Risks vs. Reward: What You Should Know About Crowdfunded Real Estate Deals
Traditionally, there have been a variety of ways for individuals to invest in commercial real estate. For example, they could buy a property directly, purchase shares in a Real Estate Investment Trust, or work with a private equity firm like ours.
However, in recent years technology and software advancements have given rise to a new option commonly referred to as “crowdfunding.”
What is Crowdfunding?
Fundamentally, a crowdfunded real estate investment is no different than a “traditional” indirect real estate investment in the sense that there is an investment manager or developer seeking funding for their deal. The major innovation in crowdfunding is the way that managers and/or developers are connected to potential investors. By combining a sophisticated technology platform with the wide reach of the internet, crowdfunding companies have created a 21st century marketplace to connect those who need capital with those who want to invest it.
In a typical deal, the crowdfunding company is a neutral third party who collects a fee on the total capital raised. And, depending on the company, they provide a variety of other services such as investor reporting and private “deal rooms” where confidential materials can be shared.
For those looking to invest capital, there are a number of significant crowdfunding benefits.
Benefits of a Crowdfunded Investment
For investors, the primary benefit of a crowdfunding platform is access to a wide variety of opportunities across different asset classes, property types, managers and locations. They can truly choose the deal that they feel is most suitable for their preferences, risk tolerance, and time horizon. In addition, crowdfunded investments offer:
- Low Minimums: In some cases, the minimum required investment is as low as $500, which is far lower than a traditional transaction where the minimum can reach $50,000.
- Dividend Income: Many of the deals offer the promise of a stable stream of dividends derived from rental income on the underlying properties.
- Simplicity: Crowdsourcing platforms are designed to be intuitive and user friendly, which creates a simple and easy investing experience.
- Manager Pre-Screens: Many of the platforms perform a minimum level of due diligence on the companies seeking investment. This often includes criminal and background checks for the management team and a detailed evaluation of their operating history and track record. For the platforms, their “value-add” is that they attempt to present investors with a curated list of companies that have met their minimum approval criteria for inclusion.
- Specific Properties: In a crowdfunded investment, investors typically know exactly what type of property or project they are investing in. This information is provided in the offering documents and it can be a major advantage over investing in a REIT or “blind pool” fund where this is not the case.
- Returns: With a combination of income and capital gains, single property real estate deals have the potential for higher returns than many other asset classes. On occasion they can exceed 20% annually.
Risks of a Crowdfunded Investment
A crowdfunded investment includes many of the same risks as a traditional real estate investment:
- Market Risk: Prevailing economic conditions can cause property lease and/or sale rates to be dramatically different than what was originally projected.
- Vacancy Risk: Depending on the size of the property, a tenant who decides not to renew a lease can cause a significant drop in Net Operating Income and it can take many months before a new tenant is found.
- Default Risk: If a tenant business experiences an unexpected downturn, they could default on their lease payments, which also causes a significant drop in Net Operating Income. Further, the process of pursuing back rent, eviction, and re-lease can be time consuming and costly.
- Property Risk: Real estate is a physical asset which means that its condition degrades over time and occasionally things break. If one of those things is a major mechanical system like a roof or air conditioner, the cost of the repair can wipe out years of profits.
But, it also includes a number of risks that are specific to crowdfunding:
- Deal Vetting: While crowdfunding platforms like to sell thorough deal vetting as part of their value proposition, it does not absolve the individual investor from their own due diligence. In the case of a crowdfunded deal, it is important that the investor understand the vetting process used by the platform to pre-screen the deal and the business plan being offered by the company seeking investment.
- Double Fees: When working with an investment manager, fees are a given. However, in a crowdfunded deal, it is critical to understand the entire fee structure. In many cases, the platform will charge a fee on top of the fee charged by the real estate company. These “double fees” can impact an investment’s overall return.
- Stability: As a concept, crowdfunding platforms are fairly new and unproven. If a platform were to run into financial difficulties, there may be a high degree of uncertainty about what happens to the investments they originated.
- Familiarity: Companies seeking a crowdfunded investment are likely unknown to potential investors. Because of the impersonal nature of the platforms, it can be difficult for the two parties to develop a relationship as communication “off platform” is discouraged. Potential investors must be comfortable placing their money with a manager they are unlikely to have a personal relationship with.
Given the crowdfunding specific risks, it may not be the best option for many individual investors. Fortunately, there are alternatives.
For accredited investors seeking exposure to commercial real estate, but wary of the crowdfunding structure, there are two alternatives to consider.
Real Estate Investment Trusts or “REITs” are companies who pool investor funds and use them to invest in commercial properties. Under IRS rules, they must distribute a certain percentage of their income to investors to maintain their tax advantaged status and they typically invest in a specific subset of the commercial real estate market like industrial or multifamily. For REITs that are publicly traded, their shares can be bought and sold like stocks and bonds, which provide a level of liquidity not available in other commercial real estate investments. However, an investor may not always know where their money is being invested beyond a general category.
The other option is to invest with a private equity firm that specializes in commercial real estate. Doing so provides all of the benefits of real estate ownership without the hassle of managing it. Depending on the manager, the investor may also have the luxury of knowing exactly what property they are investing in so they can tailor their interests and investment strategy to the opportunities being offered. In our case, we raise capital on a deal by deal basis, which provides our investors with a tremendous amount of insight into exactly how their money will be utilized. However, a private equity real estate investment does not have the same degree of liquidity as publicly traded REITs. Often, a firm may require that investment capital be committed for 5-10 years before it is returned.
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.
To learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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