Crowdfunding has emerged as a major disruptive occurrence in the finance world over the last few years. Since the passage of the JOBS Act in late 2012, the popularity of this strategy has been growing steadily. While the move toward crowdfunding in real estate has been comparatively slow — as players in the field attempt to navigate complex regulations — it is taking off as well.
Advantages of crowdfunding real estate sales
Under the traditional real estate investment framework, generally, only accredited investors are allowed to participate. The rules for who or what can be considered an accredited investor, enacted under the Securities Act of 1933, are very steep. These definitions are in place to discourage savvy businessmen from taking advantage of gullible people via securities fraud, but they also have the effect of barring most people from investing in real estate other than through direct sale.
According to the SEC, an individual who wishes to be considered an accredited investor must have a family net worth that exceeds $1 million, an individual income exceeding $200,000, a family income exceeding $300,000 or a trust with assets in excess of $5 million. Crowdfunding allows individuals to participate in real estate investing with as little as $1,000. While the statutes under the JOBS Act that will allow unaccredited individuals to freely invest in crowdfunded real estate are still yet to be implemented, many platforms accomplish a similar result using Regulation D, Rule 506.
How crowdfunding works for real estate
The exact workings of real estate crowdfunding are somewhat complex, so bear with us. When you invest via crowdfunding in a piece of real estate, you are actually buying into a Limited Liability Company (LLC) that either loans out the money to buy the property, secured by the real property, or holds the title of the real property. The rights to income generated are outlined in the Operating Agreement of the LLC, and your ownership in the LLC is considered personal property.
In the case of a loan, the LLC acts as a "bank," collecting payments on the principal balance of the loan and interest. In the event of a failure to pay, a foreclosure remains an option, meaning that this is a relatively low-risk investment. If the LLC holds the title to the property, returns that result from ownership can be relatively substantial via property appreciation and rent. However, there is no recourse to the investor should the property turn out to be a bad investment.
Disadvantages of investing in real estate through crowdfunding
While there are a lot of potential advantages to real estate crowdfunding, there are some notable disadvantages as well. The risk involved in such an investment tends to be higher than in other investments, and the lack of a secondary market means that there is considerably less liquidity for investors who want out early. Crowdfunding for real estate is still in its infancy. Considering the broader appeal of crowdfunding in other sectors, however, it is likely that this trend will continue to grow.
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