The Ultimate Guide to Real Estate Crowdfunding
Real estate developers have traditionally drawn on a limited number of private investors or syndicates to get funding for the construction, acquisition, and enhancement of their real estate projects. But these opportunities were scarce even if investors with significant means participated in them.
Another option was to invest in REITs (Real estate investment trusts) – vehicles leveraged by real estate companies to pool assets. In most cases, REITs are publicly traded entities. They access more funding sources including not only accredited but also non-accredited investors via a stock exchange. But the real estate developers and businesses had to go through the full process of a public listing if they wanted to get financing for their projects through a REIT.
With the acceptance of the US JOBS Act, crowdfunding companies were enabled to solicit investments from all types of investors without passing the procedures required to be a publicly traded entity. Until March 2021, companies were allowed to raise a maximum of $1.07 mln during a 12-months period. In March 2021, with the introduction of Reg. CF, the limit was increased to $5mln during a 12-months period. It opened even more opportunities to non-accredited investors and made crowdfunding even more convenient for real estate developers that led to the constant growth of the real estate market size globally.
What you will learn in this post:
Who Can Participate in Real Estate Crowdfunding Offerings
Since the passing of the JOBS Act and then, Reg CF, both accredited and non-accredited investors can participate in real estate crowdfunding offerings. To non-accredited investors, some limitations are applied.
If the investor’s annual income or net worth is below $107,000, then during a 12-month period, the investor can invest up to either $2,200 or 5% of the annual income.
If the investor’s annual income or net worth is equal to or above $107,000, the investor can invest up to 10% of the annual income but not exceeding $107,000. Some examples are provided in the table below:
Along with limitations on investing amounts imposed by SEC, the majority of crowdfunding platforms also impose their minimum limits.
For most offerings on CrowdStreet, the minimum investment level is $25,000. It means that offerings are available for accredited investors only.
EquityMultiple permits investments from $5,000, but for the majority of offerings, the investment minimum ranges from $10,000 to $30,000. EquityMultiple is open to accredited investors only.
There are platforms that indeed open doors to real estate investing to non-accredited investors, too. Lofty.ai enables investments in real estate projects with $50 only, and Fundrise enables investors to start with as little as $10 as an initial investment and go up to as much as $100,000 depending on the account level. The most popular account level is Core, with an initial investment of $5,000.
Financial Instruments Used in Real Estate Crowdinvesting
Real estate crowdfunding is not homogenous. Investors can find different investment options that vary in terms of expected returns, exposure to risks, interest rates, rules regarding a potential liquidation, income distribution, maturity, etc. Some projects may involve several types of investments, while others are limited to one investment type only.
The most common division of investment options is into debt and equity investment.
Potential risks and expected returns differ depending on the investment crowdfunding type.
Debt Investment
In debt deals, investors act as a creditor to the real estate developer. Investors get fixed payouts that correspond to a predetermined interest rate. The real estate serves as collateral for the deal, just like in the case of an ordinary loan.
Debt deals are divided into senior debt, bridge or mezzanine debt, and convertible debt.
Senior debt is the very first source of money that real estate developers are trying to secure. It is also the biggest component of the project funding. If a project gets into trouble, senior debt owners are the first ones to get their money back. It is the safest option to invest but in return, it offers the lowest income which is 3 – 8%. The holding period is 3-9 years. Normally, banks are the main senior debt owners but sometimes, such projects can be found on crowdfunding platforms, too.
Bridge debt or it is also called mezzanine debt, is a “bridge” between the senior debt and the equity investment. If a project has issues, mezzanine debt owners are paid their money back after senior debt owners and before equity investors. Risks taken by mezzanine debt owners are higher than those taken by senior debt owners. That’s why potential returns are higher, too, and vary between 9-15%.
The holding period and payment schedules are similar to the senior debt.
For mezzanine debt holders, it is crucial to check carefully who are the senior debt holders. If a respected financial institution is a senior debt holder, it gives other investors confidence that the project was subjected to proper due diligence and has perspectives to succeed.
Any type of investor can be a mezzanine debt holder that’s why this investment option is frequently presented on real estate crowdfunding platforms.
A convertible debt deal can be a good alternative for those investors who cannot decide between debt and equity investment. A company gets funds from investors and repays them later in the form of a property share. If investors are not willing to convert a debt, they receive returns anyway according to the agreed interest rate.
Equity Investment
In equity deals, investors are stakeholders and have a share proportional to their investment. Their returns are generated from any cash flows (rental) or value appreciation of the project when the property is sold. The access to the income from the property appreciation gives equity investors an opportunity to benefit from higher potential returns. But the risks taken by equity investors are also much higher than those taken by debt investors. Returns are derived from rental income and property appreciation, and it may take time to receive the income.
Equity investors also shall take special care with such terms as “target holding period”. This term means that the holding period is not fixed, and therefore, it is not sure when the returns are paid or what they are going to be.
There are two types of equity available for real estate investment:
- Preferred equity
- Common equity.
Preferred equity investors have priority over the project’s cash flows compared to common equity investors. It means that in case the project faces issues, they will receive their invested funds before common equity investors.
The main difference between this investment type and common equity is that returns are capped for preferred shareholders. The returns are paid out at a fixed rate and depend on the income the project generates.
This investment type is frequently confused with the mezzanine debt investment. Indeed, they are similar in many regards, especially in the expected potential risks and the amount of expected return. The main difference is the legal aspect. Equity investors are given a share in the project and thus, are entitled to the project appreciation gains while for debt investors, this opportunity is normally not available.
Common equity investments are the riskiest in real estate crowdfunding. If the project doesn’t develop as expected, common equity investors have the lowest priority in the capital stack. First, senior debt investors are paid. After them, mezzanine debt and preferred equity investors receive their share. And in the end, common equity investors receive their funds from whatever is left (if anything). But high risks are compensated with high yields. If a project succeeds, common equity investors get about 20% or even more depending on the project’s success.
Types of Real Estate Fundraising Campaigns
The fundraising campaigns hosted by different real estate crowdfunding platforms vary in many aspects such as:
- Minimal investment
- Holding period and liquidity
- Availability for accredited and non-accredited investors
- Target investment
CrowdStreet
| Minimum investment | $25,000 for most offerings. Sometimes, offerings with a minimum investment of $10,000 or even less are available. |
| Account fee | None |
| Sponsor fees | Depending on a project (2%-5% on average) |
| Offering types | Debt, equity, preferred equity |
| Property types | Commercial, residential |
| Target hold period | 3-5 years for most offerings, some projects may have the target hold period up to 10 years. |
| Secondary markets | No |
CrowdStreet is one of the leaders in the real estate crowdfunding sector. As of May 2022, over $3,16 bln were invested in 629 deals which means that the yield in distributions is about $591mln.
The platform enables investors to invest in commercial and residential real estate such as offices, student housing, industrial, and multi-family. Single-family property is not available for investment.
The absence of platform fees is one of CrowdStreet’s benefits even though sponsors may charge fees for making the project available for investment. One of the main cons is the low liquidity. Once committed to a project, investors cannot resell the deal on the secondary markets.
EquityMultiple
| Minimum investment | $5,000 |
| Account fee | Depending on a project, normally varies from 0.5% to 1.5% annually, plus 10% of investor’s profit upon exit |
| Offering types | Debt, equity, preferred equity |
| Property types | Commercial |
| Target hold period | 3-5 years for most offerings, some projects may have the target hold period up to 10 years. |
| Secondary markets | Yes |
The EquityMultiple’s average target minimum is around $500,000 even though some deals can reach several millions. The platform mostly focuses on fixed-rate offerings that deliver returns of approx. 8%-14% APR.
Lofty.ai
| Minimum investment | $50 |
| Account fee | No |
| Property types | Residential |
| Target hold period | No |
| Secondary markets | Yes |
Lofty.ai has implemented a new approach to real estate crowdinvesting by applying blockchain technology. The platform enables investors to enter the real estate investment market with as little as $50, and get income on a daily basis.
The platform manages single-family, multi-family, and mixed-use property. It doesn’t have a target hold period, tokens can be sold and bought at any time without restrictions and penalties. A secondary market for trading deals will be launched soon.
The platform charges a listing fee of 5% (or $5,000 if less than $100,000) on each listed property. Sellers pay a 3% fee (or $2,500 whatever is greater) for their property to be listed on the marketplace.
Fundrise
| Minimum investment | $10 |
| Account fee | An annual asset management fee of 0.85%, and a 0.15% advisory fee. Long-term investors pay only a 1% annual fee |
| Offering types | Debt and equity |
| Property types | Commercial, residential, single-family |
| Target hold period | 5 years to avoid penalties, a 1% penalty is paid by investors who want to request partial or full redemption of their shares. |
| Secondary markets | No |
Fundrise offers investors several account types with different investment minimum amounts, different services, and investment opportunities.
Trends in Real Estate Crowdinvesting
The COVID-19 pandemic and climate-related disruptions prompted investors to pay more attention to sustainability-related risks and challenges. Now, Environmental, Social, and Governance (ESG) play a more significant role in how companies operate. That’s why investors consider ESG for every stage of the real estate crowdinvesting cycle, from due diligence to acquisitions.
Even though such ESG real estate certifications as LEED, BREAM, and NABERS remain important measurements for the environmental performance of buildings, the focus is shifting to investment in the World Green Building Council’s (WGBC) Net Zero Carbon Buildings Commitment. It calls for all buildings to reduce carbon emissions by 2030 and the complete decarbonization of the sector by 2050. Many real estate development companies already include carbon neutrality objectives in their investment strategies, so, crowdfunding platforms are following their steps by including such projects in their listings.
Why investing in ESG projects may be interesting for investors? Just as an example, office rent for LEED-certified buildings in the USA is 11% higher than the rent for those that don’t have the certification. The LEED-certified assets had a 21.4% higher average market sales price per square foot than those assets that didn’t have the certification.
For investors, the implication is clear: in the long term, return on investment in a LEED-certified office building will generate more income than investing in a building that doesn’t have the certification. Over time, the capital value will be growing, and monthly operating and maintenance costs will be dropping. On average, the rental premium for LEED Platinum-certified offices delivers 0.51% more annual growth than non-certified buildings.
While now, investing in ESG projects is a matter of a higher ROI, in the future, it is going to be subject to regulatory requirements applied to property owners and property developers. That’s why real estate crowdfunding platforms will have to consider it, too.
How Much Does it Cost to Start a Real Estate Crowdfunding platform?
Real estate crowdfunding platform costs depend on the type of solutions you go with. For example, a business may find real estate crowdfunding software that will be cheaper than starting a crowdfunding business from scratch.
Working with a development agency will help you be more flexible and more in control of the operations, but the development costs will depend on the dedicated time and complexity of your solution. Agencies may calculate prices daily, monthly, quarterly or even yearly. Some may even offer a fixed-price project.
Depending on the location of the hired crowdfunding platform developers, the costs will vary greatly. Developers’ rates may be as little as $20/h or as high as $120/h. For the whole project, you’d probably pay over $200,000 to build a decent platform.
With crowdfunding software, monthly costs start at $1,000. Again, it depends on the type of the solution and vendor. Crowdfunding software providers also introduce monthly, quarterly or yearly pricing plans and may provide customization services to make your platform unique.
How to Develop Your Own Real Estate Crowdinvesting Platform
Developing a real estate crowdfunding platform from scratch is a challenging task. You need to choose the real estate crowdfunding software and niche in which the platform will offer the projects. You may want to opt for a wider sector such as residential or commercial real estate, or you may want to choose a more specific niche such as educational real estate, traveling, etc.
Also, instead of focusing on one real estate crowdfunding niche only, you may want to choose several of them. It won’t influence your real estate crowdfunding platform in any technical aspect. But the type of investing types such as debt or equity investing will. They are fundamentally different and are calculated differently. That’s why your platform’s core workflows will differ significantly depending on the investment type you select. The functionality of your platform will also depend on other details such as:
- Payment processing
- Capital structure
- Fee structure, and so on.
Technology-wise, your real estate investment platform shall be a tool that can be used to conduct everyday operations. On the admin side, you shall be able to perform all the required operations. If you don’t have an experienced team to entrust this task, it may be better to consider using a white label solution.
LenderKit white-label crowdfunding solutions come with a range of out-of-box features that provide the required platform functionality. You can combine different investment flows in one platform to offer more opportunities to investors. Additionally, a white-label solution can be customized to your brand, regulation, and the required processes.
