While real estate investments are a great way to diversify your portfolio, they also produce a long-term income source. However, up until recently, investing in private real estate deals was seen as something only the super-elite could do. Now, with real estate crowdfunding paving the way for new investors, there is a new way to invest in exclusive real estate deals.
To gain a better understanding of the who, what, where and why of real estate crowdfunding, DiversyFund has put together a complete breakdown about real estate crowdfunding for you.
For starters, let’s first understand what crowdfunding is. Crowdfunding involves using the power of the crowd to raise capital for startups, medical costs, charities or any other venture an individual needs capital for.
With real estate crowdfunding the power of the crowd is used too. By making private real estate deals available to the public, these platforms are using multiple investors to pool the needed funds to complete the real estate project. While there are other types of crowdfunding, this form is uniquely different in regards to how investors invest, the returns received and the level of risk taken.
To further understand the ways to invest in these real estate projects, one must know there are different types of crowdfunding real estate investments available. These can be broken down into three different types, which include:
In an equity investment, investors in the project gain an ownership stake. Typically, returns come in the form of rental income or the sale of the property. Investors receive their share of the profits either on a quarterly or annually basis.
With a debt investment, investors are investing in debt. Generally, this means investing in a mortgage loan for a property. Therefore, as the loan is repaid, you receive a percentage of the interest made on the load either monthly or quarterly.
Overall, equity investments tend to offer a higher return on investment. This is because debt investments have a limitation of the interest rate associated with the mortgage. Although investors may receive a higher payout with equity loans, there is also more risk associated with equity investments. Additionally, in equity investments, the investors are usually the last to be paid out their earnings.
On the other hand, many crowdfunding real estate platforms are combining the power of equity and debt investments to offer investors safer and smarter investment options. Our platform for example, provides investors with investments that have the perfect balance of debt and equity. These type of investments combine the best of both debt and equity, so investors are able to earn potentially higher returns with much lower risks. Plus, our capital stack means after the construction loan is paid, our investors are paid their dividends or shares. Then, the developer, DiversyFund, is paid out.
With the explosion of the crowdfunding real estate market, there have emerged various types of marketplaces. They all work in very similar ways to connect investors with new and exciting opportunities. The differences between these real estate crowdfunding websites lies in the fees associated with joining, the yields, risks and growth potential.
While each method has its pros and cons, all are great ways to start investing in real estate. Here are the three types of websites investors will come across on their search for the perfect investment platform.
An indirect investing model allows investors to participate by using a Special Purpose Vehicle or SPV, which the crowdfunding firm creates. An SPV helps to isolate potential financial risk. The firm figures out how much money they can contribute to the developer’s funds. After this, they call upon investors to fill in the difference.
While this model makes things simpler for real estate developers in terms of getting their funding, a trade off is that they can not make personal connections with investors. Since firms don’t know individual, a direct relationship does not form. This means that developers miss out on the opportunity to expand their networks to leverage in future opportunities.
In this model, the risk lays on the shoulders of the crowdfunding agency. The crowdfunding platform pays cash distributions and returns, not the real estate firm. Since this is the case, there could be a risk associated with this type of investment. This is especially true if the crowdfunding company fall upon hard times.
In such an event, an investor’s capital could be lost or their returns diminished even if the real estate asset still performs well. Overall, the health of the crowdfunding platform and the performance of the real estate asset directly impact the investor’s ROI.
Direct investing crowdfunding allows investors to directly invest with real estate firms. The crowdfunding platform becomes the middleman to facilitate raising funds from investors.
Through this method, investors are able to invest right alongside real estate firms. However, there is a risk on the behalf of the real estate firm. They’re the ones who have to fulfill the business plan for the specific project or property. For the real estate firms, there are many benefits to outweigh the risks. Not only are these firms able to raise more capital, but they can also expand their networks and make new connections to investors.
After the crowdfunding firm has successfully sponsored a deal, investors are able to directly interact with the developers. This opens up opportunities for both parties in the future, who may wish to invest in other opportunities together. Additionally, since this model eliminates the need for brokers, there are some fees that are irrelevant.
The final crowdfunding option that developers could choose is to integrate a Software-as-a-Service or SaaS platform within their existing websites. This real estate crowdfunding software allows them to begin raising funds under their existing brand. Developers can also manage investors and communicate with an existing network of private investors, as well as advertise to the public.
This model is beneficial for developers because it allows them to leverage their own investment network while expanding their brand’s reach to new investors. With this software, it’s easy for developers to create their own direct investing platforms and offer more value to current investors. Using this method, developers can also provide advantages to their private investor networks by offering investment opportunities to them first. They still typically offer them to the public later if the project still requires funds to get off the ground.
With the passing of the Jumpstart Our Business Startups Act in 2008, many new doors opened for real estate crowdfunding platforms. One of the biggest accomplishments of this act is the changes in how startups are allowed to raise capital through crowdfunding.
Since it’s passing, investors now have a number of options in how they invest in real estate deals. These options can be broken down into three different crowdfunding investment categories, which include:
Rule 506 (b) is the old school way of investing in real estate. These offerings are the same type of private placements that developers have been participating in for the past 3 decades. One thing has changed, however. Now, investors can participate in these deals online. It is not like anyone can see these opportunities. Potential investors must apply and then wait out a “cooling down phase” of 30 days before they can view any deals and begin investing.
Under Rule 506 (b), developers can raise an unlimited amount of money from an unlimited number of accredited investors plus a maximum of 35 non-accredited investors. However, deals including non-accredited investors require massive amounts of paperwork and other legal actions.
Rule 506 (c ) is very similar to Rule 506 (b), however only accredited investors can participate. Developers must also perform their due diligence before accepting investors. There is a certain amount of background work to do before individuals can begin investing. The potential investor’s tax returns and financial records must be thoroughly checked before they can begin viewing and investing in deals.
Another key difference in Rule 506 (c ) is that the real estate developers and crowdfunding sites can advertise the deals however they like. From digital to print, these opportunities are readily available and do not require any type of “cooling off phase”. This difference makes it easier for investors to find opportunities.
Similar to 506 (b), under Regulation A, both non-accredited and accredited investors can participate. And, similar to 506 (c), developers can advertise however they like: the internet, print, broadcast, etc. However, Regulation A has some major differences as well.
In order to raise money, developers must file complicated registration statements with SEC. This process can take up to 6 months and cost a substantial amount in legal fees. In some deals, the registration statement may also include audited financial statements. Once the project is fully funded, the developers may also be required to file reports periodically with the SEC.
As with any investment, it’s important that investors conduct their due diligence prior to investing in any opportunity. Due diligence is the defining factor that could make or break your credibility as an investment firm; and yet it’s one of the hardest aspects of real estate investing. “Out of 100 deals that come in the door, the underwriting team approves less than 5%,” states Craig Cecilio, Founder of DiversyFund. “Although our jobs as asset managers is to ensure investors yield compounded returns by getting their money working all the time, our number one priority is to conduct a rigorous process and in some ways marry the deal to really understand it’s true purpose.”
For real estate investments, due diligence comes in all shapes in sizes. Before anything else, you need to analyze the 3 C’s thoroughly for residential properties.
Operators must possess integrity in their work history and overall track record. The Operator’s character will be exposed in terms repaying investments when credit history is in review.
Operators need to show the ability to repay your investment. Bank statements, financial statements, W-2s, and other proof of liquidity will be needed for review.
The subject property inspection and/or an analysis of the market in that particular area says a lot. The beauty of Zillow, Redfin, and the like, will provide added legitimacy. In addition, any legal documentation pertaining to the property is subject to review. This will include current and/or previous liens on the property, articles of incorporation and good standing, insurance, and any evidence of potential red flags.
Throughout the life of an investment, investment firms never want to see investors second guess their investment choice. That is why, “we are present when investors make their decision, we are there when investors receive their disbursements throughout the life of the investment, and we are there when the investor receives their principal back. Our goal is to create an opportunity for investors to diversify their own portfolios. And our goal continues to be realized as we build more long term investor relationships,” Craig says. “We’ll let due diligence be the reason for our success.”
At DiversyFund, our team has over two decades of experience in real estate investments. However, that’s not what makes our crowdfunding real estate platform different. What makes us different is that our team of experts are on the ground and present at each project site. That’s right, we oversee everything from the loan to the construction and sale of the property.
In addition to this, our investors receive regular updates on their investments, so each investor stays “in-the-know” on how their real estate project is progressing. By overseeing and managing everything in-house, our team is able to make swift decisions when necessary, as well as provide complete transparency to investors on each investment available on our platform.
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