Real estate is the lifeline of the economy of a country and therefore any down surge in it is undesired. It is for this reason most realtor and developers make it a point that the process does not get affected even during an economic downturn.
It is for this reason that over the past few years real estate crowd funding has found a strong foothold after taking off since the Jumpstart Our Business Startups Act in 2012 or JOBS. Experts believe that this market is going to expand even more and tis belief is corroborated by a few facts and figures issued by the SEC. In its final in the Title III provisions of the JOBS Act it is found that:
- Participation of non-accredited investors are allowed in real estate sectors
- They can now perform just as those accredited investor in crowd funding real estate deals.
This investment in real estate through a specific crowd funding platform has several advantages as well on the direct ownership aspect of the property as well as over the REITs. One such significant advantage is the ability of the real estate players to choose between equity and debt investments.
Working of the debt investments
Real estate crowd funding has surely opened a new and better path for the investors. However, before you start with the real estate crowd funding principles, it will be very helpful for you to have a clear and better understanding regarding the two types of investments, their differences, the varied risks involved and other aspects.
- When you invest in real estate debt instruments, you typically act as a lender more than just a mere investor to the deal sponsor or the property owner.
- Since your loan is secured by the property itself as collateral you do not have to worry about repayment even if it fails and the party default will not have to go through the debt settlement reviews and ratings to find an agency that will help dealing with the debts.
- Through this form of funding the investors receive a return at a fixed rate and continue to do so. This rate is fixed based on the rate of interest on the loan as well as the mount that has been invested.
- In case of a debt deal, the investors have the priority in receiving or claiming a payout from the asset itself being at the bottom of the capital stack.
However, there are also a few positives and negatives of such type of investments that you should know before jumping into any final conclusion. If you consider the positives only, it includes:
- Shorter hold time: In most of the cases, all debt investments are usually related with the development projects. That means, as a result, these investments characteristically have a much shorter holding period as compared with the equity investments. Such hold times may range anywhere between six and twenty four months, depending on the size and nature of the deal. This happens to be very advantageous for those investors who typically do not want to get tied up with projects for a long term.
- Lower risk: There is also a lower amount of risk involved in debt investments as these are specifically designed. It is the structure of the deals that reduces the risks involved in such investments in which the loan itself is secured by the property. This asset acts as the insurance policy and secures the loan when it comes to repayment. In case of a deal sponsor or property owner default, the investor has the power to recover the loss on their investment using a foreclosure action.
- Steady income: Debt investors are assured to get a steady income as these are more predictable as far as the frequency and amount of return payouts are concerned. Irrespective of the fact every deal may be different in amount and terms, it is not unlikely for a debt investor to earn anywhere between 8% and 12% annually. You will continue to receive this payment that is normally paid on a monthly or in a quarterly basis.
However, debt investments are not devoid of its negatives that you should consider before going ahead with it. Though it will provide you regular and steady returns with less risk involved, the returns itself will be capped or limited. This limitation depends entirely on the rate of interest on the loan.
Another downside part from being a safer but low return bet, the debt investments may carry high fees as well when you participate in a deal. Yes, it is true that most real estate crowd funding platforms will not charge any fees from their investors for research or even to create an account, the platform may typically take away a specific percentage before paying you any interest.
In addition to that there may also be a distinct loan origination fee passed onto you as the investor. This may eat up your returns further.
Equity investment pros and cons
Most of the real estate crowd funding deals involves equity investments. In such a situation, the investor acts as the shareholder of a particular property. Their stake or share is proportionate to the amount invested. The returns in these cases may usually come from the rental income from the property or from the appreciation value when the property is sold minus ant service fees charged by the crowd funding platform.
Apart from the low fees, the advantages of equity investments are:
- Uncapped returns: Since equity investments provide a wider spectrum in terms of the earning potential, you may get an annual return to the tune of 18 to 25 percent and since there is no cap the sky is literally the limit from the perspective of the investor.
- Tax benefits: You can also enjoy the benefits of the depreciation deduction by not having to directly own the property as deals are usually not structured through an LLC.
However, these carry more risk and have a longer hold period which is why real estate crowd funding seems to be an attractive alternative for investors.