Anytime there is a new avenue for raising money, it is tempting to stroll down that metaphorical street. It’s a confusing one, as any residential real estate rehab professional knows. If the fundraising choices were buildings, there would be a few grand, stately ones that look solid, but don’t let you in (like many old-school, traditional lenders). Then there would be the “here one day, gone the next” storefronts with their homemade signs and crackling fluorescent lights. You’d also have the carnival-barker tents set up in the alleyways, offering you amazing deals on fantastic products that seem just too good to be true. It can be confusing, especially because your livelihood could depend on making the right choice.
With the market booming again, investors are looking for new ways to fund real estate acquisitions. Crowdfunding is becoming one popular investment vehicle, but is it all it’s cracked up to be? In some cases, yes, it is, but that doesn’t mean you should jump onto the crowdfunding bandwagon. Although the concept of crowdfunding is simple enough, you should look at the big picture before deciding whether to tether your business to a real estate crowdfund. Ducking immediately into the brightest tent without thinking usually leaves you on the side of the road hitchhiking home.
Crowdfunding Does Not Provide Cash Upfront
Crowdfunding does not provide instantaneous cash like a hard money loan. Rather, a financial goal is set by the crowdfund’s project sponsor, and then investors begin to pool their money into the project. This delays funding if enough people don’t jump on board and opens the door to potential property loss should the seller find a cash buyer.
Despite this, it’s tempting to buy into crowdfunding real estate. Imagine you see an opportunity for a condominium rehabilitation project. The project sponsor is investing 50 percent into purchasing the property and seeking the other half via crowdfunding. You’re strapped for cash, and this is an easy way to invest a small amount into a large project and get your foot in the door. You’re even OK with the wait, or the risk of the property falling through. So what else do you stand to lose?
Your Investment Returns Are Limited
The answer, frankly, is profit. The less you invest, the smaller your return. Depending on the density of the crowd, you might come out with little cash: CNBC reports 1 that the average return on crowdfunded real estate is 7 to 10 percent, and in “Crowdfunding for Real Estate,”2 John H. Vogel Jr. and Benjamin S. Moll question the projected returns on crowdfunding websites, which have been listed as high as 22 percent. This does indeed seem like a stretch, considering at the time of that projection, mortgage debt investment was only returning 8 to 10 percent and bank construction and acquisition and construction loan investment was only returning 4 to 5 percent.
But maybe that’s enough for you. Let’s say the project sponsor estimates a 15-percent return on investments for the condominium rehab project once the building is rehabbed and selling. This return looks good, so you invest your money into the crowdfund to become part of the project. All should be good, right?
You Don’t Know with Whom You’re Partnering
Wrong. Unfortunately, many crowd funders are not seasoned real estate investors, and you likely won’t know the reputations of the project sponsor and other investors. Unlike Real Estate Investment Trust funds, crowdfunding is not highly regulated, so you’re trusting your money with someone who is not bound to regulatory financial reporting.
So what happens if your crowdfunding project sponsor is an investor, but not a seasoned real estate investor? You realize after you’ve handed over your funds that he doesn’t understand the complexities of residential rehab projects and the fixes are more than anticipated. You can’t hold him accountable because the investment reporting is sketchy at best, and the returns are being minimized by cost overruns and project delays.
As Investopedia comments,3 real estate investments are illiquid; in other words, you can’t cash out when the going gets tough. Therefore, “powerless” is not what any real estate investor wants to be. At this point, you are left watching the returns on your investment dwindle, and you have no idea of the financial solvency of the project due to ineffective reporting and lack of first-hand interaction with the key players.
So what’s the better alternative?
A Socotra Capital hard money loan is a better plan than crowdfunding when investing in real estate, because you hold the reins over the outcome of your investment.
- You’re the sole investor. There is no issue of multiple, not to mention inexperienced, investors on your project. You have command over choosing the property and financing it.
- Your returns are higher because they aren’t divided amongst numerous people, not to mention skewed in the projections in an effort to attract multiple investors.
- You’re the one in control of the property, including choosing properties that are easier to rehab/flip, and working one-on-one with the construction crew to keep costs under control.
- You have multiple loan options for different investment properties. You aren’t bound by a project sponsor and crowdfunding.
Part of making your real estate investment work is having the power to control the outcome. Crowdfunding can work – in those rare, perfect circumstances – but you lose the stability of overseeing the project yourself, and your return is limited to your investment percentage. You don’t have to settle for a 7 to 10 percent return on investment.
Secure a hard money loan from Socotra to reap the rewards of the investment’s entire return. There is no conflict of interest in our model. We want your investment to succeed as much as you do. If you’re back on that investment avenue, we’re neither the bank that won’t open its doors nor the strange tent manned by Jojo The Dog-Faced Boy. It’s important to go somewhere you can trust, and to work with someone who understands the fix-and-flip and real estate business and who has your best interest in mind. Contact us today – our doors are always open.
- CNBC, “Choosing to Crowdfund the Real Estate Market,” http://www.cnbc.com/2015/09/30/why-people-are-choosing-to-crowdfund-the-real-estate-market.html (accessed October 10, 2015) ↩
- Dartmouth College, “Crowdfunding for Real Estate,” http://faculty.tuck.dartmouth.edu/images/uploads/faculty/john-vogel/crowdfunding_real_estate.pdf (accessed October 10, 2015) ↩
- nvestopedia, “Pros & Cons of Investing in Crowdfunded Property,” http://www.investopedia.com/articles/investing/070915/pros-cons-investing-crowdfunded-property.asp (accessed October 10, 2015) ↩