A lot has changed over the past 10+ years with respect to investing passively. Technology has rapidly changed the way we interact with one another and how we connect. While the primary aspect of our lives that has been affected by technology is how we connect with other people, there are numerous areas of our lives where technology has made a difference. Through social media and networking sites, we can now send a message halfway across the world in just a click.
As a real estate investor, I believe that the primary area that has drastically changed is how companies raise capital for a project or company, and likewise, how investors find opportunities to invest in.
The traditional way of raising funds involves conducting research, writing a business plan, creating a financial model, and marketing the idea to other individuals or organizations who might be interested in investing. Capital was historically raised from individuals and from institutions such as banks or venture capital firms that the firm may know or have a connection with. Raising capital from individuals is predicated on knowing people with money to invest, which can limit your growth. Depending on an institution is also difficult because each institution has a set amount of capital it is willing to deploy, and these institutions are looking for the best possible investment. Naturally, this reduces the chances that your real estate investment idea will get funded in that way. And unless you have the best idea or a new way of doing things, these institutions also like to see that you have had success in past ventures. As such, receiving funding from institutions often only feels like it is only open to a small group of real estate entrepreneurs.
What is Crowdfunding?
Crowdfunding is the accumulation of money for any activity, for an organization, or for real estate related activities via the internet usually through a crowdfunding platform. Crowdfunding uses email marketing, social media, and paid advertising to attract potential members and investors. While many real estate crowdfunding sites have higher minimum investment sizes, the original premise for crowdfunding was that a lot of money could be raised by more investors willing to invest smaller amounts.
Crowdfunding provides investors with the opportunity to become members in an entity that ultimately owns the property. These investment opportunities are typically deals that the investor would not have seen through normal channels had it not been for the crowdfunding platform. These platforms are websites that host entrepreneurs and real estate Sponsors who are looking for debt, preferred equity, or equity investments into their business or real estate via crowdfunding. Examples of these platforms are Kickstarter and Indiegogo for businesses, and CrowdStreet, RealCrowd, and Cadre for real estate. Crowdfunding, however, does not only limit itself to investments in businesses and real estate projects.
There are several types of crowdfunding options for real estate include debt, preferred equity, and equity options. The most prevalent crowdfunding option for real estate is the equity-based crowdfunding. Equity-based crowdfunding involves giving a share of a company to investors equal to the percentage they invested in the company or 1 share per dollar invested, which is quite similar to the stock market or membership interests in a real estate venture. This type of crowdfunding has grown in popularity among entrepreneurs since they won’t be giving up shares of their company to venture capital firms and financial institutions. On the investor side, as an investor in real estate crowdfunding, this is attractive since the investors can invest a relatively small amount in order to have an opportunity to earn from cash flow and appreciation in the future.
There are benefits to obtaining capital by crowdfunding compared to the traditional way of raising capital. Listed below are some of the advantages of crowdfunding:
· Wider audience – Since you will crowdfund through the internet, your marketing materials will reach more individuals. There is now no limit to the number of accredited investors that one can invite to invest.
· Marketing advantage – The majority of people nowadays get their news and consume content through social media sites and the Internet. These platforms are where you’ll be able to crowdfund yourself or find the best crowdfunding opportunities to invest in.
· Better feedback – With a wide range of audience comes different questions and ideas that interested investors might give you. You’ll be able to see where your business is lacking and be able to adjust accordingly. The speed of their feedback is also an advantage to you. The faster you know what they are looking for and address it, the better for your crowdfunding. Likewise, you will be able to learn more about the Sponsors that you are looking to invest with.
· Communication with investors – Since the investors primarily consist of individuals who are only known to the Sponsor through the Internet, it has become standard practice for Sponsors to openly communicate more frequently than with traditional Sponsors who do friends and family raises. Trust is built between investors and Sponsors through communications.
· Collection and Disbursement of Funds – As would be expected, crowdfunding has also automated the collection and disbursement of funds for projects. Sponsors request funds to be wired and can then do monthly, quarterly, or annual disbursements via check, wire, or ACH.
There are several avenues through which a real estate entrepreneur can start fundraising via crowdfunding and through which a real estate investor can start researching real estate projects to invest in.
There are also a lot of misconceptions that crowdfunding is easy. In its essence, it is. You find a real estate investment to acquire, market it to the public through the internet, gain investors, then collect the funds, operate the asset, distribute returns, and ultimately sell the property for a profit. And on the investor side, it is easy to get lured in by attractive deals that each crowdfunding platform is marketing on behalf of the Sponsor. However, the devil is always in the details.
Crowdfunding really took off with rewards-based investing, but the majority of the growth in crowdfunding is now being derived from equity-based crowdfunding platforms. In the past, crowdfunding was only available to investors considered by the SEC to be accredited investors, but things have changed since 2016, and now all investors are allowed to invest in crowdfunded deals assuming they meet SEC criteria.
Accredited investors are individuals who have income of at least $200,000 per year individually or $300,000 per year with their spouse, or those individuals who have a net worth in excess of $1,000,000. There are no limits imposed on accredited investors.
There are investment limits for non-accredited investors. The limits imposed by the SEC are based on both the investor’s income level and net worth. If an investor has annual income or a net worth less than $100,000, the investor can invest the greater of $2,000 or the lesser of 5% of the investor’s income or net worth. If an investor has annual income or a net worth greater than $100,000, the investor can invest the lesser of up to 10% of their income or net worth, not to exceed $100,000.
The SEC is trying to give access to all investors while also protecting smaller investors that may not have the experience or knowledge of risks. The biggest risk with crowdfunding is that most of the companies marketing their deals are not known to investors, which means that there is no history or knowledge of how the firm has operated in the past. And there is a risk that investors could lose some or all of their investment.
Crowdfunding is an investing revolution. Crowdfunding has made it easier for real estate entrepreneurs to raise money and it has made it easier for real estate investors to find attractive deals to invest in.
Crowdfunding offers investors access to deals that they may have never seen otherwise. Real estate crowdfunding uses social media and the internet to connect investors to property investments. Real estate crowdfunding is similar to equity investing since an investor can buy into an entity and become a shareholder of the entity that ultimately holds title to the property.
Crowdfunding offers companies access to capital that they might never be able to raise. There may be consolidation among the various crowdfunding platforms over time, but crowdfunding is not going anywhere. The best platforms are implementing best practices by setting rules for Sponsors and by actively adhering to SEC rules for investors. The best crowdfunding platforms are also promoting best practices related to accounting, tax reporting, investor communications, and both financial reporting and disbursement.
For investors, Crowdfunding can be a way to get access to deals that you may not invest in on your own while providing additional diversification for your investment account. You still have to do your due diligence. Try to understand the Sponsor history, the property location, the business plan, the fees, and the financial analysis the Sponsor provides. But once you are comfortable with a deal, I recommend doing these investments.
Personally, I have invested in approximately 25 crowdfunding deals across four different platforms.
Until next time, happy investing!