Real estate crowdfunding is fixing the problems in real estate investment and could be a great way to find investment properties
I got a question from a reader after my recent review of the best real estate investing books. After the collapse of the real estate bubble, the reader was wondering if real estate crowdfunding was a good investment.
He pointed out some of the drawbacks of traditional real estate investing, which we’ll get to later in the article, and the slow appreciation in prices against a hot stock market.
It’s a good question. I’ve seen a lot of advisors go back and forth on real estate investing and real estate crowdfunding is still a new alternative. Investors are still gun shy with the memory of the 2008 real estate collapse and prices have hit highs recently.
So it may surprise you that real estate crowdfunding could be one of the best investments you make, offering both returns and portfolio diversification.
Few other investments have created as much legacy wealth as real estate. Investors with assets over $10 million reported in a 2015 survey by asset manager Tiger 21 that real estate investments accounted for the largest part of their portfolio, some 27% of total assets.
Even accounting for the recent collapse, commercial real estate investment has returned an annualized 8.4% over the decade to 2010 according to the National Council of Real Estate Investment Fiduciaries (NCREIF).
And that’s not counting the rebound in prices since 2010 with a longer-term average of nearly 11% for residential and commercial real estate.
While real estate crowdfunding through websites like Streitwise may differ from traditional real estate investing, it is still a direct investment in property and addresses many of the limitations to buying property yourself.
Yes, real estate crowdfunding is a good investment but it’s not as simple as clicking over to your online broker and hitting the buy button on a few shares. It helps to know how real estate investment works and the options available.
We’ll first look at some of the numbers proving why traditional real estate is a good investment before getting into the detail of how to invest in crowdfunding.
Should You Invest in Real Estate?
Most of the answers to the question of whether real estate is a good investment revolve around the idea of calling your home an ‘investment’. We’re going to be focusing on investing in commercial and rental real estate for this article rather than whether your home is an investment but even putting money down for a roof over your head can be a great return.
The problem with comparing owning a home as an investment against stocks is that most ignore some of the intangible benefits of home ownership. The actual return on home ownership is only about 5% which isn’t bad against other safe investments like bonds.
While this return isn’t bad, it isn’t great compared to the 8.6% return on stocks so people argue that you’re better off putting that down payment in the market and just renting. This ignores the benefits you can’t put a number on like:
- Home ownership is like a forced retirement savings account, something many people sorely need to save enough for retirement.
- You can’t buy and sell your house quickly like you can with stocks. This helps avoid the bad investing behaviors that led to an average investor return of just 2.6% over the decade through 2013.
- There’s a pride of ownership and stability in home ownership that is hard to match with renting a place.
The return above is on a passive investment in your home and doesn’t include the potential for a huge return if you time it right. My aunt bought a condo in Las Vegas for $50,000 in 2011 around the bottom of the market. Other condos in her community are now selling for $120,000 giving her a 140% return on top of the money she saved on rent.
My wife and I bought a foreclosed home for $25,000 in 2010 and put $45,000 and a lot of sweat equity into remodeling. I think I read every real estate book I could find to remodel the property. We ended up selling it for $105,000 in 2013 for a 50% return in just three years.
Back to the question of whether real estate investments are a good use of your hard-earned cash. Looking back over the long-run, it turns out that real estate offers one of the best returns among asset classes.
Over the past two decades, a mix of residential and commercial real estate has beaten stocks by 2% and has provided an additional 5.3% against bond investments.
No other asset class besides bonds comes close to the kind of safety you get with real estate. According to Nobel Laureate Robert Shiller, real estate prices have increased in 14 of the last 15 bear markets in stocks back to 1956.
How Much Can You Make in Real Estate Investing?
You only have to look as far as the Oval Office to find an example of the power of real estate investing. President Trump turned a loan of $14 million from his father in 1975 into one of the most well-known real estate portfolios worth several billion.
Sam Zell’s parents escaped Poland hours before Hitler’s army bombed the tracks that ran through their town and fled to America. Zell was born just four months after and has turned real estate into a $5 billion fortune.
Real estate as an investment isn’t like stocks. Of the original 12 stocks in the Dow Jones Index created in 1896, only General Electric has survived in its original form. The rest have all been bought or busted.
But real estate is forever.
The building on the land can crumble and you’ll need to invest in maintenance but few investments are as durable and long-lasting as real estate. Passed down generations, that 10.6% annual return turns $10,000 into $1.5 million in 50 years.
This is right around the average investors have earned on Fundrise, between 8.5% to 12.5% a year on the platform's funds. What I love about Fundrise is that it gives you the opportunity to diversify across dozens of properties with a single investment. You choose between three funds focused on cash flow or growth and get professional management on the properties.
Fundrise is offering a can't-miss 90-day trial for new investors. Try it out for 90-days and if you're not totally satisfied, you get your full investment refunded!
*I know it’s a long lead-in to whether real estate crowdfunding is a good investment but I wanted to set the stage for why traditional real estate investing is a good bet first before covering some of the advantages of real estate crowdfunding.
Types of Direct Real Estate Investing
I know successful real estate investors that focus on just one type of property while larger investors tend to diversify across different property types. Just as with stocks of different sectors, different types of real estate react differently to economic factors. Residential real estate will be more consistent while values for commercial property will vary along with the economy but may offer higher upside.
I got started in residential rentals in my early 20s. It’s the most common type of real estate investment but is loaded with problems and stress. Many go into rentals thinking it’s going to be a great source of passive income and end up pulling their hair out on all the tenant and maintenance problems. Managed correctly though and single-family rentals can offer individual investors the opportunity to get started on less money down.
Multi-family rentals are easier to manage than single-family homes but still make for a lot of tenant headaches. For all their risks, residential property investment can offer one of the higher returns in real estate investing. Investing in real estate crowdfunding, you’ll see most of the deals in multi-family apartments because of the higher costs to get started.
If you’re going to put together the best real estate portfolio possible, and that goes for a real estate crowdfunding portfolio as well, you need to include commercial real estate. There are five different types of investment property within commercial space:
- Leisure (resorts & hotels)
One of the distinct advantages of real estate crowdfunding is that you can get an ownership position in each of these types of commercial property without paying out millions or without deep experience in the sector. You will still need to do some research though and you may want to consider starting a real estate investment group to pool your knowledge with other real estate investors.
Just as every investor needs stocks (equity) and bonds (debt investments) to diversify their portfolio, real estate investors should invest across equity and loans. Equity investments offer higher returns but loans offer more protection as a first-lien against the property.
I've started following Streitwise as a great crowdfunding alternative in real estate. Streitwise offers a hybrid investment between traditional REIT fund investing and the new crowdfunding.
The fund is like a real estate investment trust in that it holds a collection of properties but more like crowdfunding in its management. The fund has paid a 10% annualized return since inception and is a great way to diversify your real estate exposure.
There are no additional costs to having accounts on more than one real estate crowdfunding site. Since the industry is still fairly new, following a few sites gives you access to more deals and different types of investment.
I also follow EquityMultiple, a newer real estate platform but one that is getting some very good deals. The site targets only institutional-quality commercial properties instead of individual developer deals. That means projects are often also backed by big money institutional players that can help make the deal a success.
Following multiple real estate crowdfunding sites means you should see at least five to ten new deals a month, more than enough to be picky about in which properties you invest. One of the worst mistakes you can make is to feel like you must invest in a sub-par deal just because it's the only one available.
I've reviewed several other real estate crowdfunding platforms over the last three years but have found a lot of hidden fees and bad deals. I talked to several Patch of Land investors for my review on the site that found fees well above the average. My review of Realty Mogul complaints got me several angry letters from the company threatening legal action. Needless to say, I'm not afraid to call it how I see it.
Downsides to Real Estate Investing
The returns on real estate investing have been spectacular but those higher returns come with risk and with some distinct disadvantages. The disadvantages to real estate investing include:
- Illiquidity and investing costs – you can’t buy and sell real estate as quickly as you do stocks and transaction fees can add up to 10% or more of the price.
- Management intensive – Commercial properties are easier to manage but any type of direct real estate investing will mean actively managing maintenance, marketing and tenant problems.
- Real estate is not a get-rich-quick investment – Even the high returns on real estate investment won’t make you rich overnight. Anyone that says differently is just trying to sell you their ‘strategy’.
We’ll see how real estate crowdfunding is different from traditional real estate investment but even the old-school way of investing can be a great wealth-builder.
How does Real Estate Crowdfunding Work?
The idea of real estate crowdfunding is really nothing new. Investors have been pooling their money to invest in real estate investment trusts (REITs) for decades. Real estate crowdfunding is just a more direct way to invest in property without some of the headaches of traditional investment.
Investing in real estate on a crowdfunding website is easy, a matter of simply creating an account with your contact information. You may need to answer some questions on net wealth or income to verify your status as an accredited investor but this is also fairly easy to do.
RealtyShares usually has the most deals available among real estate crowdfunding websites with a good mix of debt and equity offers. Analysts at the platform do due diligence on any investment deals to make sure that only legitimate real estate investments make it to investors. The crowdfunding site charges a 1% management fee to investors and has helped fund over $200 million in real estate property.
As of November 2016, more than $46 million has been returned to investors on RealtyShares and more than 25,000 investors have registered on the real estate crowdfunding website. Most active real estate markets for investment include: California, Chicago and New York.
Real estate crowdfunding has grown to $2.5 billion in just the three years to 2015 and is quickly replacing traditional real estate investing as a preferred play for investors. Investing in crowdfunded properties offers several advantages to real estate investors:
- Lower costs
- Greater liquidity
- Better diversification for less investment
- Strong returns and cash flow
The investment costs for real estate crowdfunding are generally just 1% to 3% of total assets, well under the cost to buy and sell traditional real estate. Having a leaner structure; usually just a developer, remodeling crew and the investor, means total development costs are generally lower compared to large REIT companies as well.
While you still won’t be able to buy and sell your real estate crowdfunding investments like stocks, many deals offer shorter investment periods from a couple of years to less than a decade. Real estate debt offers generally mature within three years and many of the equity deals are for a remodel-and-sell investment.
Even regular investors can get diversification through participating in many real estate crowdfunding offers for different property types and locations. Most real estate crowd investments require a minimum of a few thousand which means you can buy multiple properties for $10,000 or less.
Finally, real estate crowdfunding offers returns comparable with and even higher than traditional real estate investing. Real estate debt deals generally pay between 8% to 10% through regular interest payments while it’s common to see equity crowdfunding deals offer an internal rate of return around 14% and higher.
Real Estate Crowdfunding versus Real Estate Investing
Crowdfunding opens up real estate investing for individual investors because you no longer need millions of dollars to get the kind of safety and diversification you once needed for direct real estate investment.
By investing a few thousand in different real estate projects on a crowdfunding website, you can build a portfolio of different property types that is spread across the country. You don’t have to worry that a specific property type (i.e. hotels, office space or industrial) is going to crash or that a bad local real estate market will sink your investments.
Real estate investors have had to do this previously with REIT investments but those carry unique disadvantages. REITs trade on the stock market so the value per share often rises and falls along with stocks. There are also high management costs for large REIT companies and you have no control in which property types or locations you buy.
Investing in real estate crowdfunding gives you better control by making it a direct property investment. Your money is held in an escrow account by the crowdfunding website until the project reaches its funding goal. When that happens, the money is released to the developer and you get your ownership documents.
The real estate crowdfunding developer will update investors regularly and send out cash returns for longer-term investments. Debt investments will entitle you to interest and principal over a period while equity investments in the property will pay out dividends on rent and appreciation when the property is sold.
Is Real Estate Crowdfunding Investing Right for You?
I’ve only just started investing in real estate crowdfunding myself over the last year but am extremely happy with the returns so far. I have bought an investment in six properties across three cities; two real estate debt deals and four equity offers.
But I understand that real estate crowdfunding investing might not be for everyone. Real estate investing is a great way to diversify your wealth from a simple stocks and bonds portfolio and the long-term returns create real legacy wealth. Some investors will prefer the hands-on nature of traditional real estate investing even if it comes with tenant headaches and other disadvantages.
Ask yourself these questions before investing in real estate crowdfunding:
- Do I need help managing my real estate investments or can I do everything (maintenance, marketing, tenants) myself?
- Do I have less than a few million to invest in real estate?
- Do I want a shorter investment period of up to five or ten years or do I want to hold an investment property for decades?
- Do I want more consistent cash flow from my real estate investments?
If you answered most of these ‘yes’ then you will most likely be happier with real estate crowdfunding than with buying investment property yourself. Crowdfunding offers almost all of the benefits of real estate investing but without a lot of the limitations in a way that is accessible to regular investors.
Real estate crowdfunding is a good investment and a great way for Main Street investors to get exposure to real estate investing. Besides all the benefit of traditional real estate investing, crowdfunding investment properties offers regular investors a way to get the instant diversification of real estate funds but still with a direct investment. Check out some of the current offers on real estate crowdfunding websites like Fundrise and start putting your money to work.