Real Estate Crowdfunding: Meaning, Pros and Cons, Limitations

Real estate crowdfunding is a way to raise money online for real estate acquisitions from a large group of investors. Individuals and businesses can use crowdfunding to access capital from a large group of potential investors on internet platforms and social media sites. The idea behind crowdfunding is that many people may be willing to invest a small amount in such projects, and when they do, large sums of money can be raised pretty quickly.

How Real Estate Crowdfunding Works

Crowdfunding involves raising capital from investors by using the internet or social media sites to reach a large group of investors. Crowdfunding has been associated with donations for those in need and with equity transactions that enable small- and midsized entities to pool money and use the funds to put money into the company's future, such as buying equipment or building a manufacturing plant.?

Crowdfunding for investments followed the passage of the Jumpstart Our Business Startups Act (JOBS), which permits crowdfunding for ventures in small and midsized companies. The 2012 law lowered reporting requirements for small companies and loosened Securities and Exchange Commission (SEC) regulations on small businesses, allowing a broader use of crowdfunded investing. However, it included limits on how much an investor can put money in crowdfunding offerings based on their net worth and income.

The SEC later enacted Rule 506(c) under Regulation D, which permitted public ads for securities on the condition that all investors were verified as accredited. Regulation A+ in 2015 enabled firms to garner up to $75 million annually from public investors.

In 2020, the SEC put into effect Regulation Crowdfunding (CF), which allows entities to adopt a “common owner CF” model for fundraising, which includes real estate and small business initiatives. A year later, the SEC increased the investment ceiling under Regulation CF from $1.07 million to $5 million, significantly expanding the scale of opportunities for nonaccredited investors.

Real estate crowdfunding is similar to the equity version of it in that an investor can buy into a property and become a shareholder. Investors don't need to purchase entire properties, and they earn a part of the profits generated from the investment based on the amount they invest. For example, revenue generated from a rental property or the proceeds of a sale would be paid to investors. Some of the best real estate crowdfunding sites offer investors a low entry point. As such, you can participate starting at about $1,000.

Advantages and Disadvantages of Real Estate Crowdfunding

Real estate crowdfunding can offer many benefits, such as wider access to property investments, but it's important to understand the drawbacks before you commit.

Advantages

A major benefit of real estate crowdfunding is enabling individuals and businesses to solicit a large pool of investors for their projects. Investors stand to gain by getting a small cash stake in the property (or venture).

For investors, crowdfunding has much lower capital requirements than other ways of gaining a stake in real estate. Major property investments, like apartment buildings, offices, or hotels, can cost millions or tens of millions of dollars. Through crowdfunding, investors gain exposure to these investments without putting up a significant amount of capital, and often with minimums as low as $1,000.

The SEC has lifted a ban on those who are non-accredited from investing in crowdfunding activities. Previously, investors needed to be accredited, meaning they met certain income or net worth requirements. Non-accredited investors can participate in crowdfunding for equity and real estate transactions.

Disadvantages

Real estate investment can be complicated enough before adding in the complexities of crowdfunding. Thus, everyday investors who crowdfund a real estate investment may not fully understand all the risks without spending a great deal of time doing research.

Even for successful investments, managing many investors requires resources, so fees can be high.

Crowdfunding is also relatively new, with the JOBS Act permitting it just over a decade ago. Thus, companies involved in real estate crowdfunding are newer, making it harder for you to find a longer track record to go on.

Investment Limits for Crowdfunding

There are risks in any type of crowdfunding investment, and the SEC has imposed investment limits for non-accredited investors.?

Less than $124,000

If?either?your annual income?or?your net worth is less than?$124,000, then during any 12-month period, you can invest up to?$2,500?or up to 5% of the lesser of your annual income or net worth.?

More than $124,000

If?both?your annual income?and?your net worth are equal to or more than?$124,000, then during any 12-month period, you can invest up to 10% of your annual income or net worth, whichever is lesser, but you can't invest more than?$124,000.

The Bottom Line

Real estate crowdfunding allows everyday investors to invest in substantial real estate ventures, like hotels and apartment or office buildings. However, this industry is still relatively young, making it difficult for investors to research crowdfunding companies and their track records. If you're interested in real estate crowdfunding, don't skimp on your due diligence and consider your investment's potential risks and rewards.