If you’ve seen headlines about people pouring millions of dollars into new real estate developments, purchasing exclusive investment properties, or closing on multi-million dollar real estate private equity funds, it’s easy to feel discouraged and dismiss real estate investing as something reserved for the ultra-wealthy.
We’re here to dispel the myth that real estate is out of reach. Because as it turns out, there are new ways for aspiring investors everywhere to invest in real estate.
What is real estate crowdfunding?
The Beatles were onto something with their famous lyric “I get by with a little help from my friends.” Bear with us here...
As you can imagine, financing real estate can be quite expensive and difficult to do on your own. In fact, even sophisticated institutional investors co-invest with multiple parties to diversify their holdings and mitigate risk. When you pool your assets with a larger group of investors, funding a project is much more feasible.
Enter: real estate crowdfunding.
Simply put, real estate crowdfunding is when a group of investors contribute capital to a specific real estate project. It can be a development, a portfolio, a fund, or an individual property.
In this case, the crowd is your friend. There is strength in numbers, and in crowdfunding, the whole is certainly greater than the sum of its parts.
How does it work?
Crowdfunding is a viable solution for financing real estate because real estate is extremely capital intensive. Think about all the work that goes into constructing a building—the planning, the materials, building costs, labor—buildings certainly don’t build themselves.
When a developer or a real estate professional identifies a new investment opportunity, they may not always have the ability (or desire) to fund the entirety of the project. This is where crowdfunding comes in—individual investors will contribute capital to the project to fund the remainder of the investment.
Who are the players?
There are three crucial parties involved in every crowdfunding opportunity.
The sponsor: The sponsor is the real estate professional or company that is raising capital in order to carry out the business plan. The sponsor will identify, execute, and oversee the project, which includes purchasing the asset, organizing contractors and other parties necessary to execute the project, arranging financing, managing the project, and ultimately overseeing the sale of the asset. The sponsor typically contributes capital to the deal alongside investors to ensure alignment, which means that the sponsor will also be entitled to a proportionate share of the investment profits.
The platform: Where is a sponsor supposed to find investors? Here’s where the crowdfunding platform like Republic comes into play. A crowdfunding platform is essentially a marketplace that connects sponsors who are looking for capital with investors who are looking for investments. It is crucial for a platform to have the appropriate infrastructure in place to facilitate such transactions—including technology, finance and accounting capabilities, investor relations support, legal and compliance, among other functions. The crowdfunding platform will typically ensure that both deals and investors meet necessary requirements, and is responsible for collecting investors’ funds for investments and making sure they are distributed appropriately to sponsors, and vice versa when a sponsor is making distributions.
The investors: This could be you! Investors will contribute capital to a real estate investment opportunity in the hopes of getting a share of the upside (or profits). Depending on how the deal is structured, an investor may receive income distributions (in the form of dividend payouts) and/or be entitled to a payout when the sponsor eventually sells the investment.
How does real estate crowdfunding work in practice?
Here's a high level example of how crowdfunding works.
Meet Patty, she’s an experienced real estate developer (sponsor) who has identified a multifamily property that is a bit of a fixer upper. The property is in a desirable neighborhood, but it is old and lacks the amenities that today’s tenants demand. The building is currently 60% occupied and is on the market for $4 million.
Patty has done deals like this before, and after crunching some numbers and applying her real estate expertise, she determines that she can invest $2 million in renovations and improvements, lease up the entire building, and triple the property’s rental income. She forecasts that once the property is stabilized in about four to five years, the building will have a market value of $10 million, at which point she will look to sell the building.
Between the purchase and the renovations, this property requires $6 million, but Patty is only able to obtain traditional bank financing for $3 million, and plans to commit $1 million of her own capital to the project. In this scenario, Patty could look to a crowdfunding platform, such as Republic, to list the project and offer the remaining $2 million as equity to investors (again, this could be you!). Hundreds or thousands of investors can each contribute as little as a few hundred dollars.
What are the benefits of real estate crowdfunding?
The short answer: all of the advantages of traditional real estate investing (and then some).
Traditional real estate benefits:
Passive income: You can earn income without active management. By entrusting your capital with the sponsor of a deal, you are relying on their expertise to generate returns.
Stable cash flow: In real estate, rental payments can provide steady cash flow through dividend payouts.
Capital appreciation: Historically, real estate prices have increased over time. This means that when the real estate sponsor looks to sell the property, there’s a good chance that its value has increased during the holding period. Meaning, when the investment gets sold, ideally you will have made money in two ways—from dividend payouts and capital appreciation.
Tax advantages: There are numerous tax breaks associated with real estate investing, including favorable deductions, depreciation, capital gains tax, among others. We’d suggest that you consult with your tax advisor more closely on this subject before making an investment.
Inflation protection: Real estate is an inflation hedge, because home values and rents typically increase over time and during inflationary periods.
Diversification: Real estate has low correlation to other asset classes, which means that allocating to real estate is a prudent way to improve the risk-return profile of your overall portfolio.
Crowdfunding real estate benefits:
Lower minimums: The nature of crowdfunding allows sponsors to offer lower investment minimums than typical real estate investments because these commitments will be aggregated into one meaningful investment contribution. Investment minimums can range from $50 to $500+, depending on the offering.
Choice: Many existing real estate investment options don’t offer the ability to curate and customize your own portfolio. With Republic, you have optionality. You can invest in individual properties without the headaches and hassles of managing them, you can invest by geography if there is a particular location or sector of the market you want exposure to, or you can invest in funds / portfolios if you have conviction in a particular sponsor’s investment thesis. Republic provides the flexibility to allow you to create a real estate portfolio that aligns with your personal investment objectives.
Access: Crowdfunding allows you to invest in projects may otherwise be inaccessible to you. It’s not so easy to a) buy your own skyscraper and b) build it in a cost-effective way. By relying on the expertise of sponsors, crowdfunding provides unprecedented access to opportunities that have historically been reserved for wealthy real estate owners and developers.
Approachability: Relatively speaking, it’s easy to get started in real estate crowdfunding. On Republic, all you have to do is set up your account, select and review the investment, and send money to fund the deal. Really—it’s that easy.
What are some risks to consider in real estate crowdfunding?
Loss: Like any investment, real estate crowdfunding comes with the risk of loss. This is why it’s important to do your homework into the sponsor and the deal. Typically, the higher the reward, the higher the risk. But, this isn’t unique to real estate.
Illiquidity: Real estate is illiquid, which means that you can’t just exit or sell your position whenever you want like you can in the public markets. When you commit to a real estate crowdfunded investment you are committed for the entire duration. Again, this is why it is so important to review the sponsor’s business plan. Typically, a sponsor will state what the intended hold period is, providing an indication of when he or she plans to sell the property.
Why has real estate crowdfunding become so hot?
Real estate has made millions, and even billions for people, so it’s no wonder that people perk up when there are new, more accessible ways to enter the asset class. Andrew Carnegie famously said “ninety percent of all millionaires become so through owning real estate,” and many of today’s millionaires still agree that owning real estate is a smart idea.
Real estate crowdfunding has gained traction due to the potential for attractive returns in a relatively low-risk way. In fact, this study found that average real estate crowdfunding returns are between 11% and 15%.
That being said, it is important to put things into perspective, as crowdfunding is still quite young. It all started in 2012 when the JOBS Act was passed and created an exemption under the federal securities laws that lowered the barriers to invest in private companies (including real estate). It’s also crucial to note that real estate is a long-term investment, and typically sponsors hold their real estate investments between five to ten years. So this long-term perspective coupled with the relatively nascent state of crowdfunding makes it difficult to assess performance to date. Returns will also vary depending on a multitude of factors including property type, location, investment structure, and so on.
Ok, I’m convinced. How do I start?
We thought you’d never ask. Head over to republic.co to check out Republic’s real estate investment opportunities to start building your portfolio today.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
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