The ways in which you can invest in commercial real estate are as diverse and accessible as ever.
For commercial investors of all financial standings, the ability to diversify (or even begin) your portfolio is easier than it would have been in the past.
One reason why: Commercial real estate crowdfunding—a niche industry that has exploded in recent years.
In this article, we look at everything you need to know about commercial real estate crowdfunding—from how it got started, to the pros and cons, and what it might look like in the future.
The Advent of Commercial Real Estate Crowdfunding
It used to be that investing in private real estate required investors to have some sort of personal relationship with the sponsor of the deal.
This is how commercial real estate investing became referred to as “country club” money.
This all changed in 2012 when Congress passed the “JOBS Act,” an initiative intended to spark economic activity and by extension, opened the floodgates to commercial real estate crowdfunding.
The JOBS Act prompted the Securities and Exchange Commission (SEC) to revise its regulations to allow real estate developers to sell securities in real estate deals.
Here’s how it works:
Just as someone would purchase stock in, say, Apple or Facebook, they can now buy shares in commercial real estate deals.
The entire investment is governed by SEC regulations just as they would be if the investment was a traditional security.
A number of prominent commercial real estate crowdfunding platforms have sprung up since.
They allow accredited investors to buy into a real estate deal for as little as $10,000 or $25,000.
There are also other platforms that have even lower thresholds and offer deals accessible to non-accredited investors.
Today, there are hundreds, if not thousands, of developers who crowdfund investment in their deals through these platforms.
How Online Crowdfunding Sites Work
There are three primary types of commercial real estate crowdfunding platforms:
- Those that raise debt
- Those that raise equity
- Those that raise some combination of both
You can read a bit more about the specific differences of each here.
Several websites have emerged that help raise loans for real estate projects. Patch of Land is one such example.
Investors contribute to an offering, and once funds are raised, the money is used for loans on commercial real estate deals.
The structure of these deals can vary, but they tend to be short-term construction or mezzanine loans that promise yields as high as 10% to 18%.
Returns are high given the inherent risk associated with some of these deals. “Safer” projects would typically use lower-cost bank financing.
Typically, project sponsors only turn to crowdfunding debt when there are cracks visible in the deal (such as the borrower lacking equity in the deal, refusing to give a guarantee for the deal, or when a borrower is already too highly levered).
Equity platforms are perhaps the most crowded segment of the online marketplace, with companies offering investors a slice of real estate in many different forms.
Some marketplaces, like ArborCrowd, raise equity for specific deals. People know exactly what they’re investing in with each offering.
Other equity platforms, like Fundrise, raise money for a fund, and then the fund invests in a specific asset or portfolio of assets.
These platforms are often referred to as “eREITs.”
Anyone can invest in Fundrise’s eREITs. You do not have to be an accredited investor. In fact, you can invest with as little as $500 and then grow your investment in $100 increments.
Investors select their investment objective, such as long-term growth or balanced diversification, and then are given different options (or funds) to invest in.
You can invest in a single portfolio or several depending on your goals.
Funds are then invested in different product/property types, such as apartments, hotels, shopping centers and office buildings across the country.
Investors earn their money through interest payments, property income, as well as potential property appreciation.
Each investor earns his or her share of the income on a pro-rata basis over the pre-determined distribution period.
The funds have a target return threshold (say, 8% to 10%) but the actual returns may vary depending on the portfolio’s performance.
CrowdStreet is an example of an online commercial real estate platform that offers both options: the ability to invest in a fund or the ability to invest in specific deals.
Other examples of popular platforms offering real estate crowdfunding are RealtyMogul and Groundfloor.
The Pros and Cons to Commercial Real Estate Crowdfunding
There’s a lot to like about the option to invest in commercial real estate via online crowdfunding platforms.
But don’t be fooled – it’s not “too good to be true.” There are certainly some downsides to commercial real estate crowdfunding.
Below, find the pros and cons.
PROS of Commercial Real Estate Crowdfunding
For one, commercial real estate has notoriously high barriers to entry.
Allowing people to invest with as little as $500 is very appealing to those just getting started.
Most platforms don’t require you to be an accredited investor, which opens the door for the first-time or average investor.
This allows people to dip their toes into the commercial real estate waters without putting too much of their own capital on the line.
- Investors gaining access to asset types and deal sizes they wouldn’t normally have access to.
- Experienced investors looking to expand into new territories or asset types without a putting too much on the line.
Consider the case of a multifamily apartment building selling for $10 million:
Most lenders will want to see at least an 80% loan-to-value ratio, meaning you need to come up with 20% equity for the deal.
On a $10 million project, this requires $2 million in equity.
Few investors have that amount of capital to invest, and therefore, cannot buy into projects of this scale.
Now, with online crowdfunding, that same investor can take an equity stake in a similar project by investing as little as $500.
Their equity is pooled with dozens, if not hundreds, of others and profits (and risk) are shared accordingly.
Finally, commercial real estate crowdfunding offers a good alternative for investors who do not have the time or wherewithal to find deals on their own.
Crowdfunded projects have already been identified. The deals have already been vetted. The numbers have already been analyzed by others who usually have years of experience in the industry.
This lifts the weight of the acquisition and due diligence process off the individual investor.
CONS of Commercial Real Estate Crowdfunding
For all the benefits of commercial real estate crowdfunding, there are equally as many cons to this investment approach.
The reasons mostly have to do with the inherent lack of transparency in commercial real estate crowdfunding.
Let’s start by addressing the elephant in the room. Many of these platforms were established by software developers, not real estate developers.
Sure, while software providers might have real estate experts on their board of directors, the extent to which these experts are involved in analyzing deal flows will vary.
As an outsider, there’s really no way for you to know which platform has the most expertise relative to the others. As a result, eager investors can easily be swayed by sleek websites and highly aspirational marketing campaigns.
You can read around online and check reviews to find the best crowdfunding sites for real estate.
Now let’s get into some of the more specific “cons” of these platforms.
These platforms don’t have a particularly long track record.
The quality of a sponsor can make or break a deal. You want to be sure you’re investing with someone who’s highly adept, has proven experience, and ideally, has weathered multiple real estate cycles.
Crowdfunding platforms can’t really say that. Most are still relatively new, having been around for less than a decade.
Many companies tout their great returns to date, but these companies have only invested in a mostly-bullish market. How their portfolios perform during a market downturn remains to be seen.
Similarly, it remains to be seen how investors treat their crowdfunded investments in the event of a downturn.
Investors might be more likely to try and sell their equity in a crowdfunded deal, where individual stakes are lower, than they would be to sell a deal they’ve personally invested in more substantially.
If many investors pull their money out of these portfolios, the entire portfolio could cripple.
It can be hard to discern what fees you’ll be charged.
A quick look at offering materials is illustrative. Most crowdfunding offering packages cite a range of fees (e.g., an acquisition fee of 0% to 3%). What does that mean?
In actuality, these companies can assign any fee to the deal that’s most advantageous to the platform – not its investors.
eREITs like Fundrise don’t have the same pressure of trying to achieve the internal rate of return they’ve promised investors, because that’s usually expressed as a range too (more on that below).
On top of the fees associated with the actual deal, there are also fees charged for managing the fund. Asset management fees and advisory fees can quickly diminish a project’s overall returns.
When investing in a fund, the rate of return is really just a guess.
When investing in a fund, like an eREIT, investors are promised a projected rate of return, ranging from X% to Z%, such as 6% to 8% — but that’s just a guess, because the actual investments have not yet been identified.
This is much different than investing in a traditional syndicate, where investors are guaranteed a certain rate of return (which is easier to determine given they know more about the actual investment), and the sponsor isn’t paid out their profit until investors receive their promised rate of return.
You often don’t know much about the actual assets you’re investing in.
Many commercial real estate crowdfunding platforms are aggregating capital for a fund.
The challenge with investing in these funds is that investors are usually left in the dark about the specific asset, asset class (Class A, Class B, Class C), or the exact location of the investment.
For example, an eREIT may target an asset class generally, such as industrial or multifamily residential, or they might target a specific region, like real estate in the Northeast, but otherwise – there’s no detail about the type or quality of investment you’re buying.
Moreover, there’s no guarantee that the fund will deploy capital in line with these overarching objectives.
There are several reasons why this is a problem, but specifically, it prohibits investors from doing their own due diligence or their own underwriting, which limits their ability to vet an opportunity prior to investing.
You’re essentially putting blind faith in platform’s investment team.
There’s an inherent lack of liquidity when investing in crowdfunded deals.
While commercial real estate is considered illiquid as a whole, this is particularly true when investing in crowdfunded deals.
Let’s use Fundrise again as an example:
Fundrise, like many of its competitors, offers a redemption mechanism that allows investors to exit the deal prior to the maturity period, but redemption typically carries heavy fees and penalties.
The Fundrise platform says investors can withdraw their money at the end of any quarter—subject to availability.
So, let’s say the market starts to soften and multiple investors want to pull their money out. Fundrise has the ability to halt the redemption altogether.
With that, the actual liquidity of eREITs remains questionable.
And the absence of a secondary market restricts easy access to selling opportunities for investors who may otherwise be able to cash out of the deal.
The Future of Commercial Real Estate Crowdfunding
Despite the drawbacks of commercial real estate crowdfunding, there’s no indication that interest in investing this way will slow down any time soon.
Again, using Fundrise as an example: when the platform opened its first eREIT offering in 2015, the first $1 million was fully filled in just four hours.
This is despite investors not having any information about how the eREIT would invest those funds.
A few days later, the fund reopened briefly to raise another $1 million. Once again, the fund was filled in mere hours. Fund after fund continue to draw interest.
Commercial real estate crowdfunding remains in its infancy, and as such, we expect to see this funding mechanism continue to evolve as market cycles come and go.
What’s certain, however, is that there is no shortage of interest in the medium.
In the meantime, these crowdfunding platforms remain an option for those looking to invest even minimal amounts of capital in larger CRE projects.