7 Things You Must Know About Real Estate Crowdfunding

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Real estate is an excellent way for physicians at any stage of their career to begin building passive income, but it can be an uphill battle if you do it alone without the proper foundation and guidance.

Juggling the demands of your medical practice, your family and partner while trying to vet real estate deals on your own limited time is a tall order.

So how do you start creating passive income from real estate without making it a second job? The best answer I've found is passive real estate investing through syndications and funds. You're able to leverage the sponsor's (the one running the deal) experience, network, team, and most importantly time to meet your income goals.

The question I get the most about this type of investing is, “How do I properly vet these deals?” Reading, studying, experience, and courses (eg. Passive Real Estate Academy) is how I answer that question.

The next question is inevitably, “Where do I find these deals?” I tell people it's usually through connections and personal networks. However, a lot of people have turned to online platforms referred to as real estate crowdfunding sites.

Crowdfunding allows you to pool your money with other investors to purchase a share of a commercial or residential property. 

However, are all crowdfunding platforms created equal? Are they a good source of deals? Are there quality deals on these platforms? 

I know it can be confusing so I've come up with some things you should absolutely know about these platforms before investing in anything you see on these sites.

What You Need To Know About Real Estate Crowdfunding 

1) Crowdfunding Is All About Access

Long ago, crowdfunding projects were known as “Country Club Deals.” To get into private deals, syndications, and funds, you had to know someone to be able to invest. That was the rule according to the SEC, but in 2012, a lot of that changed. This is the year when President Obama signed the Tax Cut and Jobs Act into law. It allowed private real estate deals to be promoted online and to a broader audience of investors who qualified.

This act allowed the industry of modern real estate crowdfunding to be born. Now, you have access to a wide array of investment opportunities by simply going to a platform and registering. You can then see the types of deals that are out there, and you can compare them from the convenience of your computer.

2) Understand What Types of Deal Are Offered

Many types of real estate deals are available on crowdfunding platforms. However, it's important for you to understand what you're investing in. Primarily you'll see “debt” and “equity” deals.

Debt Deal

You might see a debt deal, where you act as the bank. You invest by lending out money, typically to a fix and flipper or someone who needs a short term bridge loan.

You should expect to receive interest payments throughout the term of the deal (just like the bank does) and once the deal is over, your initial capital gets returned to you as well.

The income is taxed at your normal marginal tax rate.

Equity Deal

You also might find an equity deals on these platforms. In this case, you invest your capital and actually own a percentage of the deal or property. If there are distributions, you'll receive those along the way according to the percentage you own of the deal. When the property is eventually is sold, you get to participate in the profits. So not only do you receive monthly cash flow, you get a percentage of the “upside.”

As a limited partner in the deal, you'll receive a K-1 at the end of the year which will show any distributions you've received as well as any paper “business losses” that you've accumulated.

So when looking at a deal on a crowdfunding site, figure out which type of deal it is. This will impact your returns and how the income is taxed. 

3) Spend the Time to Do Your Own Due Diligence

One thing you need to know is that you must do your OWN proper due diligence and not just rely on the platforms themselves. Yes, the platforms perform their due diligence prior to each deal that makes it on the sites. You'll hear them often say that <5% of deals are accepted and make it to investors. If a deal goes bad, then it reflects poorly on them and they could potentially lose investors.

However, crowdfunding platforms also make money by having deals on the platform, so they're incentivized to have more deals for investors to participate in. Therefore, it's important for you to accept that the alignment of interests is slightly off between you and these platforms. 

As time has gone on, I have seen the quality of the deals and sponsors improve on the best sites. Sponsors with great track records are finding out that it is an excellent way to reach a broad investor base.

So, although crowdfunding platforms screen their deals, you cannot rely on that solely to make an investment decision. You have to be able to examine and understand the deal itself because at the end of the day, it's your hard earned capital being put at risk.

You want to make sure you get a good return for the risk and that it ultimately fits your financial goals.

4) Crowdfunding Platforms Might Have Lower Minimums

One good reason to consider crowdfunding platforms is that they typically have lower minimums to invest. Private real estate deals can range from $25,000 to $100,000 minimum to invest. Crowdfunding platforms often allow you to invest for less. Since everyone online is putting their capital together for a more significant investment, it's possible that each investor only needs to put in a smaller amount to reach the total investment needed.

Years ago, I was able to begin with a $5,000 investment. This helped me dip my toes in the water, and it felt like if I lost that amount, I still had food on the table. Make sure you check each platform to see what their minimums typically are.

5) The Crowdfunding Platform You Use Matters

Investing with a good crowdfunding platform matters. Here are some questions to ask and consider:

  1. How long has the crowdfunding platform been in business?
  2. How many deals have they done / How much capital have they raised?
  3. How many deals have gone full cycle (completed)?
  4. In how many deals have investors lost money?
  5. What happens when a deal goes poorly? What role does the platform play?

Not every investment goes as you expect. In one situation where investors were having problems with a particular sponsor, the crowdfunding platform stepped in and made sure the sponsor fulfilled their obligations.

Many crowdfunding platforms (over 100) have been created over the past ten years, but many of them simply did not survive. They did not find a way to manage the investments sustainably. That left investors in a situation where they had to manage their own investments.

Before choosing a crowdfunding platform, you should understand the background of the company, explore the management team, and ask for their track record if it is available.

Other things to look for in a good crowdfunding platform:

  • High quality sponsors
  • Good communication
  • Proper tax preparation
  • Schedule K-1 prepared and collected on time
  • Have all documents and information available on platform in clear format

6) The Crowdfunding Site Is Only As Strong as the Deals on it

Crowdfunding platforms are often simply connectors to sponsors and deals. So, the success of the deal has nothing to do with how fancy the site looks. It all depends on the skill of the sponsor.

So look for sites that have sponsors with a track record of success. 

7) You Should Know Your Goals Before Investing in a Crowdfunding Deal

Before investing in a crowdfunding deal, it's absolutely important to understand what you're expecting to get out of it and why. Here are some questions to ask yourself:

  1. What are your financial goals?
  2. How much passive income are you looking for monthly, yearly?
  3. How much of your portfolio do you want to allocate to real estate?
  4. What asset class within real estate are you interested in – debt, multifamily, industrial, retail, office, etc?
  5. How passive do you want the income to be?

Once these questions are answered, then you can explore the sites to find deals that match your goals and objectives. 

Summary

So, at the end of the day, real estate crowdfunding can provide access to investments to diversify your portfolio with real estate at low minimums. I have used it to invest in some great deals. I have also invested in some deals that have not gone perfectly.

That is why it is absolutely important to do your due diligence. Take the opportunity and time to learn from each deal and what they can tell you about how to improve for the next time you choose to invest. 

If you’ve already started in real estate crowdfunding, what lessons have you learned?   Share your experience in the comments below.

 

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