Real estate crowdfunding has totally disrupted the real estate industry. It has made the market more accessible and has allowed newer investors to benefit from the experience of the ‘collective knowledge’ of the wider investment community. However, until very recently, this type of real estate investing was limited to accredited investors, who have a net worth of $1 million or more or earn at least $200,000 a year.
On May 16 of this year the Securities and Exchange Commission’s Title III of the JOBS Act went live, opening the door to non-accredited investors, who were previously unable to to take part in this new asset class.
What’s more, now might be a good time to be investing in this asset class. According to data from realtytrac, the U.S. housing market is starting to bounce back, with March 2016 seeing the highest average price gain for home sellers in any month since the onset of the Great Recession. So for those who are new to this asset class, what are the pros and cons of leveraging crowdfunding in a real estate context, and who is best suited to this type of investing?
The benefits of real estate crowdfunding
1. Widens scope for local investors
In the past, investing in real estate relied heavily on developing networks of personal and industry connections in your local area. Investors needed to keep their eyes peeled and their ears to the ground for hot tips about new and used properties coming onto the market to stay one step ahead of the competition.
Nowadays, real estate crowdfunding platforms are opening up access to deal flow, allowing investors to search for, and become a part of projects from outside of their personal contacts and local area. Potential investors can now browse deals from all over the country from the comfort of their own home or office, without having to put in the time ‘walking the beat’ in search of new projects.
In up-and-coming ‘high demand’ neighborhoods, and ‘booming’ cities like New York or even Pittsburgh investors can now have access to these markets online without the need to source investments on their own. This creates access to markets and investment opportunities on a national scale like never before.
2. Lowers entry point for investors
To get involved with real estate, historically, investors needed to write a rather big check to become part of a deal. A real estate operator would typically want to syndicate a deal with minimum investments of $50K or more in order to keep the process simple.
But now, thanks to efficiencies provided through technology and the JOBS Act, platforms like fundrise.com are able to allow minimum investments of $1K. This allows investors to spread their capital over multiple different projects at any one time. From a portfolio theory standpoint, this strategy is far less risky than investing larger amounts in fewer projects.
3. Allows investors to leverage the experience of the platform
Crowdfunding allows less experienced investors to learn from and leverage the experience and expertise of the management teams of the crowdfunding platform without having to climb the learning curve themselves. In the past, investors who wanted to go at it alone needed to be savvy about complicated procedures and legal requirements or risk getting burnt on a deal.
Investing in real estate involves understanding complicated title insurance policies, ensuring the borrower has adequate property and casualty insurance and understanding the nuances of each State’s processes regarding loan recourse, just to name a few.
Crowdfunding platforms help you get up to speed faster. A high-quality platform staffed by experienced real estate experts are going to curate each deal. They do the heavy lifting on underwriting and properly originate each loan allowing you to learn and understand the risks via the platform’s website.
The downsides of real estate crowdfunding
1. Restricted entry
Until the recent Title III of the JOBS Act, the main downfall was lack of access for investors that didn’t qualify as accredited investors. As this legislation is still rather new, most platforms are still open only to accredited investors.
2. Market and startup risk
While the general conversation around this new type of realty investment has been positive, real estate crowdfunding is still new and evolving. Since the first platforms emerged in 2013 the real estate market has been in a positive trend, so it is hard to know how these new platforms will perform in a downturn.This level of unpredictability may be enough to discourage the more cautious investors.
And it’s not only a market crash that could affect investors. Alan Gula, Chief Income Analyst at Wall Street Daily suggests that in the coming years, banks will start offering credit more liberally, which in turn could lead to lower risk-adjusted returns for investors on these platforms..
There is also the added risk that the majority of these type of platforms are startups, which have a notoriously high rate of failure. Investors need to consider the risk of having a company which could potentially go under as their middle man. Hesitant investors need only look at the recent Lending Club challenges to see the risks involved. There are ways to protect your investment for these scenarios, so be sure to speak with any platform you invest with to understand their bankruptcy remote structure.
3. Conflicting interests
There could be some conflicting interests from a platform perspective. Platforms naturally want to facilitate as many loans as possible as they earn their fees from the origination of loans, not necessarily on the loans performance. As an investor, it is important to recognize the aims of the platform, alignment of interests and any inherent conflicts of interests. A well structured platform will align interests with their investors. It is important to choose a platform that has an incentive to make sure each deal is well underwritten.
Who is best suited to this type of P2P investing and who is not?
While the recent legislation changes have opened the doors to virtually all investors, this asset class is still best suited to investors who have a strong understanding of the risks of real estate investing. These investors don’t need high amounts of liquidity and have a significant amount of capital where diversifying into real estate fits within a larger investment allocation strategy.
For these people, crowdfunding offers a passive way to access real-estate investing across the country with very little startup cost and a lower learning curve.
However, for more traditional investors accustomed to sourcing and originating their own loans, real estate crowdfunding may not be a great fit. The ‘hands off’ nature of real estate crowdfunding might be an unnatural change. Using a crowdfunding platform essentially “outsources” many of the functions investors may prefer to do themselves, such as property “drive-bys”, inspections, loan workouts, etc. As with all new technology, there will always be those who prefer to stick to time-tested methods which have worked for them in the past, and for more ‘hands on’ investors who prefer to make decisions based on their own experience, these platforms might not be a good match.
In summary, real estate crowdfunding is creating new levels of access to all kinds of investors. There are benefits of leveraging the expertise of the platforms and the “crowd” and getting started in markets you’d normally not be able to reach economically. The trade-off for those that already have some level of experience is that you are giving up some level of control. This may not be right for everyone, but on the whole real estate crowdfunding seems to be here to stay!
About the author: Matt Rodak is the founder of Fund That Flip, a company which provides fast, convenient and affordable capital for real estate developers that buy and rehabilitate residential properties.