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The positives and negatives of real estate crowdfunding

The positives and negatives of real estate crowdfunding

As I've documented over the course of the blog, I am really into real estate investing. It would stand to reason that I would be pretty excited about real estate crowdfunding as well. But, I am unsure if it's really a perfect corollary to "real life" real estate investments. Before I dove in, I wanted to take a closer look at the positives and negatives of this interesting asset class. 

What is real estate crowdfunding

For the uninitiated, real estate crowdfunding is fairly simple. Think of it as a way for you to invest a (relatively) small amount in a share of a real estate investment. Sites like Fundrise  and RealtyShares offer previously vetted deals from "lead" real estate investors or developers, most with a significant amount of experience. Investors take a small share in a large deal, with an expected annual return and exit date (if applicable).

What I like about real estate crowdfunding

Obviously, there is a lot to like about this method of investing.

1. Diversification

Investors can spread their money out across multiple properties and regions without having to shell out a massive amount for any one property. The relatively small investment minimums offered by some of the crowdfunding startups make it relatively easy to spread money around enough to prevent an enormous loss. 

2. Overhead

Since the deal is being led by an experienced investor and owner, there is almost no management overhead. Compared to owning and managing a single family home, it's a walk in the park!

3. The returns

Real estate crowdfunding returns look generally very favorable with expected returns from 6-12% and up... assuming everything goes to plan of course. One potential source of these returns is the size of properties that you can invest it. It's easier for a small investor to turn a 100% profit on a single family home (with leverage) than it is for an institutional investor to turn a 100% profit on a huge office building.

Problems with real estate crowdfunding

1. CONTROL

One of the things I like the most about real estate investment is the almost unlimited number of knobs you can turn to improve your returns and investment. Not getting the rent you want out of your property? No problem, refurbish with some fresh carpet and new countertops and raise rents. Want to buy an additional property? Cash out refinance your old property and jump in. Want to get out of the investment? Sell the property. 

With real estate crowdfunding, all of those knobs are unavailable or significantly hampered. Selling is possible but difficult. There's no way to leverage the investment (although to be fair it will likely already be leveraged by the lead investor). You can't actually alter the property or work with it in any way. You own it... but you don't control it. 

Perhaps worst of all, you don't have any say or control over the person who is actually making decisions about the property. You don't REALLY know if they are trustworthy or savvy, despite the (likely) thorough vetting from the crowdfunding site you are working with. 

Call me old fashioned, but I don't like to put my investments on autopilot. I want to be flying the plane.

2. TAXES

Real estate investing is so lucrative because of the extremely favorable tax treatment. Put simply, our government is handing out freebies to real estate investors and I want in on the action. The mortgage interest deduction and depreciation can often completely offset the tax bill from any profit you make on a physical real estate investment. It's one of the few really good tax loopholes that's exploitable by nearly anyone, and the benefit can be enormous over time.

It's true that the deals you invest in through real estate crowdfunding will take advantage of interest deductions and depreciation. But, and this is a big but, YOUR investment is subject to neither advantage. Any income you see through your ownership will be taxed at your full income rate. And there's no way in hell you can depreciate a financial investment. 

3. FEES

This is a simple one. I hate fees. I really hate fees that are more than 1% a year, and most of the leading real estate crowdfunding sites have fees from 2-3%. That's just too much. You wouldn't invest in an S&P 500 index fund with a .5% fee, why invest in a real estate investment with similar risk and returns for 3-6x the fees? 

4. We just don't know the risks

If you're anything like me, you're getting really tired of hearing about bubbles, and the looming threat of another crash (please everyone, stop calling the top), but I have to bring it up. What do these crowdfunded investments look like in a downturn? What happens if your lead investor over-leverages and the property is foreclosed on? What happens when vacancy rates go through the roof? What happens with natural disasters, insurance recovery... etc. 

We. Just. Don't. Know.

5. REITs

At the end of the day, real estate crowdfunding's biggest issue are REITs. There's already an easier, lower fee and highly diversified way to invest in real estate indirectly. Sure, the returns may be slightly less in the up years, but no one could argue that REITs are significantly safer than crowdfunded real estate. My current REIT investment (VNQ) yields 4.75%, and has appreciated around 12% in the year and a half that I've owned it. That's over 10% per year in total, with zero effort or thought, and it only took me two seconds to buy it. Plus, it's so diversified I haven't had to think about it once since I bought it.

Conclusion

Now, I could be wrong. There's plenty of bloggers I respect who have been dipping their toe into real estate crowdfunding. But, I won't be for a long time. I know I want to see how these investments perform in a down market, and I definitely want to see fees come down. After that, I'll definitely be more interested than I am now. 

For the time being I'll be sticking to good old fashioned real estate investing. 

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