GUEST POST: What is “Real Estate Crowdfunding”?

[Real estate crowdfunding has become a viable investment vehicle recently.  The guest post below provides an introduction to this (relatively) new and exciting investment option.  This guest post is provided by Soren Godbersen of EquityMultiple.  We have no financial relationship.]

In 2012 - in the throes of the Great Recession - Congress sought legislation to relieve credit tightness gripping the economy, and stimulate small business activity. The JOBS Act was quickly signed into law in April of that year, reversing or modifying a number of existing financial regulatory statutes. Most notably, the bill lifted the ban on ‘general solicitation’, allowing companies to advertise private placements of securities for the first time since 1933. The legislation was first harnessed by companies looking to raise operating equity capital for their startups - typically in the tech and ecommerce space - giving rise to platforms like CircleUp and Wefunder that connected startups with investors eager to gain access to an alternative asset class. The new paradigm proved a natural fit for real estate as well, allowing real estate companies to offer access to a broader audience of individual investors, in much smaller increments.

Prior to the JOBS Act, there were 2 very imperfect ways for investors to access commercial real estate: by pooling cash with other investors to buy and manage property; or by investing through a real estate investment trust (REITs). The former is prohibitively costly and time-intensive for most investors, while REITs are typically opaque, highly-correlated with public markets, prone to high fees, or all of the above.

Real estate crowdfunding offers an alternative that, at its best, is more transparent than REITs, and more efficient than direct real estate ownership, with a lower barrier to entry.

Why does real estate investing make sense in the first place?

High-net-worth individuals and institutional investors have long held substantially higher allocations of real estate ownership in their portfolios than individual investors. Here are a few of the core reasons:

  • Consistent cash flow: Many real estate investments provide regular cash flow in the form of rental income, as opposed to bonds and many stocks, which either do not generate cash-flow, or do so at lower rates.
  • Low Correlation with Public Markets: While public REITs are traded and tend to correlate strongly with public markets, private real estate investments show a low correlation to public debt and equity markets, providing downside protection for portfolios that already contain stocks and bonds.
  • Tangibility & Scarcity: Real estate is scarce by definition, and holds inherent worth. Since the supply of developable land remains fixed while population and cities grow, real estate has consistently appreciated in value over time.

Real estate crowdfunding allows individual investors to realize these same benefits without the high barriers to entry, and allocate a more meaningful portion of their portfolios toward direct real estate ownership. 

Does this fit my portfolio? 

While the new world of online real estate investing affords much greater access to the asset class, there’s still plenty of reason for individual investors to move cautiously. Above all, it’s important to note that not all platforms are created equal, and real estate crowdfunding platforms have diverged into different distinct products in the 5 years since the JOBS Act passed. As of this writing, here are the dominant themes:

  • Direct, Distinct Properties: some platforms, such as EQUITYMULTIPLE, offer equity investments in larger multifamily, office and mixed-use projects, allowing individuals to invest alongside experienced real estate companies in institutional commercial real estate. Investors can pick specific properties and projects they want to invest in, and participate in greater upside for successful deals. Of course, risk and potential return always move inversely, and thus there is somewhat greater risk associated with these platforms (EQUITYMULTIPLE offers senior debt and preferred equity investments as well, in part to reduce the risk profile of the overall portfolio). These platforms are more appropriate for opportunistic investors and those with more time to understand individual real estate projects.
  • eREITs: several companies - most notably RealtyMogul and Fundrise - have pivoted to offering blind or semi-blind funds that aggregate multiple individual real estate properties into a single investment product, similar to the real estate investment trusts (REITs) that have existed since long before the JOBS Act. eREITs ostensibly provide built-in diversification, particularly for investors that lack the time, knowledge, or means to spread their investment dollars across specific properties and markets. On the other hand, some investors may be turned off by the lack of transparency. These platforms are most appropriate for non-accredited investors looking for built-in diversification at a very low minimum.
  • Senior Debt: several platforms have opted to concentrate on debt financing of smaller projects (typically fix-and-flip operations), while on the other side of the coin offering a fixed-rate investment offering to investors. PeerStreet, LendingHome and Patch of Land remain the biggest names in this space. On the plus side, these platforms offer an easy-to-understand investment opportunity and unambiguous flat rate of return. Investments offered through these platforms are typically secured by a first lien (similar to a mortgage), adding a layer of security to the investment. On the other hand, upside is limited; investors will not exceed the flat rate of return. These platforms present an interesting alternative to other fixed-rate vehicles, such as bonds and treasury notes. These platforms are most appropriate for conservative investors seeking preservation of wealth.

Regardless of how offerings are structured, investors should carefully consider the real estate experience of the people behind the platform. As Lending Club’s recent debacle showed, “move fast and break stuff” may work as an axiom for growing a tech company, but not when it comes to investing. Any real estate platform worthy of your investment dollars should be transparent, attentive, and able to articulate a strong investment thesis for any particular offering. 

Soren Godbersen is VP of Marketing & Communications at EQUITYMULTIPLE is a secure online platform that connects accredited individuals with exclusive, high-yield commercial real estate investment opportunities.  Partnered with Mission Capital - a national real estate advisory firm based in Manhattan - the EQUITYMULTIPLE team has closed a combined $70 billion + in real estate transactions.  We have no financial relationship. 

Future Proof, MD

Dr. Bo Liu is an aspiring radiologist-in-training and the founder and editor of the White Coat Money Blog.  He has an interest in interventional radiology and helping his medical colleagues get ahead in this mad world of medicine and money.  When he's not crushing the list at the PACS station or typing up your next favorite blog post, you can usually find him at the local badminton club, movie theater or the most recently opened restaurant.