Basics of Immobilien Crowdfunding

Crowdfounding_Basics

Real estate crowdfunding is a new way to invest in commercial real estate and in recent years, it has exploded in popularity. Crowdfunding may be a lucrative kind of investment in real estate, but it’s not ideal for everybody. With that in mind, here’s a beginner’s guide to investing in crowdfunded real estate deals that can help you decide whether it suits well with your investment and risk tolerance goals.

What is crowdfunding for immovables?

Crowdfunding refers to a group of individuals who pool their money together to accomplish a common goal. Some crowdfunding activities are of a charitable nature β€” for instance, if a individual faces medical bills that they can not afford, they may seek to crowdfund the expenses. Crowdfunding can also apply to investment situations, and real estate has gained popularity as one of the latest applications.

Real estate crowdfunding includes a group of investors each contributing money to a particular real estate deal. For example, if an experienced real estate investor identifies a lucrative opportunity to renovate an apartment building and then sell it at a profit but does not have the necessary capital, they could turn the investment into a crowdfunding opportunity and try to raise the rest of the necessary funds from investors like you.

How does crowdfunding work in real estate?

The basic concept behind crowdfunding for real estate is that when a developer or seasoned real estate professional finds an investment opportunity, they don’t necessarily have the resources (or desire) to finance the investment entirely on their own. So, they will allow individual investors to contribute some of the capital of the project to raise enough money for their plan to be implemented.

There are three key players in every opportunity for investment in crowdfunded real estate.

First, the sponsor is the individual or firm identifying, planning and overseeing the investment itself. The sponsor of the deal will facilitate the purchase of the asset, arrange for any contractors or other required work, arrange financing and take responsibility for the property’s eventual sale. Deal sponsors generally contribute some of the financing of the project themselves, and they are also entitled to some share of any profits they earn for investors in the deal.

Second, there’s the crowdfunding platform where the sponsor finds investors to collect the money needed for a project. Think of a platform between investors and sponsors as the middleman. The platform will ensure that a deal meets certain standards, advertise dealings with potential investors, ensure investors meet investment requirements and address regulatory issues. The platform will also raise funds from investors on the sponsor’s behalf.

Finally, the investor (that’s where you come in) is contributing some of the capital needed of the deal in exchange for a share of any income that the deal generates. An investor can get some form of allocation of income and/or be entitled to a proportional reward from a potential successful sale.

Here’s a simplified example of how this might work: Let ‘s say an experienced real estate developer β€” the sponsor β€” identifies an office building that’s outdated and lacks modern amenities β€” and is occupied by only 50 percent β€” for sale at $5 million. The sponsor determines after a thorough analysis that they can invest $3 million in renovations and improvements, lease up the vacant space, and triple the rental income of the property. Not only that, but the building will also have a market value of $12 million once occupancy is stabilized in three or four years, at which time the sponsor will sell the property.

However, although the incentive needs $8 million in capital between the acquisition and the repairs, the investor can only get $5 million in bank funding, and has just $1 million in their own money to contribute. So, they opt to list the deal on a crowdfunding platform and offer investors like you the other $2 million as equity in the project.

Why has crowdfunding become so popular in real estate?

The short answer is that the successful crowdfunding deals require a lot of money to be made. As I write this, there are five single-asset investment opportunities listed on the popular CrowdStreet platform, all of which target an annualized internal return rate (IRR) of 12.7% to 18%.

To be sure, because the industry is so young, we do not have a ton of data on actual investor returns, but the numbers so far look quite promising. As of July 2019, CrowdStreet had published 352 crowdfunded investment opportunities throughout its five-year history, and only 17 of them had been “realized” or completed in full, meaning the property in question was sold or otherwise cashed out by investors.

Of those 17 investments realized, only one has lost money to investors. Most met or exceeded their target returns, and 14 of the 17 (82%) generated IRRs above 14%. With returns like this, it’s no wonder that crowdfunding for real estate has attracted a lot of investors’ attention.

Benefits of investing in crowdfunded real estate

As with every investment opportunity, crowdfunding in real estate is not a good match for everyone. There are several potential pros and cons of crowdfunding for immovable property that should be considered before deciding whether it is right for you. We’ll start with the reasons you may want to make a crowdfunding investment:

  • First, there is the potential for higher returns than any other major asset class would have you get. I mentioned in the last section that the majority of crowdfunded deals that have been completed yielded annual returns exceeding 14%. Seeing a 20 per cent or even more IRR from a successful deal is not uncommon.
  • Crowdfunded investment in real estate will provide a diversifying factor for your portfolio. It is particularly true if most of your assets are currently invested in stocks and bonds, because these usually don’t move with real estate in a correlated way.
  • Crowdfunding allows you to take advantage of the potential of investments in a single property without the headaches of actually becoming a landlord or dealing with renovations.
  • Crowdfunded real estate helps you to invest in properties which you would otherwise consider unavailable. Would you just go out and buy an office tower or an apartment building that is high up? Even if you could, would you know how you can cost-effectively add value to the property? Crowdfunding enables you to harness other people’s resources in assets which have traditionally been the domain of wealthy developers.
  • In comparison to real estate investment trusts ( REITs), which usually hold a portfolio of several properties, most crowdfunding deals concentrate on a single property.
  • Crowdfunded real estate investments often have an income component at the end of the investment time frame as well as a targeted lump-sum return.

Potential drawbacks of crowdfunded real estate investment

There is no such thing as a perfect investment, as I have said. Before making any investment decision, it is always necessary to weigh the pros and cons, so here is what you should think before deciding if crowdfunded real estate investing is right for you.

  • No investment capable of double-digit return rates is risk-free, and crowdfunded real estate surely is no exception. That’s a high-risk , high-reward type of investment, to be perfectly clear. Most crowdfunding deals involve a lot of execution risk and there is also the inherent risk that comes with investing in a single real estate asset (as opposed to a property portfolio).
  • Investments in crowdfunded real estate are highly illiquid. Once you’ve put your money in, you ‘re committed pretty much for the duration. Unlike when you own an investment property, you can’t just decide when you want to sell your investment.

How to find crowdfunded investments in real estate

I stated earlier that the crowdfunding platform acts as a middleman between the sponsors of the deal and the investors in real estate. One of the crowdfunding platform’s major functions is vetting deals before posting them to its investor site. So, it’s fair to say that using a reputable platform that takes appropriate action when it comes to evaluating the opportunities it’s willing to present to investors, is extremely important.

Make sure that you understand the vetting process of the companies, both for the developers it allows to support deals on its site, and how it vets those deals before they are allowed to reach the market. The top crowdfunding platforms for real estate all apply a high degree of due diligence on both the sponsor and the stage of the contract. Often, make sure you understand where your investment dollars really are heading. In most cases, you will directly invest in the real estate asset, or in a legal entity (such as an LLC or limited partnership) that owns a stake in the property, something that can protect your assets if the platform fails. When your money is an investment in the platform itself, not the real estate asset, then if the platform has financial problems, your investment will be at a much higher risk!

Finally, look for a platform with the kinds of real estate investments you’re interested in, whether it’s individual properties, a handful of properties, or a highly diversified fund that holds a stake in dozens of properties. If you plan to pick individual properties and choose how much to invest in each one, then a platform that only offers funds doesn’t make sense, and vice-versa.

How to evaluate crowdfunded investments in real estate

I’ve written a thorough guide that can help you assess crowdfunded investment opportunities in real estate, but here’s a list of some of the key things to look at:

How dangerous the idea is?

Finding a crowdfunded real estate opportunity is uncommon and may be considered a “low-risk” investment. Nonetheless, different forms of commercial real estate ventures come with varying levels of risk.

When assessing risk there are a few factors to consider. To list only a few of the most important ones:

  • How cyclical is that type of property? If you’re invested in a fully occupied Class A office property and struck by a recession, the loss may not be severe. Most office tenants are on long-term leases, and businesses need some space from which to operate. When you invest in a hotel and enter a recession, on the other hand, profitability will plummet.
  • How much risk of execution? Most crowdfunding investments have some sort of strategy to add value. Now that can be as simple as refinancing an existing loan to save money on interest costs. Or it may be as complicated as simply demolishing the entire property and building a new one.
  • How much return on the investors depends on the property’s sale? A property that has a large Day One income stream can be a much lower-risk investment than one whose return on investor is mostly dependent on the ability of the sponsor to sell the property at a profit.

What is Category of Investment?

Much of the time when we are talking about crowdfunding real estate, we ‘re talking about equity investments. In other words, you are investing some of your money and you own an share in the income created by the land, in return.

There are however two other possible types of investment structures for crowdfunding β€” debt investments and preferred equity. You are basically behaving as a mortgage lender when selecting a debt fund. You provide some of the financing for the deal, and you get an agreed-upon series of interest payments in return. You ‘re not going to get to share in any profits the investment generates, though.

Preferred equity is a bit of a mix. It usually has some kind of guaranteed return, but preferred equity investors often often get some kind of performance-based return in crowdfunding deals.

What amount of debt does the project take on?

It’s important to read the prospectus of any investment thoroughly and the capital stack is one area that is particularly important to pay attention to. This tells you about a deal’s financial structure β€” how much money comes from which sources, and who holds the most senior claims to the assets of the deal in case something goes wrong. That can also tell you how leveraged an investment is (debt-dependent).

Here is a simplified example of a capital stack which you could see:

CAPITAL TYPEAMOUNTPERCENT OF TOTAL
Sponsor Co-Investment$500,0005%
Investor Equity$2,500,00025%
Subordinate Debt$3,000,00030%
Senior Debt$4,000,00040%
Total$10,000,000100%

There are no set guidelines as to how much debt is appropriate, but I usually look for total debt that accounts for less than 70% of the capital stack. And if the debt of a project is relatively high, I ‘m expecting the expected return to reflect that additional risk factor.

What experience does the sponsor have, and how much money do they put in?

Notice the line in the capital stack above that says “sponsor co-investment.” The sponsor will contribute some of the funding required by a project in most deals, giving them skin in the game along with the investors. There is no specific cutoff to look for, but the more money a sponsor is willing to put in, the more confident that makes me an investor.

It’s a good idea even to do your homework on the source of the contract. Have they got a lot of experience? Is the sponsor familiar with this sort of contract, or at least deals of a similar nature?

Certain the fees are reasonable?

The people who play an active role in making money from investors get paid in most passive investment opportunities and that is definitely true in crowdfunded real estate investment. So, a significant part of the research will be deciding whether the payments are fair and whether the interests of the sponsor are compatible with your own.

There are two key forms a sponsor is paid for a contract. When the funds have been raised and the property is acquired, there is generally some sort of acquisition fee. The acquisition fee is typically a percentage of the property’s purchase price, and standard is 1 percent to 2 percent.

The second way a sponsor of a contract can get paid is called sponsor return, which is where the real money can be made. In most crowdfunding deals, investors are paid a certain return before the sponsor receives a dime (called preferred return). Beyond the preferred return the sponsor receives a certain percentage of the returns generated by the investment. For instance, a deal can pay investors the first 6 per cent of annualized returns, and the sponsor gets 20 per cent above that amount.

The sponsor return is, in many cases, a multi-tiered structure designed to motivate the sponsor to produce even higher return levels for investors than the project was aiming for. My preference is for deals with fairly low acquisition fees and generous but growing returns from sponsors. In short, I want the sponsor really to be inspired to make me money.

What’s the return on target?

Crowdfunded deals will generally provide for their investors with a targeted internal rate of return, or IRR. And while IRR calculations are a little complicated, the thing to note is that this is a return metric that incorporates any expected revenue from the contract, as well as the expected income from the property’s eventual sale.

One thing to bear in mind is that the goal IRR should be taken into account in tandem with the other features of the contract, and that higher IRR estimates are necessarily no better than lower ones. A lower-risk deal with a 14 percent IRR from an experienced deal sponsor, for example, can be a far better investment opportunity than a high-risk investment targeting a 20 percent IRR from a less experienced sponsor.

It’s also worth noting that there are two target IRR levels listed in many deals β€” the IRR at project level and the IRR investor. You want to pay attention to the investor IRR, as this is the return that the deal sponsor expects to receive after they have collected any performance-based fees.

What is the Goal Period?

With most crowdfunded investment opportunities in real estate, there’s some kind of target holding period, or a timeframe for the entire investment. This is because crowdfunded investments generally have some sort of exit strategy β€” typically after a certain number of years, a profitable sale of the property.

For example, a sponsor may plan to purchase an old apartment building, renovate all units over a two-year period, rent the building at higher rents, and then sell the property after four years holding it.

It is important to remember that these are pure estimates. There is nothing that forces the sponsor to complete the investment strategy by a certain amount of time, nor is there anything that prevents them from selling a property sooner than anticipated. For example, if the sponsor plans to sell the property after four years and a recession happens at that time, they may decide that it is in the best interests of investors to wait.

The target holding period is important to include in your analysis because a crowdfunded investment in real estate during this time is extremely illiquid, even as far as real estate investments go. In other words, if you’re going to use the money in seven years to support your child’s college education, you can only find investment opportunities with substantially shorter target holding periods.

Is there an income aspect to the investment?

This one is rather self-explanatory, but noteworthy. Many investors automatically assume that real estate investments are going to pay income but that’s not always the case with crowdfunding.

If you depend on your investments to produce a steady revenue stream, you will need to carefully analyze the distribution strategy for a contract. For example, some crowdfunding deals don’t anticipate paying shareholders any distributions in the first few years. And unlike other income-based real estate transactions, such as REITs, the revenue forecasts for a transaction are just that β€” a estimate. Keep that in mind when doing research on your investment.

Which are the investment conditions on a crowdfunded real estate deal?

There are a few crowdfunded real estate ventures that are open to all investors but these are usually solely revenue-focused deals or funds that spread the money around a bunch of different ventures like a mutual fund might. Most single-asset crowdfunding real estate transactions are open only to accredited investors. That means you have either of these:

  • Net assets amounting to at least $1 million, excluding your primary home value.
  • At least $200,000 in gross compensation ($300,000 when combined with a spouse’s) for each of the two prior years and this year’s projection of the same.

If these conditions are not met, you will need to concentrate on deals that are available to all investors and not just approved investors.

Minimum contributions for single-asset crowdfunding transactions are at least $25,000. However, the majority of platforms require a minimum investment of $50,000.

Tax implications of crowdfunding immovables

Now for the favorite part of all β€” taxes.

When you are invested in a crowdfunded real estate deal and making a lot of money, then the increased tax bill is not really a bad thing. But it’s better to know what to expect before you find yourself in that situation.

With that in mind, there are four forms of taxes that you as an investor in real estate crowdfunding might potentially face:

  • Income tax: Rental income generated by the properties in which you invest may result in taxable income, which will be reported annually to you (and to the IRS) on a K-1 tax form. The good news is that the taxable amounts you see are likely to be lower than the amount you actually received, because of the magic of real estate depreciation.
  • Capital gains tax: When a property sells more than its purchase price, capital gains tax is due on your income share. When the investment has been kept for more than a year, the long-term capital gains tax would apply to this. If not, the revenue will be considered ordinary.
  • Recapture of depreciation: Depreciation can lower taxable rental income for real estate investors each year. However, the IRS takes that benefit back upon the sale of the property. Any accrued depreciation benefits you receive upon selling of the property will be taxed as ordinary income. This tax is known as recapture depreciation.
  • State taxes (and not necessarily your own): as a part owner in a property in another state, that investment falls within the jurisdiction of its respective state and all property taxes apply.

You’re considered a part of a collaboration as an investor in a crowdfunded real estate contract. You will submit a K-1 tax form shortly after the end of each tax year which will report your share of income (or loss) from the partnership. If there’s a loss, you can use that to lower certain types of deferred income β€” say, capital gains or stock dividends β€” but usually you can’t use it to lower your taxable income overall. And, in most instances, you would be expected to file a state tax return in the state in which the partnership performs its business for any partner income.

Of course, these are general rules so be sure to work with a tax professional to help.

Was real estate crowdfunding right for you to invest?

There is no perfect answer to this question, but one key takeaway is that there is a tremendous amount of variety within the crowdfunded real estate industry in terms of risk tolerance, time commitment, and other factors, so it is likely that there is some form of crowdfunding for real estate that’s right for you as long as you’re a long-term investor.

If you’re ready to jump in and start exploring crowdfunding, make sure you first read our reviews of the best platforms for crowdfunding today.

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