Real estate crowdfunding profitability
First time real estate investors often ask how profitable is real estate crowdfunding. Data shows that real estate crowdfunding is profitable.
First off, real estate crowdfunding is highly profitable because it has fixed, and high returns. The range of real estate returns is around 8% to 14%.
For the investors, real estate crowdfunding profitability depends on the size of dividends they receive. The higher the dividends, the more profitable an investment into real estate is.
Most real estate crowdfunding projects have a yearly dividend-payment schedule. This means that the investment returns are paid to the investors at a same time every year. For a two-year project, the investors would receive their returns on investment twice.
Let’s look at a basic example of how profitable real estate crowdfunding is. The dividends can be set at 11%, and the project ending date can be in 1 year. This would mean that the investor, in a year, will get back their initial investment, and will receive profits. The profits would be received in the form of 11% dividends from the investment. A $100 investment into a project like this would net the investor $11 profits. A $10,000 investment would bring profits of $1,100.
The range of how profitable real estate crowdfunding is, depends on the market a real estate crowdfunding website is oriented towards.
Real estate crowdfunding in older, and more developed markets, will be less profitable. More developed markets tend to carry lower risk. Lower risk translates into lower interest rates for the developers, and lower dividends for the investors.
How profitable real estate crowdfunding is, also depends on the developer and the real estate project.
More well-known developers will have more credibility and lower risk levels. Thus, their real estate crowdfunding projects will also receive a lower risk score, and consequently, investors will be paid out lower dividends.
Lesser known real estate developers won’t have much credibility. Hence, their projects will carry a higher risk factor. This risk factor will translate into higher dividends for the investors.
Real estate projects in previously undeveloped areas will be more profitable (for the investors) than real estate projects in already developed areas. This is a consequence of the inherent uncertainty new projects tend to cause. A building in an already developed area is more likely to find buyers. It will also benefit from the positive associations the prospective buyers already have.
A real estate project in a previously undeveloped area, will carry more uncertainty both for the developer and the investor. The developer, because of the uncertain market response to the new development, will have to deal with a higher interest rate. The investor will have to evaluate whether higher profits outweigh the risks associated with a new project.
A real estate crowdfunding investment will bring higher profits if the investment is directed at a buy-to-sell project. Buy-to-sell crowdfunding projects are based around buying already built real estate, improving it, and selling it for a premium.
The developers of buy-to-sell projects have an incentive to lock in the best deal they can. Locking in the highest price would mean higher earnings for them. The investors of buy-to-sell real estate crowdfunding projects win from this investment structure. They can be sure that the project will sell for the best possible price, and will bring more profits to the investors.
Of course, the project may not sell well. However, the investors at least know their developer will try to get the highest price for the real estate unit.
Real estate crowdfunding risks should not be forgotten when thinking about profitability. It’s only important how profitable is real estate crowdfunding, in the cases when the investment does not fail. If an investment fails, all thoughts about profitability will become unimportant.
Thoughts about real estate crowdfunding risks and mismanagement, will instead take the first place. Regrets about the investment, and “obvious” red flags in the project, will emerge.
Even for low risk investors, profits are important. For high risk investors, profits are the main goal. However, as with any other investment, the profitability should not blind the investors to the fact that real estate crowdfunding risks are real.
It’s important to learn how real estate crowdfunding works, its limitations and advantages. This information will help to view the profitability of the investment in a more measured way.
Real estate crowdfunding. How does it work?
The answer to the question “How does real estate crowdfunding work?” is both simple and complex.
Real estate crowdfunding works as any other type of crowdfunding. Many investors have the opportunity to participate (on equal terms) in the crowdfunding of a certain real estate project.
Firstly, a real estate developer has to submit a real estate building project to a crowdfunding website. The analysts of the website will determine whether the project is viable. If the project is accepted, the real estate crowdfunding platform will set the interest rate for the project. The interest rate is essentially the dividend rate for the investors.
The analysts of the real estate crowdfunding site also set the date for when the developer has to return the investments they have received. This time may vary between a year or two years. The initial investment sum is returned to the investors before the set date.
When the dividend rate for the investors is set, and the real estate project page is created, the real estate project goes live.
Investors then can invest from small to large ($50,000+) sums of money. Every crowdfunding platform sets its own minimal investment sum. They vary from over $5,000 in USA, to sums smaller than $1,000 in Europe.
When the investor chooses the real estate crowdfunding project they like, they have to create an account on the crowdfunding platform. After creating an account, the investor has to agree to the conditions of the investment, and transfer the investment sum into an escrow account.
When the desired investment amount for a real estate project is collected, the real estate developer starts building the project, and paying dividends to the investors.
Real estate investing, through real estate crowdfunding, is similar to other loan-based investments. The lenders (the investors) give money to the lendees. The lendees, in real estate crowdfunding, are the builders.
The lendees pay off the loan (the investment), and its interest (the dividends) either through regular payments, or a one-time payment, when the project ends.
Minimal investment size also influences how real estate crowdfunding works. In platforms where lower minimal investments are accepted (e.g. 50 euros), it’s more likely that an investment will be backed by more investors than in platforms where higher minimal investments are a requirement.
Why it’s important that more investors are able to back up a crowdfunding project? More investors means more power. In a case of delays of a dividend payment, the investors will have more bargaining power. 100 unsatisfied investors will attract more attention than just 10.
Real estate crowdfunding pros and cons
Real estate crowdfunding pros and cons are based around the profitability of real estate crowdfunding, its costs, and barriers to entry for the investors.
Main real estate crowdfunding pros and cons:
- comparatively higher profitability;
- low costs;
- low barriers to entry;
- lack of investment protection;
- performance correlates with the performance of the housing market;
- limited investing opportunities.
Pros of real estate crowdfunding:
First off, real estate crowdfunding has a comparatively higher profitability than other similar investments.
Business crowdfunding may offer higher returns on investment, but it comes with significantly higher risk of failure. Business crowdfunding is mostly based around the crowdfunding of startups. And startups are very likely to fail. Even if a startup becomes successful, its investors will likely have to cope with share dilution. Share dilution is bad for the investors, as it can lead to lower profits and a loss of voting rights.
Real estate crowdfunding can also be more profitable than investing in real estate through own efforts. Buying a house or an apartment to later sell it, as an individual, takes time and effort. In the article, Lessons from investments for high net worth individuals, Money Bear Club calculated that it can take more than 20 years before an investment in a rented unit becomes profitable. Preparation of legal documents, and the sale of real estate, also come with their own costs.
The profitability of real estate crowdfunding (the dividends to the investors) is also big enough to beat the inflation numbers. Yearly inflation numbers in USA, Canada and the European Union range from 2.2% in USA, to 1.7% in Canada. Returns from real estate crowdfunding range from around 8% to 14%.
Thus, real estate crowdfunding is not only profitable enough to protect investments from depreciating in value because of inflation. It’s also profitable enough to be higher than the inflation by at least 5.8% to 6.3% .
Another pro of real estate crowdfunding is its low costs. The costs of real estate crowdfunding are higher in USA-based platforms, but they are significantly lower in other countries. One UK-based platform offers real estate investing from sums as low as £50, and an Estonian platform offers investing from €50.
The final pro of real estate crowdfunding is the low barriers to entry for the investors. Some investments, like mutual funds, have barriers to entry in the form of minimal initial investment. Other investments, like venture capital funds, only can be used by “experienced” investors (investors with higher income than $200,000, or asset worth higher than $1 million).
Real estate crowdfunding only sometimes has similar barriers to entry. USA-based crowdfunding websites almost always have a minimal investment threshold. Some USA-based websites also only accept accredited investors.
In other countries, the only requirement is to have some money for the investment, a bank account, and an internet connection. That’s all investor has to have to be able to invest through real estate crowdfunding sites.
Cons of real estate crowdfunding
The main factor that works against real estate crowdfunding is the lack of investment protection.
In some jurisdictions, real estate crowdfunding investments aren’t insured. This means that some governments view real estate crowdfunding as a high risk investment. The governments won’t be footing the bill, in case a real estate developer becomes unable to pay back the investors.
From the eyes of the government and other tax payers, this action is fully justified. However, lack of investment protection makes real estate crowdfunding an investment that is more similar to an investment in the stock market.
In the case of a bankruptcy of a real estate developer, which received funding through a crowdfunding platform, the crowdfunding investors will not necessarily be able to get their investment back. This condition presents a serious consideration to think of, before investing in real estate by crowdfunding.
The performance of a real estate crowdfunding investment will highly correlate with the performance of the housing market.
A downturn of the housing market, in the area where the crowdfunded project is being developed, may cause difficulties for the developer. These difficulties may range from larger investors pulling out, to difficulties in selling the real estate unit. Hence, real estate investors should be aware that a crowdfunded project does not exist in a vacuum separate from the whole housing market. A housing market downturn has the ability to affect an investment made through a crowdfunding platform.
Limited investing opportunities are another factor against investing through real estate crowdfunding. Many projects that could bring high returns to the investors, aren’t approved because of the perceived risks they bring. It’s up to the analysts of every platform to approve or reject a project. And the decisions of the analysts can lead to the investors not being able to invest in a worthwhile project.
Limited investing opportunities aren’t necessarily the worst factor against real estate crowdfunding. Bad judgement calls, which lead the investors to lose their money, is another potential problem for real estate crowdfunding platform investors.
Even analysts make mistakes. However, for investments where the minimal threshold can begin at $5,000, the loss to the investors makes the mistakes very expensive.
Thus, investors should view every project posted on a crowdfunding platform with certain scepticism. After all, even the analysts of a platform may not know all of the information related to a particular real estate project.
Choices and consequences
Every investment is a choice. A choice to accept the consequences, however good or bad they may be.
How profitable an investment is, and its advantages, are the main factors investors base their decisions on.
Yet, maybe the worst consequence of an investment, should be the main factor?
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