Real estate crowdfunding is a relatively recent development made possible by the advent of online platforms that match the demand and supply of funds for real estate investment and development. Instead of having to approach a single lender to fund a real estate project, entrepreneurs can choose to have it funded by a large number of retail investors, each investing a relatively small amount of money. Conversely, people with cash surpluses eyeing the lucrative real estate market can invest their funds in multiple projects to balance their ROI and diversify their portfolio for extra security as compared to investing a large sum of money in a single project. According to https://www.forbes.com, real estate crowdfunding platforms have enabled retail investors to invest in the property market relatively easily due to the lower financial barriers.
Benefits of Real Estate Crowdfunding
For the real estate developer, raising money through a reliable crowdfunding platform is a way of accessing large amounts of money relatively easily and quickly compared to the bureaucratic traditional lenders like banks. It is also often possible to get the funds more cheaply because retail investors do not have to deal with the overheads that conventional bankers are forced to. The lower rate of interest on crowdfunding loans makes for better margins and profitability. For the real estate investor, using the crowdfunding platform is a good way of deploying the cash in attractive projects without needing to invest very large amounts in a single project. They can choose to invest smaller amounts in multiple projects and thereby, diversify the risk across multiple factors like real estate type, location, currencies, and more.
Types of Real Estate Crowdfunding
Typically, it is possible to classify real estate crowdfunding into two types depending on whether it is based on equity or debt. The differences between the two must be understood properly as the two types vary remarkably in their risk and return profiles.
Equity-based real estate crowdfunding: In this type of crowdfunding, the investor is offered equity in the commercial or residential project of his choice instead of interest on the funds that he has invested. In effect, the investor becomes a shareholder in the project and will start earning from the rental income of the property or get a portion of the sale proceeds if the property is sold off.
Lending-based real estate crowdfunding: In this kind of lending, the investor receives a fixed return on the invested amount, which is equal to the rate of interest that the borrower is willing to pay for the money. The interest amount may be returned periodically or at the end of the loan tenor, as mutually decided.
The Pros and Cons of Equity-Based Real Estate Crowdfunding
Typically, the yield of debt instruments is dictated by the rate of interest charged by banks and private online lenders like Liberty Lending. If you need higher returns than what debt will deliver, you will need to assume a greater risk profile, which is where equity-based real estate crowdfunding comes in. Normally, investors in a property that is going to be developed or renovated and then sold off at a handsome profit will do well to invest in equity of the project. The higher returns are essentially to compensate you for the additional risk that you assume. There can be tax benefits associated with equity investments that can boost the real rate of return.
The risk that an equity investor takes is that the project may not yield the desired profit or even result in a financial loss in case of a slump in the property prices or rentals in the region. In an extreme case, it might mean that the investor does not get back any reasonable return in case the project fails. However, even if the business environment is good, there is a lot of uncertainty regarding the holding period because normally equity in real estate does not have a well-developed secondary market. If there is a downturn, you may find yourself locked into a holding period that maybe five years upwards.
The Pros and Cons of Lending-Based Real Estate Crowdfunding
Given the same set of circumstances, it is taken for granted then lending is safer than equity in real estate. The basic reason behind this is that in case the property is foreclosed and sold off, the debtors will have preference over the equity holders. However, despite the lower returns that debt fetches, it should not be presumed that debt would always be a safer bet. If the project itself is intrinsically bad, the loss can wipe out everyone. However, normally, debt investments have a certain stability and predictability associated with them as opposed to the complete uncertainty of equity investments. The returns to the investor are generally based on a contracted rate of interest that the borrower is obligated to pay regardless of the performance of his asset. Investors can also choose the period of their investment, which is far shorter than of equity.
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As will be appreciated, the risk of debt investment being lower, it also means that the returns from the investment will also be lower. In case, the property produces very good returns by way of lucrative rental incomes or a big jump in the sale price, debt investors will not be able to profit by it. Conversely, investors are also better insulated against extraordinary losses.
While the investment process is quite simple, it may not be equally easy to choose the right crowdfunding platform that gives the right mix of safety, reliability, and returns. Many of the platforms have eligibility norms so investors will need to qualify in terms of net worth or income criteria. Different platforms have different minimum investment amounts so investors should ideally hunt out the lowest ones so that they can diversify their portfolios more easily. Conduct research on each of the platforms that are shortlisted to establish their levels of transparency and business health. Finding out about the credentials of the key people and the levels of complaints should not be ignored. More importantly, investors should be able to identify projects that fit their risk profile. Also, investigate what the business model of the crowdfunding platforms is. Even though all platforms will charge fees, investors should target those that charge the least.