How it Started and How it Works
Credit constraints being a persistent foil to many small investors since the global financial crisis starting in 2007; investors got savvy and took to Crowdfunding as a means to leverage their collective investment and purchase power, reduced risk, to access the often lucrative Real Estate Investment markets.
Real estate crowdfunding enables aspiring entrepreneurs to tap into real estate’s wealth-building potential. The ability to pool the resources of many investors to buy into commercial or residential real estate developments makes real estate investing more accessible to a broader audience and class of investors. It’s also a great way for investors to diversify their portfolios in a cost-effective manner.
The real estate crowdfunding phenomenon has surged in popularity recently because traditional lenders and banks aren’t always accessible to the entrepreneur looking to launch a commercial property or apartment complex. Investors have realized they don’t necessarily need the help of an advisor to grow their portfolios and make solid investments.
The minimum investment with many platforms ranges from $5,000 to $10,000.
Two Flavors of Crowdfunding, Equity-based vs Debt-based Real Estate Investing
Real estate crowdfunding is popular because of how accessible it is. If you have an internet connection and discretionary income, you can invest right away! Crowdfunded equity may represent a portion or all of the equity used in a real estate transaction.
Both equity and debt investments have their good and bad sides, which savvy investors must take the time to weigh carefully. Understanding what you stand to gain versus what you’re risking can help you decide whether one or both types of investments are a good fit for your portfolio.
Think platforms like RealtyMogul or Fundrise. They often compare (and contrast) themselves to REITs, often highlighting their advantages over such funds. While REITs and Fundrise/RealtyMogul have similarities, they are different in key ways.
REITs are NOT crowdfunding vehicles. They are investment funds, first and foremost.
REITs offer a lower cost to investors because management fees are significantly lower. REITs are easier to trade in and out of, meaning your money is easier to move, regardless of the reason. Fundrise/RealtyMogul intend to have their investors hold their investments for at least five years. This is generally referred to as a Hold Term. They also charge a certain percentage penalty for withdrawing funds (around 1%).
- Greater potential earnings, and there are no caps on those returns.
- Potential tax benefits associated with the properties, i.e. cost of repairs, depreciation, etc.
- Fully managed by the fund.
- Greater risk from properties that fail to make their investment returns
- Longer hold periods. You’re expected to hold your investments with the firm for several years, typically five years.
- Higher fees than REITs as they are externally managed
Still, with Fundrise/RealtyMogul, your investment nets you a piece of real estate equity, and you regularly see returns on those investments. With this approach to generating funding, investors provide capital infusion (monies) for a stake in a promising property.
Investors are lenders to the property owner(s) when investing in real estate debt. The property secures the debt, and you, the investor, receive a fixed rate of return, determined by the interest on the loan taken out for the given property.
Real Estate debt investors receive payouts before their equity-based crowdfunding investors. Debt investors receive less in payouts from properties/funds compared to their equity-based investor counterparts.
- Lower risk, investors can expect to be paid first when properties pay out.
- Shorter hold time
- Steady income
- Lower rate of return (Capped returns)
- Susceptibility to early payoffs of a mortgage by the fund, which can affect investor payouts.
Real Estate Crowdfunding Website Examples
Fundrise, RealtyMogul, and Patch of Land are all examples of crowdfunding services that are helping investors find deals that match their investment preferences and goals. These options are hosted and managed by the business, not the investor. You can’t run your own business on these platforms.
That’s where platforms like IgnitionDeck come into play. You have complete control of the platform, and you can set up your own Fundrise, of sorts.
Self-Hosted Real Estate Crowdfunding Example
A stellar example of Real Estate Crowdfunding is our customer, PeerBrick. Peerbrick is a European-based real estate investment platform that offers its investors high-profit projects starting at €500.
They control their investments, deciding which opportunity they invest in and how much they invest. Investors obtain attractive returns with a reduced level of risk since there is always a property behind your investment.
What Are the Legal Requirements for Real Estate Crowdfunding?
While crowdfunding is becoming a more widely-known way to raise capital for real estate projects, it is still not accepted in all localities. It is important for you to consider any local, state, or federal/international laws about crowdfunding before you make your intentions public.
What Tax Benefits Exist for Crowdfunded Real Estate properties and Property Managers?
Crowdfunding investment in Real Estate provides several tax benefits. Here are a few worth noting:
Tax Benefits for Real Estate Investors
- As an investor, your investments are taxed as a passive activity, meaning no self-employment taxes are due.
- When you invest via Real Estate Crowdfunding, you may offset passive gains with passive losses. Meaning if you have other similar Real Estate holdings that incur losses, you can use that to deduct your gains, reducing your tax bill.
- Investments are eligible for depreciation deductions
- You can also fund your Crowdfunded investments through your IRA. Hosted platforms like Fundrise or Crowdstreet provide a mechanism for this
- Investments are often taxed at a capital gains rate
Tax Benefits for Real Estate Property Managers and Sponsors
A sponsor is a person or entity that originates a Real Estate investment. They are also the property’s operator and manager, tasked with maintaining and improving the property so that investors get a better investment return.
Sponsors deduct various expenses so that you, the investor, can also save on taxes. These include:
- interest expenses,
- operating expenses, and
- net operating losses.
As a partner in a crowdfunded investment deal, you don’t pay interest on the loans directly. But the LLC passes these expenses on to shareholders, which are reflected on the K-1 form. Make sure you’re deducting them from your gross income.
Choose a platform wisely
There are several different online crowdfunding platforms. Each platform has different guidelines for accepting or denying projects. To determine which platform is best for your needs, it is important to understand the guidelines for the platform you are considering. You may also want to consider which platform will be the most effective at attracting investors to your crowdfunding campaign.
The requirements for real estate crowdfunding are that projects must involve residential properties, and each project must have a website. The website should be structured to make it easy for users to discover the project, learn about it, and learn how they can invest in it.
One of the primary benefits of real estate crowdfunding is that it can connect you to new investors. However, these investors may not fully understand your crowdfunding campaign if it is not presented clearly. For this reason, you must invest in creating a well-designed crowdfunding website. You want to develop a website that has a professional design. The layout of your website should be clean and uncluttered, and it must communicate the information your potential real estate investors need.
Real Estate Crowdfunding is an exciting space to be in and one where you can build a viable business on top of. Determine what kind of Real Estate Crowdfunding suits your preferences and connections the most and get started.
Starting small with crowdfunding can help you ease into things, and you’ll increase the chances of the success of your campaign. As you gain more investors for your real estate project, you can add additional properties to your campaign.
Crowdfunding is a great way to obtain funding for your real estate project. However, you must understand both the legal implications of crowdfunding and the best practices for a successful campaign.
IgnitionDeck provides the technology for your to build your platform; you’ll need to be clear on the legal ramifications of building such a platform.