Real estate could be a safe bet if you’re worried about a bear market setting in. If you don’t want the hassle of owning an investment property directly, crowdfunding may be the answer.
Crowdfunded real estate investments account for $2.5 billion of the $7 trillion commercial real estate market, according to CFX Markets. There’s major growth potential in the industry as more investors lock in on the benefits of investing in real estate through crowdfunding platforms.
“Real estate provides high cash flow as compared to its value, whereas stocks have low cash flow and a lot of appreciation,” says Eric Bowlin, real estate investor and founder of Ideal REI, an education site for real estate investors. “The only way to get money from your stock portfolio is to sell your stocks while real estate provides stable cash flow for a very long time.”
Real estate crowdfunding offers a way to generate consistent returns without having to do the heavy lifting associated with direct ownership or worrying about the volatility associated with stocks and real estate investment trusts. Not to mention, it comes with some key tax benefits.
[See: 16 Things Investors Should Know About Crowdfundng.]
“The IRS allows investors to deduct depreciation of income-producing properties,” says Steve Azoury, owner of Azoury Financial in Troy, Michigan. “For someone who owns a large amount of commercial property that produces a significant amount of taxable income, these deductions can be extremely valuable,” and real estate crowdfunding yields these same benefits to investors in a streamlined way.
Crowdfunding also eliminates some of the barriers that previously made real estate investment out of reach for the everyday investor.
“Investors can become equity partners in deals that were usually reserved to people with personal relationships with the deal sponsor,” Bowlin says. Those deals often came with a five-or six-figure initial buy-in, while real estate crowdfunding makes it possible to invest with as little as $1,000. “Crowdfunding is making it less about who you know and more about good deals.”
If you’re wading into the real estate crowdfunding waters for the first time, here’s how to pick your first investment.
Debt or equity? Real estate crowdfunding investments can be broken down into two broad categories: debt or equity. Both have pros and cons and you need to know how they stack up.
“The difference between real estate debt and equity crowdfunding is, in many ways, similar to the difference between investing in bonds versus stocks,” says Charles Clinton, CEO of real estate investment platform Equity Multiple. “When investing in real estate equity, there’s the potential for strong upside, as investors can share in uncapped gains if the profit outperforms expectations. On the other hand, debt investors mitigate their risk because even if the project fails, the investment is secured by lien on the underlying property.”
Equity investment returns are based on a share of the net profits; debt investments offer a fixed interest return. When you invest in equity, you’re investing in the property’s return potential, based on the rental income it generates. When you invest in debt, you’re investing in the mortgage note that’s secured by the property.
There are also hybrid real estate crowdfunding investments that blend elements of debt and equity and offer a middle ground on the risk/rewards spectrum, Clinton says. “Investors need to consider what their investment goals are and what their risk appetite is and start building a diversified real estate portfolio that best aligns with their strategy.”
That includes factoring in your timeline and liquidity needs.
[Read: A Small Investor’s Path to Private Equity.]
Debt investments tend to be for shorter durations, says Chris Rawley, CEO of Harvest Returns in Fort Worth, Texas. Equity investments, on the other hand, “can last several years and can be reliant on a sale or refinance of the asset in order for the investor to get their principal back.”
If you favor liquidity, debt investments might make more sense. On the other hand, Rawley says, equity investments “have the potential to produce much higher returns.”
If you’re not comfortable trading off liquidity for returns or vice versa, investing in both debt and equity crowdfunding investments is a compromise.
Check the downside. Real estate is never completely risk-free and real estate crowdfunding has its own unique risks investors need to be aware of. “When it comes to analyzing the pros and cons between debt and equity, it all comes down to risk tolerance,” says BiggerPockets president Scott Trench.
“In the event of a loss to the business, most or all of the equity may be eliminated, and you may lose every penny you invest as an equity investor,” Trench says. “While you may also lose money as a debt investor, in the event of a bankruptcy or foreclosure, any proceeds are paid to holders of debt first, reducing one’s risk.”
The convenience real estate crowdfunding offers can also work against investors.
“The downside of crowdfunding is that because it’s relatively easy to invest in deals, folks who lack understanding of the marketplace or the work underlying the deals may find themselves at a disadvantage,” Trench says.
In other words, you need to know what you’re investing in, the same as you would if you were investing in a stock or mutual fund.
Rawley says the main risk factors with crowdfunding are the same risks as other real estate investment channels. That includes market risk, interest risk and liquidity risk.
“Investors should understand the specific risks that affect their investments and be informed about factors like location, condition of a specific real estate market and general economic conditions,” he says.
Choose the right platform. There are hundreds of real estate crowdfunding platforms out there but they’re not all the same and there’s a certain amount of due diligence required on your part.
Bowlin says investors must consider where investments are available, the fees involved, the minimum investment and whether there are protections in place in case a deal (or the crowdfunding platform itself) goes south. Limited investment choices, a too-high minimum investment or stiff fees could make a platform a mismatch for what you need.
The expertise of the team behind the platform also matters, as does the platform’s track record. “The obvious indicators of quality, like any business, include the age of the platform, number of opened and closed offerings, amount of total funds raised, average length of time an offering is open, etc.,” Rawley says.
Clinton advises looking at the overall stability of a crowdfunding platform before investing.
[See: 6 REIT Funds to Buy With Robust Dividends.]
“While the industry as a whole is new, there’s a difference between being a six-month old company and a three-year-old company,” he says. “As with any place you’re considering putting your money, ask questions.”
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How to Choose Your First Real Estate Crowdfunding Investment originally appeared on usnews.com
