Real estate offers a fantastic counterbalance to stocks in your investment portfolio, especially in an era of low interest rates and bond yields. But not all of us have $300,000 just sitting around to start snapping up properties.
Enter: crowdfunded real estate investments. A relatively recent addition to the arsenal of investment options, crowdfunding allows thousands of investors to pool their funds, so each investor can invest a small amount of money in larger projects.
Like all investments, real estate crowdfunding has its own pros and cons, and comes in many flavors and varieties. Before you invest a cent in any asset, you must first understand the risks, rewards, and the role the investment plays in your portfolio.
How Does Real Estate Crowdfunding Work?
On the simplest level, real estate crowdfunding involves many people each contributing a small portion of the greater cost of a real estate-related investment.
But “real estate-related investment” can carry many meanings. Keep the following variations in mind as you explore real estate crowdfunding investment options.
Equity vs. Debt
When you invest money through a crowdfunding platform, does the money go toward the direct purchase of new properties, or toward loans servicing other people’s properties?
If you know publicly traded REITs, you understand the difference between equity REITs and mortgage REITs. The former buys and manages real estate; the latter lends money secured against real estate.
Crowdfunding works similarly. In fact, many real estate crowdfunding investments are REITs — they’re simply sold privately rather than on public stock exchanges subject to traditional SEC regulation (more on regulation differences shortly).
Many private crowdfunded REITs offer both equity and debt REIT options. As a general rule, debt REITs generate more immediate dividend income, while equity REITs include an element of long-term appreciation in addition to income. For example, Fundrise offers several broad basket portfolios weighted more heavily toward either real estate equity or debt investments.
Not all real estate crowdfunded debt investments come in the form of REITs, however.
Peer-to-Peer vs. Fund Investments
In the case of private debt REITs, you invest money with a pooled fund, and the fund lends money to real estate investors as it sees fit. The alternative model for crowdfunded real estate debt involves lending directly to the borrower.
Crowdfunding platforms that follow this model allow you to browse individual loans, so you can pick and choose which loans you want to put money toward. For example, Groundfloor caters to real estate investors — mostly house flippers — lending them money to buy and renovate fixer-uppers. As a financial investor, you can log into your account and review available loans, including details about the project and borrower, and then put varying amounts of money toward as many or as few loans as you like.
Your loan is secured by a lien against the property. If the borrower defaults, Groundfloor forecloses to recover all investors’ money.
Some real estate crowdfunding platforms specialize in residential real estate, while others focus on commercial.
Within each of those wide umbrellas, there’s plenty of variation as well. Residential properties could mean single-family rentals, or it could mean 200-unit apartment complexes. Commercial real estate could mean office buildings, or industrial parks, or retail space.
Before investing, make sure you understand exactly what you’re investing in — and more importantly, why.
Availability to Non-Accredited Investors
Some crowdfunding services like FarmTogether only allow accredited investors to participate. Others are open to everyone.
To qualify as an accredited investor, you must have either a net worth over $1 million (not including equity in your home) or have earned at least $200,000 for each of the last two years ($300,000 for married couples), with the expectation to earn similarly this year. So, most Americans can only invest with crowdfunding platforms that allow non-accredited investors.
Before doing any further due diligence, check to see whether prospective crowdfunding platforms even allow you to invest. Otherwise, no other details matter.
Advantages of Real Estate Crowdfunding
These relatively novel investments come with plenty of perks, especially for everyday people with few other paths to invest in large real estate projects. I myself invest in several real estate crowdfunding platforms.
As you compare crowdfunding investments to other types of real estate investments, keep the following pros in mind.
1. Low Cash Requirements
Through crowdfunded real estate investing, investors gain access to expensive investments like hotels, office parks, and apartment complexes that would otherwise remain unavailable to them. I don’t have $5 million to buy an apartment building. But I do have $500 that I’m happy to invest in a private fund that owns apartment buildings.
Although every crowdfunding platform imposes its own minimum investment, some of those minimums remain quite low. Groundfloor, for example, allows investments as low as $10.
Other platforms impose minimums of $500 or $1,000, keeping the minimums within reach of middle-class earners. It marks an enormous advantage to investing in real estate indirectly: you don’t need a full down payment plus closing costs in order to diversify your investments to include real estate.
2. Easy Diversification
With crowdfunding investments, you can easily include real estate in your asset allocation.
And not just through publicly traded REITs, which often move in greater sync with the stock market than with real estate markets because they trade on public stock exchanges. You can invest money toward any type of real estate, residential or commercial, in any grade of neighborhood, spread across many cities in the U.S. or even around the world.
For example, I have a little money invested in commercial office space through Streitwise, and a little invested in residential real estate (equity and debt) through Fundrise’s REITs. I also have money spread among a range of individual loans through Groundfloor. All in all, these investments expose me to real estate in 15 states.
Imagine how much harder that exposure would be if I had to go out and buy individual properties in 15 states?
3. Strong Income Yields
Crowdfunded real estate investments tend to pay reasonably high income yields. Which is always welcome, whether you’re pursuing financial independence at a young age, looking to build more retirement income, or simply enjoy earning more passive income each month. Because when you have enough passive income to cover your living expenses, work becomes optional.
I’ve consistently earned income yields in the 8% to 9% range on my investments with Streitwise and Groundfloor. With Fundrise, I earn around 5% in dividend yield, plus long-term appreciation.
Not many stocks or ETFs offer those kinds of yields.
4. No Labor and Little Skill Required to Invest
As a direct real estate investor, I can tell you firsthand how much skill and labor it takes to find good deals, analyze cash flow numbers, renovate properties, hire and manage contractors, and so forth.
With crowdfunded real estate investments, you outsource all of that to someone else. You just click a button to invest your funds, and sit back and collect the returns.
Don’t get me wrong, direct real estate investment comes with many of its own perks, such as the potential for higher returns, greater control, and real estate-related tax advantages. But you have to earn those advantages with sweat and knowledge, much of it required before you even buy your first property.
This ease of investing through crowdfunding platforms comes with a side benefit: you can automate your investments. Set up monthly or biweekly investments to avoid emotional investing and build wealth and passive income on autopilot.
5. No Property Management Required
It takes an effort not to laugh out loud when tenants call you complaining that a light bulb burned out, and ask you to come over to replace it. Unless the call comes at 3 a.m. — that’s less funny.
Few landlords enjoy managing rental properties, between chasing down nonpaying tenants, hassling with constant repairs and maintenance issues, and all-too-frequent complaints from tenants and neighbors — “this person plays their music too loud,” “that one smells like weed when they pass in the hallway,” ad nauseum. It’s why so many landlords end up hiring a property manager to take the headaches off their plate.
You don’t have to worry about any of that when you invest in crowdfunded real estate investments.
6. Protection Against Inflation
“Real” assets such as commodities, precious metals, and, of course, real estate all have inherent demand. Regardless of the currency you pay with or its value, you pay the going rate based on the underlying value of these physical assets.
That makes these assets an excellent hedge against inflation. If rents drive inflation higher, rental properties only become more valuable, with higher revenues. If the dollar loses value, people pay more for housing and commercial space.
In contrast, investors actually lose money — in terms of real value — on a bond paying 2% interest when inflation runs at 3%.
Disadvantages of Real Estate Crowdfunding
No investment is perfect, without risks or downsides. Thoroughly review these drawbacks and risks before parting with your hard-earned money.
1. Poor Liquidity
It takes a few clicks to sell a stock or ETF. Investors can liquidate their holdings instantaneously, leaving them with cold hard cash.
Real estate is inherently illiquid. It takes months to market and sell properties, and for large commercial properties it can involve hundreds of thousands of dollars in costs. So investors usually hold them for at least five years, and when these investments are funded through a crowd of financial investors, that means individuals can’t easily pull their money back out of the deal.
Most crowdfunded real estate investments advise prospective investors to plan on leaving their money in place for at least five years. Some do offer early redemption to sell their shares, but not instantaneously, and usually at some sort of discount or penalty.
Don’t invest anything you might need back within the next five years.
One notable exception includes short-term peer-to-peer loans secured by real estate, such as those offered by Groundfloor. These loans usually repay within nine to 12 months. Even so, you still can’t easily pull your money back out before the borrower repays the loan in full.
2. Complex Regulation and Performance Transparency
The regulation on crowdfunded investments can quickly make the average investor’s eyes cross. For a quick taste, investors have to navigate between Regulation D investments that fall under either 506(b) or 506(c), and Regulation A and Title III investments — also known as Regulation Crowdfunding or Reg CF.
Regardless, investors can’t use the familiar brokerage account tools that they’re already familiar with to research these investments. The SEC does require crowdfunding platforms to disclose a wide range of information, but it will look and feel unfamiliar for many retail investors.
There is one huge advantage that crowdfunded private REITs have over publicly traded REITs: the flexibility to reinvest profits to buy more properties. Publicly traded REITs must distribute at least 90% of all profits to investors in the form of dividends. That leaves them with high dividend yields but poor prospects for appreciation and asset growth. Private REITs like DiversyFund can employ far more flexibility to build their portfolios.
3. Limits on Participation
The SEC puts limits on how much money non-accredited investors can put into crowdfunded investments each year. Those limits are as follows:
“If either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth.
“If both your annual income and your net worth are equal to or more than $107,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000.”
They provide a table by way of example:
||greater of $2,200 or 5% of $30,000 ($1,500)
||greater of $2,200 or 5% of $80,000 ($4,000)
||10% of $107,000 ($10,000)
||10% of $200,000 ($20,000)
||10% of $1.2 million ($120,000), subject to cap
Still, these speedbumps serve as reasonable cautions and protections for the average investor. These investments do come with an element of risk, and shouldn’t make up 70% of your retirement portfolio.
4. Less Protection from Default Than Other Real Estate Investments
When you own a rental property and your tenants stop paying the rent, you can evict them. You own the property, you can insure it against damage, and it comes with a certain amount of inherent value.
Real estate crowdfunding investments don’t come with these protections. You typically own paper shares of a fund, not all or part of a physical asset. Your investments aren’t even secured against the underlying properties with a lien in most cases.
Exceptions do exist, however. For example, when you invest fractionally in loans on Groundfloor, those loans are secured by a lien against real property. If the borrower defaults, Groundfloor forecloses in order to recover most or all of your money.
5. Lack of Control
Although stock investors have little control over the performance of their share prices, direct real estate investors do enjoy control over their returns and management. They can make renovations to boost the rents and property values, can tighten their tenant screening criteria to avoid deadbeats, can even insure against rent defaults.
But when you invest in real estate indirectly through crowdfunding, you surrender control to the fund manager. If they do well, you (hopefully) earn a strong return. If they mess up, you get stuck with the costs of their bungles.
Where Does Real Estate Crowdfunding Fit Into Your Portfolio?
While stocks belong in just about every investor’s portfolio, not everyone feels comfortable with real estate crowdfunding. Still, these investments offer a fine counterweight to stocks when used responsibly.
Your ideal asset allocation is personal to you, and depends on factors ranging from your age, target retirement horizon, net worth, and risk tolerance. I recommend thinking of crowdfunded real estate investments as an alternative to higher-risk, higher-yield bonds and public REITs.
For example, say you aim for an asset allocation of 60% equities and 40% bonds. Those equities include 57% stocks and 3% REITs, and your bonds include 30% low-risk government bonds and 10% higher-risk corporate bonds. You could take part of the 13% of your portfolio earmarked for REITs and higher-risk bonds and test the waters of crowdfunded real estate investments. If you like what you see, you can then move a little more, up to your comfort level.
However, real estate crowdfunding should not take the place of extremely low-risk investments in your portfolio, such as Treasury bonds or TIPS.
With real estate crowdfunding, you have the luxury of investing small amounts to gauge the performance of your investments and your comfort.
These investments can play a role in any investor’s portfolio, but that role should start small. Don’t invest any money that would financially cripple you to lose, and do your homework on any crowdfunded investment’s past performance and risk management measures.
Most of all, always keep these investments in the perspective of your broader portfolio and asset allocation. These investments don’t exist in a vacuum — they play a role in a larger performance.
Have you ever invested in crowdfunded real estate? If so, what were your experiences?