What Is Commercial Real Estate Crowdfunding & How Does It Work?
In the past, investors interested in commercial property development or ownership faced two options: produce enough cash to purchase a property outright or qualify for a loan to cover the cost of the investment. Most real estate investors don’t have the capital necessary to complete the purchase of a commercial building outright, so they turn to private investors who bring the money in exchange for equity. In 2012, the Jumpstart Our Business Startups (JOBS) Act opened opportunities for real estate investors, including non-accredited investors to participate through commercial real estate crowdfunding sites.
In this article we explore commercial real estate crowdfunding. We will explain how real estate crowdfunding works and discuss the pros and cons of real estate crowdfunding. By the end of the article, potential investors will be able to determine whether crowdfunding is a suitable way for them to participate in real estate projects.
At First National Realty Partners, we are a private equity firm who specializes in the purchase and management of grocery store anchored retail centers, and we have deep experience with commercial real estate crowdfunding. If you are an accredited investor, interested in partnering with a private equity firm to allocate capital to a commercial real estate investment, click here.
What is Commercial Real Estate Crowdfunding?
Many commercial real estate partnerships rely on a handful of investors to finance the real estate deals that the general partner underwrites. Real estate crowdfunding is a financing method that relies on a larger pool of investors to come on as equity investors. A crowdfunded effort might involve anywhere from a few dozen up to thousands of investors in the same project. Investors can contribute almost any amount of money to the deal and receive a proportionate amount of equity ownership. These investors are considered limited partners, just like a limited partner in a traditional commercial real estate syndication.
Commercial real estate crowdfunding is a relatively new offering that has grown in popularity since the passage of the JOBS Act in 2012. Crowdfunding offers the opportunity for smaller, non-accredited investors to participate in commercial equity investments that they otherwise wouldn’t have access to. This method also opens the door to commercial real estate investing for those who don’t have enough capital to participate through more traditional investment options, and it allows investors to achieve diversification that is often difficult to attain in commercial real estate due to the typically high purchase prices associated with commercial properties.
How Does Crowdfunding Work in Commercial Real Estate?
After the passage of the JOBS Act in 2012, several startups were formed to help real estate investors participate in crowdfunded investments over the internet. Some of the more popular crowdfunding websites that facilitate this type of investment are Fundrise, CrowdStreet, and RealtyMogul. These websites tend to offer different types of real estate investments, including single-family and multifamily properties.
The way commercial real estate crowdfunding works is investors create accounts with one of these websites and search for a deal that meets their investment objectives. Crowdfunding websites often present potential investors with many commercial real estate deals, so it can be time consuming to filter them to find those that are the best fit.
Once the investor has narrowed the potential deals down to a short list, it is time to determine how much to invest in one or more deals. One of the benefits of crowdfunding for real estate investing is investors, regardless of net worth, can choose to invest in multiple deals to achieve diversification. They must decide how much to invest into each deal and usually have to meet a small minimum investment requirement.
Similar to investments in other types of real estate vehicles, such as publicly traded REITs, crowdfunding websites usually maintain regular dividend payouts to investors. Over time, investors can also benefit from appreciation in the market value of the rental properties they have invested in.
Real Estate Crowdfunding Laws
The Securities Act of 1933 is one of the most important pieces of legislation in the United States financial system. It stipulates that the offer and sale of securities must be registered unless an exemption from registration is available. This means every investment sold to investors in the United States must be registered with the Securities and Exchange Commission (SEC) unless it meets one of a handful of exemptions
The JOBS Act offers a few exemptions from the registration requirement. Specifically, Title III Securities Act Section 4(a)(6) of the JOBS Act provides an exemption from registration for certain crowdfunding transactions. This provision allows early-stage businesses to offer and sell securities through crowdfunding. The JOBS Act also allows companies to raise up to $1 million in any 12-month period through crowdfunding.
Companies looking to raise capital can’t offer crowdfunded investments directly to the general public. Instead, they are required to engage an intermediary that is either a registered broker-dealer or registered with the SEC and the Financial Industry Regulatory Authority (FINRA). This regulation is the reason why so many crowdfunding websites have been established in recent years. It’s important to know the only companies eligible to offer crowdfunding investments are non-Exchange Act reporting companies, which includes most private equity firms.
For more information on crowdfunding regulations, investors should visit the SEC’s website on crowdfunding.
Pros and Cons of Commercial Real Estate Crowdfunding
Commercial real estate crowdfunding, like any investment, has pros and cons investors should be aware of before choosing to invest. We’ll start by exploring both in the sections below.
Pros of Commercial Real Estate Crowdfunding
We’ll start with some of the pros associated with commercial real estate crowdfunding.
Low Minimum Investment
Perhaps the most commonly cited benefit of investing in crowdfunded commercial real estate projects is the low minimum investment requirements. For investors with lower annual incomes or those just getting started with commercial real estate investing, this can be a big boost. Rather than having to come up with a large down payment to purchase a property outright or attain accreditation status, individual investors can make investments as small as ten dollars to get started in crowdfunded commercial real estate deals.
Professional Investment Managers
One of the barriers of entry to real estate investing is the vast knowledge an investor needs to acquire before investing significant money into a property. New investors often struggle with the nuances of sourcing properties, performing due diligence, and fundraising. As a result, many people have chosen to avoid commercial real estate in the past due to the lack of knowledge and difficulty entering the market.
Commercial real estate crowdfunding has transformed the industry and created more opportunities for people who don’t have experience with real estate holdings. New investors can invest alongside professional management teams who understand the industry. Many of these managers and investment firms have been handling commercial real estate holdings for many years, even before crowdfunding became an option in the industry. These people have applied their knowledge to the crowdfunding platform, giving average investors an opportunity to benefit.
Diversification
Historically, commercial real estate investors who wanted to diversify their holdings had to purchase additional properties outright or source additional syndication deals. Both of these options tend to be capital intensive, and investing in syndications requires accreditation. With crowdfunding, investors have the option to invest small amounts into a project alongside other investors.
Crowdfunding real estate investments is beneficial because it allows for easy diversification, regardless of net worth. Instead of tying up capital for a single investment, an investor can create a portfolio that includes various property types.
Tax Benefits
A benefit of investing in real estate over other types of investments is the available tax benefits. IRS rules make it possible to deduct depreciation associated with properties that produce rental income. Many real estate investors use these deductions to manage annual tax liabilities. Similar tax benefits are available to investors who opt to invest through commercial real estate crowdfunding.
Another tax benefit that should be considered is the ability to defer capital gains taxes upon the sales of a property using a strategy known as a 1031 exchange. Learn more about this strategy here.
Property Management
Commercial real estate investors need to consider how they will handle the ongoing management and maintenance for any property they acquire. Commercial real estate crowdfunding offers a solution. Using this strategy, investors have partial ownership of a property or portfolio, and they can effectively outsource the property management to the general partner. This relieves investors of managing the day-to-day details of the investments, and it allows them to benefit from the skills and knowledge of a professional property management company.
Cash Flow
Many investors are attracted to commercial real estate for the possibility of generating passive income. The basic idea is a real estate investor can invest capital upfront and then receive cash flow by way of distributions from the general partner. The investor does not need to take ongoing action to get this cash flow, hence the term passive income.
For some investors, the available cash flow can help them live the lifestyle they choose, or it can help them achieve financial objectives. Many crowdfunding investments are structured to send distributions to investors on a regular basis – monthly, quarterly, or annually.
Property Value Appreciation
Similar to any public or private real estate investment, investors who opt for crowdfunding stand to benefit from property value appreciation over time. Crowdfunded commercial real estate investments can appreciate in different ways, including forced appreciation through rehab work or rent increases. The management teams that are most skilled at increasing the value of the property can generate higher returns for investors over time.
Tangible Assets
Investors often find it reassuring knowing their money is invested in tangible assets. The intangible nature of stock market investments leaves investors with less confidence in their holdings. In comparison, the market valuation of real estate might fluctuate over the years. But, many investors find comfort in knowing they own a physical property that will probably appreciate over time and can be rented to tenants to generate cash flow.
Cons of Commercial Real Estate Crowdfunding
Illiquid
Crowdfunded real estate investments can be illiquid, meaning investors may not be able to request the return of their capital before a specified amount of time has passed. This might be fine for some investors. But, investors who have a short-term need to cash, should be aware of a minimum investment period.
Fees
Crowdfunded real estate investment, like other forms of real estate investing, have fees associated with them. General partners charge fees to their limited partners to support the management of the capital and property as well as to pay salaries and other administrative expenses. Over time fees can reduce the rate of return investors see on their capital, so they should take the time to understand the fee structure before investing.
Limited contact with GP
Crowdfunding, by definition, means an investor is likely to be one among many. For this reason, they may not have much interaction with the general partners responsible for managing the project. This is similar to other types of investments, such as real estate investment trusts, but investors should consider if they are satisfied without having direct access to the management team.
Why Choose Real Estate Crowdfunding Instead of Other Investments?
There are many reasons why investors choose to invest via real estate crowdfunding as opposed to other asset classes. Perhaps the most commonly cited is the idea that commercial real estate can generate satisfactory returns with less volatility than other asset classes, such as stocks or cryptocurrency. Many investors like the stability that comes with commercial real estate investing.
Additionally, real estate crowdfunding comes with many of the same benefits as other forms of real estate investments. As we discussed above, commercial real estate crowdfunding comes with tax benefits and the potential to generate periodic cash flow from distributions.
Real estate crowdfunding also gives investors a way to diversify their holdings away from stocks and debt investments, which can be valuable during times of market volatility. Crowdfunding becomes particularly attractive to investors looking to achieve this level of diversification on a relatively small amount of capital.
Real Estate Crowdfunding vs. Traditional Real Estate Investing
Prior to the rise in popularity of real estate crowdfunding, there were barriers placing commercial real estate investments out of reach for many individual investors. An investor looking to purchase commercial deals often needed a prohibitively large amount of capital. Often, the minimum amount of capital needed for this type of commercial real estate investing is well into the six figures.
In comparison, crowdfunding allows investors to join with as little as $10 in some cases. Investors have the opportunity to start small and build a sizable investment portfolio over time. This can be a great way to break into real estate investing and learn the ropes while growing a capital base.
Best Commercial Real Estate Crowdfunding Platforms
There are hundreds of commercial real estate crowdfunding platforms, but they are not all created equal. Investors need to complete due diligence in order to determine which platform is right for them.
Investors should take ample time to read all the information provided by the crowdfunding platform. Investors should understand important pieces of information, such as the minimum required investment, any fees the platform charges, and protections in place to minimize risk.
Find information about the track record of the investment platform.
- How long has the company been in business?
- How many years of experience are brought to the table by the investment team?
- How many deals have been completed?
- What strategies are used when identifying investment properties?
- What is the total amount of funds raised?
- How long are the offerings open?
Many crowdfunding operators were involved in the real estate industry prior to 2012, when crowdfunding started to gain in popularity. Investors should evaluate the amount of experience the management team gained with commercial real estate investing before crowdfunding became available in 2012. Deep industry experience is an invaluable resource that can help to increase the possibility of long-term success.
While there is no “best” crowdfunding platform, there are questions investors can ask to begin learning about an investment platform. The goal is to find the one that meets the investor’s needs and investment objectives.
How to Get Started in Commercial Real Estate Crowdfunding
Investors looking to get started with commercial real estate crowdfunding should take a few steps.
First, they should take the time to think about how much capital they are able to invest, for how long they are comfortable locking it up for, and what their risk tolerance is. This information will guide the investor as they search for the right crowdfunded real estate investment.
Next, investors should take the time to explore different crowdfunding options. There are many websites that offer crowdfunded real estate investments, but they are not all created equal. Investors should find one that offers the types of deals they are targeting – apartment buildings in the Midwest for example.
It is important for investors to do an adequate amount of due diligence before investing in a crowdfunded real estate deal. Investors should read all information and disclaimers offered by the general partner and crowdfunding broker and understand the fee structure and minimum investment amounts and time horizon. Investors should also perform due diligence on the property and the market where the property is located as well as the general partners to ensure the deal fits their investment objectives.
Once these items are complete and the investor is comfortable with the deal, it is time to fund an account with the crowdfunding broker and allocate capital to the chosen investment. This signals the start of the crowdfunded investment. But, the investor should continue to check in periodically to see how the investment is performing, read any updates provided by the general partner, and understand how distributions are handled. Crowdfunding can be a great source of passive income, but prudent investors still check in from time to time.
Is Commercial Real Estate Crowdfunding Right for You?
Every investor and every investment is unique. Investors should take the time to think about their investment objectives, risk tolerance, and time horizon when deciding whether commercial real estate crowdfunding is right for them.
Investors interested in commercial real estate crowdfunding should consider building a team of experienced investment advisors to help with the decision making process. For example, investors might consider working with a CPA, tax attorney, or financial advisor to explore each investment option in relation to their objectives.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
