If you're an active real estate investor, you're probably familiar with investing through real estate investment trusts (REITs). These sell shares in a group of real estate investments similar to mutual funds. Many investors prefer these to outright real estate ownership because their investments are more diversified. However, the two biggest drawbacks are all of the fees charged to manage the trusts and the fact that investors have no say in what real estate is purchased by the trust.
Today, a new investment model is emerging in the form of crowdfunding. The crowdfunding concept is for people to pool their money together for a specific project. The concept has been around for a few years but is just now gaining momentum for real estate investing. Pooling funds enables investors to invest in bigger properties than they otherwise could or would want to as individual investors. Typical projects include properties with existing cash flow, such as apartment buildings, office buildings, retail shopping centers, self-storage facilities, and pools of single-family homes.
With REITs, investors have little information available about the actual investments being made. You have no opportunity to select properties that you are familiar with or invest in your own geographical location. Crowdfunding is much more transparent and gives investors much more control over where and how their money is invested. You can invest in smaller or larger investments depending on your personal choices. You can put together a crowdfunding group to buy an apartment building in your town or city.
Federal securities law requires that securities issued by private companies to their investors be registered with the Securities and Exchange Commission (SEC) unless the offering qualifies for an exemption from registration. Crowdfunding is an exception from SEC registration.
The exception that crowdfunding falls under is only offering investment opportunities to accredited investors. The SEC defines an accredited investor as having $200,000 of annual income per individual ($300,000 per couple) with the expectation of that continuing, or a net worth of more than $1 million, excluding the value of the primary residence.
As with any emerging new business model, you can expect the crowdfunding model to be refined and changed over time. The most common current model has investors purchasing shares in a LLC that in turn invests in a particular property or pool of properties. This model provides investors with liability protection to shield other investments from the operations of this specific LLC.
LLCs are governed by an "operating agreement". Each LLC operating agreement is slightly different but typically a manager is put in place to make day-to-day operating decisions. Other members of the LLC are "limited members". For the most part, the income from the LLC is passive income.
However, the operating agreement will require all members to vote on certain activities. Typically, this includes buying or selling a property within the investment portfolio. It can also be removing the manager for not operating within the guidelines of the operating agreement or for gross negligence. Expect this business model to change as crowdfunding gains in popularity.
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