In addition to being able to support the business ideas of friends and family, individuals can use crowdfunding to add real estate to their investment portfolio. Typically held on the Internet, crowdfunding campaigns allow for anyone to raise money for projects and business ventures from a large number of individuals who contribute small donations.
Entrepreneurs have been positively impacted by this phenomenon. It has allowed them to start, grow and even save their businesses with very cheap capital compared to alternative financing options, such as equity and debt financing. Developers have also been able to tap into the potential of crowdfunding. Platforms such as Fundrise, CrowdStreet and RealtyMogul have allowed them to raise money to acquire and develop income-producing real estate. These platforms have also given individual investors an alternative to real estate investment trusts (REITs) and have allowed them to directly invest in property development and acquisitions. (For more, see Real Estate and Crowdfunding: A New Path For Investors.)
Although the basic concept of real estate crowdfunding might sound great, it does come with a few disadvantages, about which potential investors should be aware. Below we shall explore some pros and cons of investing in real estate through a crowdfunding platform. (See also: What Crowdfunding Means To Investors.)
Unlike REITs, real estate crowdfunding gives investors the ability to decide exactly which properties they would like to include as well as exclude from their portfolio. When a person buys shares in a REIT, he is essentially investing in a geographically diverse amount of properties. If the REIT's holdings are large, it might be a bit hard for shareholders to analyze all of the properties in the REIT's portfolio. When an individual invests in a real estate crowdfunding campaign, they are investing in a single property. This allows the investor to know what exactly is in his or her portfolio.
Additionally, investments in real estate crowdfunding campaigns are not publicly traded and thus are not given a mark-to-market valuation every minute of the day. As a result, fluctuations in the value of real estate crowdfunded investments do not occur. The stock price of a REIT can dramatically move up and down throughout every trading day, and many times the movement of the stock price is influenced by external factors. REIT investors who are looking to escape the volatility of the stock market might find a safe haven in the illiquid nature of crowdfunded investments.
There are also some investors who simply want to realize a gain from the disposal of a piece a real estate and collect regular rental income, while avoiding the challenge of property management. Real estate crowdfunding is attractive to investors that would like to reap the benefits of owning income-producing property but not necessarily manage it.
Furthermore, real estate crowdfunding campaigns do not require a large minimum investment. This means that investors can own a stake in a sizeable real estate project without having to put down a large amount of money. As a result of being able to invest small amounts of money in real estate deals, investors can diversify their ownership in multiple properties, leading to a more diversified portfolio and minimized risk exposure. For example, instead of an investor putting $250,000 into one property, he can invest $50,000 in four different campaigns. (For more, see: Real Estate and Crowdfunding: A New Path For Investors.)
Real estate crowdfunding might not be a suitable route for investors who would like to play an active role in the management of their real estate holdings. Investors in crowdfunded property usually have little control and must trust the developer or operator to successfully manage the property.
Another issue is the fact that real estate crowdfunded investments are illiquid and not traded. This means that in the event of an emergency, it might be near impossible to cash out on an investment before the property is disposed.
Moreover, unlike REITs, real estate projects that are backed on crowdfunding websites are not required to distribute 90% of the rental income to investors. This might disappoint REIT investors who are accustomed to above-average yields.
Lastly, crowdfunded property is not as regulated as REITs. As a result, the reporting to investors may not be of the same high standards. (See also, As Crowdfunding Matures, Investing In Startups Gets Easier.)
The Bottom Line
Similar to REITs, real estate crowdfunding has democratized access to investing in income-producing property. However, investing in crowdfunded property is not for everyone who is looking to add real estate to his portfolio. As with any investment opportunity, there are a number of advantages and disadvantages that come with putting money into a real estate crowdfunding campaign.