Owning a residential or commercial property can be a great way to generate a steady stream of passive income and at the same time, insulate a portion of your assets against a sometimes volatile stock market. Managing a property does come with certain headaches, however, and the job isn’t right for every investor. Fortunately, real estate crowdfunding now makes it possible to invest in real estate without having to do any of the hands-on work.
Real estate crowdfunding: How does it work?
Real estate crowdfunding is an offshoot of the 2012 Jumpstart Our Business Startups (JOBS) Act, which lifted certain restrictions on how securities are marketed to investors. The JOBS Act outlined crowdfunding rules for start-up fundraising and investing, allowing the real estate crowdfunding industry to take shape.
In terms of the mechanics, the premise is fairly simple. Real estate crowdfunding platforms list investment opportunities in commercial and residential properties. Investors research these opportunities and pool their funds in a particular investment. Investors then claim a portion of any profits the property generates.
Investors can make money with real estate crowdfunding in two basic ways: equity and debt investments. When you invest in equity, you invest in shares of a specific property. For example, you may invest in a multi-unit office building that leases out space to different businesses. As the tenants pay their rent, a percentage of it goes into your pocket based on how much you have invested.
Debt investments work a little differently. With this type of investment, you’re investing in the mortgage note attached to a particular property. As the borrower repays the loan, you receive a portion of the interest the lender charges.
Between debt and equity investments, debt investments are the safer option. The trade-off is that the returns are usually smaller.
Who can invest?
Until recently, only accredited investors could take advantage of real estate crowdfunding opportunities. To qualify as an accredited investor, you must have a net worth of at least $1 million or earn a net income of at least $200,000 for two consecutive years. If you’re married, the income requirement increases to $300,000 annually.
In October 2015, the Securities and Exchange Commission finalized Title III of the JOBS Act, allowing non-accredited investors to get in on the action. Certain limits apply, to how much money non-accredited investors can funnel into real estate crowdfunding deals.
Under the SEC rules, if you earn less than $100,000 per year, you can invest $2,000 or 5% of your net worth or annual income, whichever is greater. If you earn more than $100,000 annually, you can invest 10% of your net worth or annual income, whichever is less, up to a cap of $100,000.
Aside from meeting those general requirements, you also need cash to get started. With most real estate crowdfunding platforms you’ll need $5,000 to $10,000 to invest. You don’t need great credit. The investing platform typically runs credit checks on the individual or agency sponsoring a deal but not on individual investors. If you’re curious about what your credit looks like, visit Credit Sesame to get your free credit report.
Benefits to investors
Real estate crowdfunding comes with a few nice benefits, especially for investors who don’t have the time or the money to invest in real estate directly. The most significant advantages include:
Flexibility When you become a landlord, you’re essentially at the beck and call of your tenants. If something needs to be repaired or another issue arises, it’s up to you or your property manager to sort things out. With real estate crowdfunding, you don’t give up any of your time because the crowdfunding platform oversees the investment for you.
Cost Prior to the JOBS Act, investors needed five or six figures in cash to get involved in a private real estate deal. Real estate crowdfunding has set the bar much lower, a welcome change for investors who can’t or don’t want to invest large dollar amounts in a single property.
Variety Most of us don’t have the ability to individually bankroll investments in multiple properties. With crowdfunding, however, it’s possible to spread your investment dollars out over several different property types and locations. For example, you could invest in apartment buildings, office buildings, warehouses, medical facilities, retail space, hotels or residential properties. The many options mean itis much easier to fine-tune the level of diversification you want to add to your portfolio.
Tax benefits One of the most appealing things about owning an investment property is how it can work to your advantage at tax time. For example, you can take deductions for things like depreciation and property taxes. Tax benefits and liabilities are quite complex and depend on many variables. Talk about the investment in detail with a tax professional who has experience with real estate investment.
How to choose a crowdfunding platform
If you’re ready to get started with real estate crowdfunding, be sure that you use the right platform. As you compare different companies, here are a few things to keep in mind:
Cost Every real estate crowdfunding platform arranges their fee schedule differently so look closely at the cost. Check upfront fees the ongoing cost to maintain your investments.
Selection Some crowdfunding platforms offer a wider range of investments than others and the one you choose should feature the kind of properties you’re most interested in. Consider the individual property types as well as the investment structure (i.e. debt vs. equity).
Reputation Real estate crowdfunding is a relatively new industry. When vetting companies, consider their track record and reputation to see how they stand out from the competition and what they can offer you that others don’t.
Real estate crowdfunding is a relatively hassle-free way to invest in real estate and it offers the potential for big rewards. Like any other investment, a certain degree of risk is always present.