What is Real Estate Crowdfunding and How Does It Work?

Are you looking for a new, innovative way to diversify your portfolio that’s popular with investors of all demographics in both residential and commercial sectors? If so, then real estate crowdfunding may be perfect for you. 

According to Polaris Market Research, the global real estate crowdfunding market was $10.78 billion (USD) in 2021. That number is expected to increase by a compound annual growth rate (CAGR) of 45.6% from 2022-2030, and you’ll soon see why! 

In this post, we’ll explore:

• What is real estate crowdfunding
• How crowdfunding works in real estate
• The benefits and drawbacks of real estate crowdfunding
• Types of real estate crowdfunding
• How to get started in real estate crowdfunding

Let’s get started.

What is Real Estate Crowdfunding?

In crowdfunding, a large group of people each contribute a small amount of funds to raise a lot of money. Real estate crowdfunding is no different, except instead of raising funds for a new board game or invention, you’re funding real estate projects. 

How Crowdfunding Works in Real Estate

Although digital crowdfunding has been around since 1997, when the JOBS Act passed in 2012, it expanded crowdfunders’ ability to advertise their efforts. Since then, crowdfunding has skyrocketed in popularity. Companies can raise money without giving up control to venture capitalists. Instead, they can simply offer their investors equity in their venture. 

It only makes sense that real estate investing and crowdfunding would cross paths. Historically, real estate is usually considered the most favored and consistent long-term investment strategy. These days, crowdfunding is one of the most popular investment opportunities around.  

Although real estate crowdfunding is still a new concept, many investors see its potential. Real estate crowdfunding lets you diversify your investment portfolio and breaks down some barriers for investments most people couldn’t access before, such as luxury high-rises or certain types of commercial real estate.

Like real estate investment trusts (REITs), there are tons of crowdfunding opportunities and niches to choose from. Also, like REITs, crowdfunding is a form of passive investing, so the only effort required on your part is choosing a crowdfunding opportunity to invest in. 

Benefits of Real Estate Crowdfunding

In addition to being a great source of passive income, let’s dive deeper into the benefits of crowdfunded real estate investments. Here are the main ones:

Portfolio diversification

Crowdfunding lets you diversify your real estate portfolio. Instead of investing in a single property, you can spread your funds across multiple investments, minimizing risk. 

For example, Jeremy invests $50,000 in a single investment property, while Maria invests $50,000 across five different properties. If both lose 20% in a single property, it costs Jeremy $10,000, but it’ll only cost Maria $2,000, which could be offset by the success of one or more of her other properties. 

Geographic expansion

Geographic diversity can be as important as portfolio diversification. The real estate market is in constant flux, and multiple areas can perform differently. Austin, Texas, has experienced substantial growth and a thriving housing market since the pandemic began. Flint, Michigan, on the other hand, not so much. The more markets you can enter, the less risk you’ll assume. 

Low buy-in

Many people think they need tons of capital to break into the real estate market. That’s no longer true. Some real estate crowdfunding platforms, like Fundrise, let you start investing for as little as $10. That’s great news for newer real estate investors who want to get their feet wet or those who don’t have tens or hundreds of thousands of dollars of liquid capital at their disposal.

Increased accessibility

As previously mentioned, the JOBS Acts broke down barriers, and now everyone has access to a variety of crowdfunding platforms—each with its own niche. Some specialize in apartment buildings, while others focus on commercial real estate investments or mixed-use developments. When it comes to real estate crowdfunding, your passive income options are as abundant and diverse as the crowdfunding websites themselves. 

Build loyalty

If you want to start a campaign instead of investing in one, crowdfunding is a savvy way to prove a project’s financial viability. There are always real estate investors looking for a new property to support. Perfect your pitch and create a landing page with compelling information about your project, including why you chose it and its profit potential. 

After you secure your funding, your contributors will want it to succeed. If you can maintain clear communication and deliver positive results, your investors will likely want to work with you again—and tell their friends. You’ll also gain valuable feedback, which can help you improve your processes during future endeavors. 

Drawbacks of Real Estate Crowdfunding

No investment is perfect, nor is it for everyone. Real estate crowdfunding is still new, so despite the many crowdfunding platforms around, none of them can boast decades of success. Here are a few cons of real estate crowdfunding:

Illiquid investment

Crowdfunding is typically considered an illiquid investment. In other words, it’s not easily sold. In order for you to sell your stake in an investment, someone needs to buy it. This process can take a long time and could impact the value of the property you’re invested in. 

Investment limits

The JOBS Act broke down barriers but also set limits for nonaccredited investors. Due to the risks involved, the law states that you can only invest up to $2,200 or 5% “of the lesser of your annual income or net worth” during a 12-month period if either is less than $107,000. 

If both are more than $107,000, you can invest up to 10% of whichever is less during a 12-month period, but you can’t invest more than $107,000. 

If your annual income is $120,000 and your net worth is $100,000, you can only invest $5,000 (5% of $100,000) during a 12-month period. 

Accredited investors aren’t bound by these limitations. 

Lower returns

Real estate crowdfunding typically yields a lower return than what you would receive through more active investments in real estate. The developer or operator you’re investing with gets their cut for the work they do, and your return often accounts for that. Even so, successful real estate investments still bring decent returns, especially in equity investments.

Less control

As a passive investor, the developer or operator makes decisions on your behalf. If you want to have more influence on your investment, consider real estate investments that are more active, like short-term rentals or house flipping. 

Taxes and fees

Real estate crowdfunding platforms typically charge management or advisory fees. You’ll also have to pay taxes on the dividends you receive.

Types of Real Estate Crowdfunding Opportunities

There are two main options for crowdfunding: equity investments and debt investments. 

Equity investments

Equity investments give you an equity stake in a property, which basically makes you a shareholder. In equity investing, you’ll earn money based on the property’s rental income minus the fees charged by the real estate crowdfunding platform. You’ll also receive a share of the property’s appreciation value if it’s sold. 

Equity investors can see higher returns (sometimes comparable to that of a short-term rental owner), and you can deduct expenses come tax season. However, equity investments are also riskier, and their holding periods typically range from 5-10 years. 

Debt investments

Debt investors are basically the lenders for the property. Like lenders, you’ll receive a steady, fixed return based on how much you’ve invested and the interest rate of the mortgage loan. You’ll also have priority during payouts over the property owner. 

Debt investors make a lower ROI than their equity counterparts, but they also assume less risk. Since debt investments are usually for development projects, they have shorter holding periods. However, you may also be subject to higher fees, and your returns are capped. 

How to Get Started in Real Estate Crowdfunding

Crowdfunding platforms are easy to find online, but finding a promising real estate project isn’t as simple. Here are a few tips to consider when doing your research:

• Know your preferences: Are you more interested in equity or debt investments? In residential or commercial real estate deals? Which types? In what areas?
• Investment amount: Determine how much you are comfortable investing and how much you can invest based on the JOBS Act. If you qualify as an accredited investor, prepare any documentation you’ll need to prove it. 
• Compare websites: Crowdfunding sites have varying fee structures, terms and conditions, investment opportunities, and more. 
• Read reviews: Look for comments and feedback from other investors and what they have to say about a specific site or service. 
• Investment portfolios: Look for platforms that can prove their previous successes when handling the type of investments you’re interested in.
• Solid backing: Look for sites with strong capital venture backing. You want to ensure the platform you’re using is credible and will be in operation for a long time. 
• Holding periods: Compare the length of holding periods and determine how comfortable you are with them. 
• Consult a tax professional: Ask your accountant about the potential tax impact of an investment.

Also, don’t hesitate to check our forums and see what the real estate investment pros have to say about crowdfunding investment opportunities. You’ve got a wealth of knowledge at your fingertips! Are you ready to get started as a real estate crowdfunding investor?

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.