan, a real challenge for many consumers today, even those with decent credit, and one that’s led to the growth of peer-lending sites like Prosper and LendingClub.
Privlo, expected to launch soon, reports that is has already funded $28 million in loans to those who hold non-traditional jobs and therefore have a hard time meeting traditional credit standards. LendInvest, based in the U.K., also offers a peer-to-peer lending network focused on residential and commercial mortgages.
Sure, disintermediation is occurring in many areas thanks to the Internet. The difference, however, is that these platforms aren’t featuring products for sale, but, rather, people’s money and ability to repay. The novelty, coupled with the risk to average investors (think Bernie Madhoff online), really demand protections for consumers.
Real estate, real due diligence
If you’re thinking of venturing into the real estate crowdfunding world, there’s a lot to keep in mind. This is new territory (no pun intended) with lots of unknowns.
Like any kind of crowdfunded project with many small owners, if the firm or platform behind it fails, the investor has a mess to sort out to track his investment.
“There’s so much to know, like who’s the general partner of the properties,” says Deena Katz, CFP, of financial planning firm Evensky Katz and an associate professor of financial planning at Texas Tech.
Just as when you purchase a REIT or any other investment and put your faith with the manager, you’re placing your trust into the vetting process and expertise of the people who select the properties placed onto the platform. Do they have the expertise? What’s their process? How can you believe that what they say is true — from the backgrounds of the leaders to the facts about an investment? And if location really does matter in real-estate investing, that can be tough to gauge online.
Indeed, the average investor may have excess cash to invest, but that doesn’t mean he or she has the sophistication to monitor these properties and understand aspects ranging from the financial statements, default rates, and tax implications to developer compensation models and how to unload the property if needed.
The Internet is transforming investing. For regulators, it’s an opportunity to better protect consumers and ensure true transparency: collect comments and data online that could even speed up the capture of the next Bernie Madhoff.
For investors, it may be a way to further diversify your portfolio. But be sure you do your homework and remember one of Peter Lynch’s golden rules of investing: “You have to know what you own, and why you own it.”