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Real estate crowdfunding has emerged as an innovative way for individuals to invest in property markets without the need for large capital outlays or property management responsibilities. By pooling funds with other investors through online platforms, you can gain access to residential, commercial, and mixed-use properties that were once reserved for institutional investors.
This democratization of real estate investment not only diversifies your portfolio but also provides potential for passive income and long-term growth. In this guide, we explore how returns are earned in real estate crowdfunding.
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How Real Estate Crowdfunding Returns Are Earned
There are several different investment strategies used in real estate crowdfunding opportunities, so the way the return on investment (ROI) is earned varies depending on the type of investment and the strategy being used. Here we’ll look at the differences between equity and debt crowdfunding.
Equity Crowdfunding
Perhaps the most common type of crowdfunded real estate investment is equity crowdfunding. With equity crowdfunding, each investor purchases a share of equity in the project. Let’s take a look at some of the ways returns are calculated with equity crowdfunding.
Cash-on-Cash Return
One way investors receive a return on their investment with equity crowdfunding is through the cash flow the property generates from the rental income. The deal sponsor typically distributes the cash flow (profits) generated from the investment each quarter after the property expenses, operating expenses, and debt service are paid for.
Appreciation
With investment properties, such as commercial real estate, property values are tied to the net operating income (NOI) the real estate produces and the returns that investors expect based on risk and market conditions.
The values of this type of real estate appreciate when the NOI increases and the overall risk decreases. Many real estate crowdfunding sponsors achieve this by making improvements to the property, increasing rents, and getting higher-quality tenants or longer-term leases.
Equity
Most real estate deal sponsors launch crowdfunding campaigns to raise the capital for the down payment needed to acquire or develop the property and finance the rest through a traditional lender.
Over time, as the rental payments are being used to pay the debt service on a property, the principal balance is reduced, and the equity increases. When the property eventually sells, the payoff balance on the mortgage is less than what was borrowed on the property, so the proceeds from the sale are higher.
Internal Rate of Return
In a typical equity real estate crowdfunding deal, investors will receive a cash distribution each quarter during the investment term and then receive a larger payout once the property sells and the returns from the appreciation and equity build are realized.
The internal rate of return (IRR) is the total returns realized, annualized over the entire holding period. For example, say you invest $25,000 into a deal that paid a cash distribution of 5% for 5 years and then was sold at the end of the 5th year.
Over the 5 years, you received a total of $6,250 in cash distributions, then received a payout of $43,750 when the property sold ($25,000 equity you contributed plus profit from appreciation and equity).
Your total return on the investment would have been $25,000. Divided by the 5 years you held the investment, the realized IRR would be 20%. Even though most of the return was realized at the end of the investment, the IRR is averaged out over the total investment term.
Equity Multiple
Another way returns are calculated with real estate crowdfunding is with an equity multiplier. This is calculated by dividing the total dollars received from the investment by the total capital invested.
For the example above, this would be $50,000 / $25,000 = 2.0x equity multiple.
Debt Crowdfunding
Investing in a real estate debt crowdfunding offering generates returns in a different way than equity deals. Instead of owning equity in a project, investors are basically lending money to an investor or developer on a deal.
Returns on a debt investment are usually earned through interest payments made on the loan. Just like a bank earns interest on money it lends, investors receive interest on money they lend through debt crowdfunding.
What is the Typical Investment Term for Real Estate Crowdfunding Investments?
It’s important to understand that real estate is an illiquid investment. Investors can’t simply sell their shares when they need cash, like they can with stocks. Money that’s invested in a real estate crowdfunding investment will be tied up until the sponsor either sells or refinances the property.
Most crowdfunding deals have terms between 5 and 10 years. This gives the deal sponsor enough time to increase the revenue and property value, build equity in the asset, and sell it for a profit.
Depending on the deal, investors may have to wait a few years to even start receiving any cash distributions. This is often the case with crowdfunded development deals. It may take 2 years for the developer to complete the construction, then another year to lease the property and start receiving rental income.
The cash returns may even start small during the first couple of years of the holding period, while the property is being renovated, and rise as more units are leased and rents increase.
Debt crowdfunding investments often have shorter terms since the loans are usually used as a bridge loan to finance construction or until long-term financing can be obtained. These deals may have terms as short as 6 months, but are often 1 to 2 years.
Popular Real Estate Crowdfunding Platforms
Arrived is a real estate investment platform that allows individuals to invest in rental properties with low capital. Founded in 2019 and backed by notable investors, Arrived enables fractional ownership of single-family rental homes, making real estate investing more accessible. With a fully managed approach, investors earn passive income without the responsibilities of property management. This review explores Arrived’s investment process, returns, fees, and overall suitability for different types of investors.
- Small- to medium-sized investors
- Investors interested in rental income
- Investors looking to diversify
- Buy-ins as low as $100
- Open to non-accredited investors
- Offers ownership shares in real property (and all the tax benefits)
- Multiple ways to earn dividends (rental income and property appreciation)
- Great way to diversify portfolio
- Open to self-directed individual retirement accounts (IRAs)
- Detailed analytics and data to help investors make informed decisions and maximize their returns
- Long hold periods
- No secondary market to liquidate shares
Yieldstreet is an alternative investment platform that provides access to asset classes typically reserved for institutional investors. Founded in 2015, it offers opportunities in real estate, art, marine finance, legal finance, and more. By focusing on income-generating investments with varying risk levels, Yieldstreet aims to help individual investors diversify their portfolios and potentially achieve higher returns. This review explores Yieldstreet’s offerings, fees, returns, and overall suitability for different types of investors.
- Accredited investors looking to diversify
- Alternative investments to stocks and bonds
- Investors looking for passive income
- Easy-to-use platform
- Carefully selected offerings
- Excellent mobile app
- Full spectrum of alternative offerings
- Options for non-accredited investors
- Majority of investments only open to accredited investors
Fundrise is an online real estate investment platform that allows individuals to invest in a diversified portfolio of commercial real estate properties. The platform pools investor funds and uses them to acquire, manage, and sell various types of real estate assets, such as apartment buildings, office spaces, and retail centers.
One of the key advantages of Fundrise is its accessibility to individual investors who may not have the capital or expertise to invest directly in real estate. By pooling funds together with other investors, Fundrise allows individuals to access a diversified portfolio of real estate assets without having to purchase properties on their own.
Fundrise also offers transparency to its investors. The platform provides regular updates on the performance of the portfolio, allowing investors to track their investments in real time. Additionally, Fundrise offers a user-friendly interface that makes it easy for individuals to invest and manage their portfolios online.
- New real estate investors looking to get their feet wet
- Non-accredited investors
- Real estate investors who want a “set-it and forget it”-oriented option
- Investors looking for low-to-moderate cost buy-ins
- Multiple offerings available to non-accredited investors
- Simple menu of investment options
- Can use for IRA contributions
- Incredibly affordable buy-ins
- Low, easy-to-understand investor fee schedule
- Extended hold periods
- Limited secondary market
Managing Risk vs Return
While offerings with the highest target returns may be the most appealing, they may not always be the best investments. A project’s return is typically directly tied to its risk. Higher-risk investments usually offer higher returns, but they also come with a greater chance of a complete loss if the project doesn’t work out as planned.
Lower-risk investments typically come with lower returns, but the chances of realizing those returns are greater.
A good example is comparing a value-add opportunity where a real estate company is raising capital to purchase an apartment building that has 80% occupancy and is in need of major renovations, with an apartment building less than 5 years old that’s receiving market rent and has 98% occupancy.
The value-add opportunity has a lot of room to increase rents and the property value. However, a lot has to go right in order for it all to work out. The renovations have to be completed within the planned budget and timeframe, or the project may run out of money, and investors either have to put in more capital, or the bank loan may not get paid.
The newer apartment building doesn’t have much room to raise rents or increase the property value because it’s already maximizing its income potential, so the potential returns won’t be as high. However, there’s not nearly as much that can go wrong, so the risk to investors is less.
It’s important to consider your overall investment goals and risk tolerance when choosing a real estate crowdfunding investment. All investments have their risks, so it’s important to manage those risks carefully.
Bottom Line on Real Estate Crowdfunding Returns
Real estate crowdfunding returns can be quite attractive if you’re careful about choosing the right investment offerings and the platform you invest with.
Crowdfunding platforms like the ones discussed in this article have thorough due diligence processes to minimize the risks their investors are exposed to while offering investments with the highest potential returns.
Frequently Asked Questions
What is the average return on real estate crowdfunding?
The returns on a real estate crowdfunding investment vary greatly depending on the risk involved and the term of the investment. Equity crowdfunding investments on reputable platforms, with terms of 5 or more years, have an average IRR of over 17%. Shorter-term real estate crowdfunding investments have average returns in 10% to 12% range.
Is real estate crowdfunding profitable?
Yes, real estate crowdfunding can be profitable, with potential annual returns ranging from 5% to 15% or more, depending on the investment type. Investors earn through rental income (dividends) and property appreciation. However, profitability depends on factors like market conditions, platform fees, and investment duration.
How do investors get paid back from crowdfunding?
Investors in real estate crowdfunding are typically paid back through rental income distributions, interest payments, or property sales proceeds, depending on the project’s structure. Payments may be made monthly, quarterly, or upon project completion, and are proportional to the amount invested.
The post Real Estate Crowdfunding Returns by Kevin Vandenboss appeared first on Benzinga. Visit Benzinga to get more great content like this.