Do you know the best way to invest in commercial real estate? If yes, real estate crowdfunding is your best option. However, it’s not good for everyone.
Crowdfunding means a group of people pooling their money together to achieve a common goal. Some a charitable in nature while others are for business purposes. Real Estate Crowdfunding means a group of investors contributing their money for a particular real estate deal. In the end, they sell real estate and share the profit.
How does it work?
The method is simple, a real estate professional identifies an investment opportunity that he cannot invest in on this own only, he tells other investors and they pull their resources together to execute the plan. Here, there are 3 key players. They include the sponsor: that is the person who identified the opportunity. He will facilitate the purchase of the asset and arrange all the needed works, financing, and responsibility. He as well earns a percentage of the profit.
Another player is the crowdfunding platform where the sponsor finds the investors to raise the capital needed for the project. This platform is the middleman between the investors and sponsors. It is the platform that advertises the deal to potential investors and ensures that they meet up all the requirements.
Finally, the 3rd player is the investor. He contributes certain amounts of the deal’s requirements in exchange for a share of the profit.
Why is real estate crowdfunding very popular?
The answer is simple, ‘’it is very lucrative’’. There is always a potential for higher returns. Sometimes the returns are from 14% up and more.
It helps give your portfolio diversification. Here most of your assets are in stock and bond. Also, it helps you to earn from property investment without being a landlord or dealing with renovations. Lastly, it helps you to invest in assets that if it were only you, you won’t have access to them.
What about the negative sides?
This type of investment is highly illiquid, your money is your commitment, it is different from owning a property. Sometimes, things may not work out.
How to Find Crowdfunded real estate opportunities
The crowdfunding platform is the middleman between the sponsor and the investors. Their vetting process has to be superb to ensure that everything goes on well. No wonder you need the very best platforms.
Further, know where your investment dollar is going to. It may be going directly in the real estate asset or in a large entity like LLC or limited partnership that has a stake in the property.
Finally, find a platform with the kind of real estate investment you like. If you are choosing an individual property, choose how much you want to invest in each.
Is it risky?
Consider the factors below to know how risky it is or not:
- What type of property is it? What if a recession hits how will you be affected?
- How much execution risk is there? Is there a value-adding strategy such as loan refinancing or another option?
- How much can I get a return at the sale of the property? It is important to consider these factors before taking a step.
What is the investment category?
This is an equity investment. It means that you contribute some of your money in exchange for the profit gotten from the property. There are 2 types here. They include debt investments and preferred equity. If you choose debt investment, it means you are a mortgage lender. In this case, you will only get some part of the interest payment. The second option has some guaranteed return.
Further, carefully review the investment prospectus especially the capital stack. This tells you the financial structure of the deal (like how much is coming from each source and who holds the most senior claims to the deal’s assets). It as well tells how leveraged the investment is.
Also, take into consideration the experience of the sponsor. Get to know how long he has been in the industry, how many deals he has covered, and how profitable the deals have been. Check if the fees are reasonable for you or not. Review the target holding period and the income component too.
Requirements for investing in crowdfunded real estate
Many single-asset crowdfunding real estate deals are only for accredited investors. Accredited investors have the following features:
- Firstly, at least $ million in net assets, apart from the value of their primary home.
- Also, at least $200,000 in annual income ($300,000) when combined with a spouse’s for each of the previous 2 years and an expectation of the same this year. If you don’t meet these requirements, focus on deals that are open to all investors.
What about real estate tax implications?
Income Tax: rental income generated by the properties you invest in can lead to taxable income. This will be reported to you and the IRS on a k-1 tax form yearly. But due to real estate depreciation, the taxable amount lowers.
State Taxes: if you are a part of the owner of a property in another state, the investment falls under its state jurisdiction and property taxes apply.
Depreciation recaptures: this can lower taxable rental income yearly. When the property is sold, the IRS will take back the benefit.
Capital Gain Tax: this is for a property that sells more than its purchase price. You owe capital gains tax on your share of the profit.
After considering all of the above, you can decide if Real Estate Crowdfunding is an option for you.
