Investing in real estate crowdfunding has actually been going on for a very long time. The problem, from a small investor standpoint, is that in order to participate you need to be an accredited investor.
Because of the financial requirements needed to be an accredited investor, the vast majority of investors have not been able to participate in real estate crowdfunding.
With the relatively recent passing of the JOBS ACT, that situation may be changing, and real estate crowdfunding is now beginning to gradually move to include small investors.
What is Real Estate Crowdfunding?
Crowdfunding has been around for decades, but primarily outside the US. Investors invest money to both individuals and small businesses for upstart ventures or expansion.
But in order to participate here in the US you needed to be a high net worth individual. That was at least, until 2012 when the “Jumpstart Our Business Startups (JOBS) Act” was enacted.
As it currently stands, crowdfunding is an activity primarily aimed at sophisticated, high net worth investors, commonly referred to as accredited investors.
As you might expect, the accredited investor requirement will exclude most small investors. The Securities and Exchange Commission (SEC) and some states are working to lower the dollar requirements for crowdfunding investors, so hope is on the horizon.
Though crowdfunding is becoming increasingly available throughout the economy, real estate crowdfunding could be a way of enabling investors to circumvent banks, and their stiff lending requirements for investment property.
The concept of real estate crowdfunding is actually simple – it’s the application where it gets more complicated. Both investors and real estate borrowers come to a given web platform, or even deal direct with one another, to create real estate investments that are agreeable to all parties.
The regulations for such platforms are the source of the complication – and the limitation on who can participate. But more on that in a bit.
Who is an “Accredited Investor”?
In general, an accredited investor is a high net worth individual or couple, who are deemed to be sophisticated in matters concerning investments. It is actually a legal definition that has been articulated by the SEC.
One of the primary defining characteristics of an accredited investor is a net worth of at least $1 million. In general, this net worth must exclude the value of your personal residence, as well as the mortgage that it secures, unless you owe more on your home than the property is worth.
Alternatively, you can meet the requirement if you have an individual income of least $200,000 per year, or a joint income of at least $300,000 in each of the last two years, and have a reasonable chance of maintaining that level in the future.
You can also qualify if you are a general partner, executive officer, director or a related combination of all three for the issuer of the security being offered.
But what if you don’t meet any of these criteria?
Crowdfunding Under the Jobs Act
Under the JOBS Act, crowdfunding companies can now advertise their investments over the social media to a wider number of potential investors than just accredited investors.
At the moment however, most crowdfunding sites are still requiring that you be an accredited investor. The market for crowdfunding sites that do not require that status is still very new, and quite limited.
That presents another issue in that a lot of new sites are coming about that are unproven. If you are not qualified as an accredited investor, you will have to do your research before participating in any of these sites.
Make sure that any crowdfunding site you join has been around for more than a year or two. Find out if the principals behind the site are active real estate investors, and if they have any kind of capital investments in the platform.
Even better is if you can get a referral from a trusted third-party, who can endorse the platform, as well as produce evidence of satisfactory performance.
The site should also have deep resources that can adequately explain the risks involved in real estate crowdfunding, as well as how to mitigate those risks.
And finally, you should have some general familiarity with the kind of real estate investment that you are putting your money into.
Real estate crowdfunding platforms are not like mutual funds, that are professionally managed and invested in diverse assets. You’ll be investing your money in a single real estate transaction, that has the very real potential to go sour.
Whether or not you will be able to participate in real estate crowdfunding without being an accredited investor may have something to do with geography.
At least a dozen states have legalized crowdfunding, often doing so with much lower financial requirements than are currently the case for accredited investors.
Those states include:
If your state is not on this list, pay close attention to legal developments pertaining to crowdfunding. Many more states are considering legislation in this direction, and your state could be one of them very soon even if it isn’t right now.
Top 5 Real Estate Crowdfunding Platforms
Realty Mogul – is an online capital marketplace for real estate, connecting borrowers and sponsors to capital from accredited and institutional investors.
FundRise -is a real estate crowdfunding and investment platform. Fundrise is real estate investing for everyone.
RealtyShares – a leader in real estate crowdfunding, RealtyShares enables investors to purchase shares in private real estate investments for as little as $5000.
GroundBreaker – a leader in equity-based real estate crowdfunding, GroundBreaker focuses on investments in local private commercial and residential property.
Patch of Land – is crowdfunding real estate through its P2RE (peer-to-peer) online marketplace offering various typologies of secured real estate debt on assets backed by first position liens and personal guarantees.
Advantages of Real Estate Crowdfunding
Since real estate crowdfunding typically takes place on web platforms, the entire process of investing in real estate, either as a principal or as a lender, is greatly simplified. There is no need for face-to-face meetings, or long processes haggling with banks. Everything is done on the web, minimizing the amount of time and conflict involved in the process.
Each website represents a virtual market of potential real estate investments. That means that you will be able to go to a single web platform, or a combination of platforms, and gain access to a large number of potential real estate transactions. You will then be free to sift through the choices, and decide which investments are best for you.
The fact that you have a wide assortment of investment choices means that you will also be able to develop a diversified real estate portfolio. In a typical real estate crowdfunding arrangement, several investors will come together and put up the capital needed to make the transaction. This means that you can invest a relatively small amount of money in each of several different real estate transactions. This will minimize your risk of loss from participation in any single transaction.
Perhaps most importantly, real estate crowdfunding will open up a world of commercial real estate investing to people who might not ever have a chance to get involved. It represents the marriage between developers – who have knowledge of the market – and investors – who have capital to invest – so that both can benefit from the advantages provided by the other.
The Risks of Real Estate Crowdfunding
There are inherent risks involved in real estate investments, particularly commercial ventures. Those don’t magically go away because you’re investing through a crowdfunding platform, or because there are multiple investors and developers involved in a single project.
Commercial real estate can be more heavily affected by the business cycle than residential real estate. In addition, if a particular investment is centered on a certain economic sector, a decline in that sector could have a negative impact on the real estate investment.
As well, the sudden surge in vacancy rates – often caused more by overbuilding than by economic factors – can send a commercial real estate investment plummeting in value.
Unfortunately, the risk of default on a real estate project is actually higher when crowdfunding is involved.
When a bank provides most of the financing for a particular real estate project, they will underwrite the loan according to standard commercial lending requirements. Those requirements may be absent in a crowdfunding situation, raising the likelihood of a deal going sour.
Finally, despite the open market appearance of crowdfunding, selling off your position in a particular real estate investment may be extremely difficult.
After all, it’s more than likely that you only have small piece of a large investment. This is completely unlike the situation in which you are the primary investor, or even the developer, in a given deal.
In that case, you can sell your entire interest in the property, which is much easier and cleaner to do then selling only a small sliver of it.
Real estate crowdfunding for non-accredited investors is very much in its infancy. The potential looks outstanding, but until the industry develops more fully, do your homework and tread lightly.
Right now you might want to consider the peer-to-peer real estate site Blackhawk Investments.