Real estate crowdfunding has made real estate investing available to a broader range of potential investors. But this ease of access also means it is easy to make a bad investment. Before you begin turning over your hard-earned money to a real estate crowdfunding platform, here are a few things you should know about investing in real estate crowdfunding deals.
What Is Crowdfunding?
With the introduction of the Tax Cut Jobs Act (TCJA), crowdfunding sites have popped up all over. These sites open to the door to investments that weren’t previously available or easily accessible for many investors. Before TCJA, small business funding sources included a bank loan, friends and family, or for a very few — a handful of investors. Now, these businesses have a much larger, new source of funding.
Additionally, for most crowdfunding sites, the requirement to be an accredited investor has been removed. In a way, crowdfunding sites are similar to buying stocks on a public stock exchange. Crowdfunding sites are also regulated by FINRA.
Crowdfunding sites are platforms that allow investors to participate in offerings by small businesses. These offerings include real estate offerings.
What is Real Estate Crowdfunding?
Real estate crowdfunding is a type of syndication. Investments that used to be available only to the super-wealthy have become available to the average investor. For investors, syndications mean passive investing. Meaning, investors do not have to be involved in the day-to-day operations of the investment. Passive investing also means investors will have a passive income or loss.
Passive income and passive loss are both tax terms. Passive losses can be carried over from one year to the next until the loss has been exhausted. One benefit of crowdfunding is long-term capital gains. When an asset held for more than a year is sold, long-term capital gains apply. Additionally, depreciation deductions are subject to tax rates not to exceed 25%. At the end of each year, investors will receive a K1 for the tax filings.
Types Of Crowdfunding Deal Structures
Real estate crowdfunding deals can come in a variety of structures, but two are common — debt and equity. Before getting involved with any deal, it’s important to do due diligence. Because the deal is easier to access doesn’t mean due diligence should be skipped over. Be sure to read through all the deal notes and platform fine print. In there, you’ll discover various fees for each structure that may not be listed on the deal page.
A debt structure means you’re the lender on the property. The investment is secured by the property or promissory note issued by the LLC, which is the small business behind the crowdfunding platform. These investments are designed to provide you with regular payments plus interest from your investment. The deal agreement will dictate the exact terms. If the borrower defaults, as a debt holder, you are first in line to receive any compensation. Debt deals are shorter than equity deals — generally a few months to a couple of years.
Unlike an equity structure, there is no upside gain because you aren’t participating in the asset’s appreciation. For that reason, there is less risk. There also is no depreciation deduction. Fees can be higher as well with debt structures compared to equity.
The greatest potential advantage equity structures have over their debt cousins is upside. When you invest in an equity deal, you become a shareholder in the property, which also means you are part owner. As an owner, any upside in the property is proportionately your gain, based on your percentage ownership. Again, due diligence is necessary to fully understand the deal structure and your participation in any gain.
A downside to being an equity investor is the same as owning a stock — the investment can depreciate, creating a loss. As an equity owner, you are generally last in line to receive any compensation should the investment fail. Equity investments are also longer-term holds than debt (i.e., think several years), which is a long-term gain tax benefit. As well, equity deals generally cost less to enter and exit than debt deals.
Real Estate Crowdfunding Platforms
Real estate crowdfunding platforms are the marketplaces that investors go to when they want to find real estate investment deals. Investments will be listed on these websites along with their details, for all to see. Crowdfunding websites are extremely efficient in that regard. You don’t have to spend lots of time going from location to location, speaking with multiple real estate agents, and chasing down other leads. The website platform will bring it all to you. Basically, all of your due diligence can be done right from your keyboard.
If you have questions that can’t be answered by the deal page, send an email to the sponsor or platform owner. If you don’t get a response in a timely manner, this can be a real flag. In fact, it might be a good idea to send an email even if you don’t have questions, just to see what type of response you’ll get. You want to know the people behind the deal and platform are there to support you and are legit.
Additionally, you can research reviews about different platforms to see what other investors are saying. There are syndication forums that you can also join. In these forums, you’ll meet other crowdfunding investors. You’ll be able to learn a lot more about different platforms and how to successfully perform due diligence for crowdfunded deals.
Investing in real estate can be rewarding. But before the TCJA, if you didn’t have a network of people in the know and plenty of money to invest, you were left out of many great deals. That has all changed with real estate crowdfunding. But easy access doesn’t mean your investment will be a success. It’s important to continue with due diligence not just on every real estate deal but on every platform as well.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as the primary basis for investment decisions.
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