Crowdfunding is all the rage. It is a great way to bring an innovative product to market or help someone in need pay for enormous medical bills. However, it is less optimal for real estate. There are a lot of myths out there about real estate crowdfunding, and it is important to get the facts before you put your hard-earned cash into an investment.
Real Estate Crowdfunding
Crowdfunding is gathering large amounts of money in relatively small increments from many people at once. It’s become such a hot idea that regulations have changed to make crowdfunding easier, and with those changes, we have seen a rise in real estate crowdfunding apps and websites.
8 Myths About Real Estate Crowdfunding
1. The Website or App Owners Have Done Due Diligence
When you invest in crowdfunded real estate, it is natural to assume that the platform’s founders have done all their due diligence on any deal they present to you. In fact, isn’t allowing people with little expertise in real estate to get in on the action the purpose of these platforms?
Unfortunately, there is no such guarantee with crowdfunding platforms. The platform founders and owners could live anywhere, and you have no assurance that they know anything more about the market in Charlotte or St. Petersburg than you do. The only way to be certain of your investment is to learn about the local market, and with real estate crowdfunding, you are relying on someone else to do that.
2. The Platform’s Goal Is Smart Investment
This is one of the most dangerous myths about crowdfunded real estate platforms. As an investor, you naturally assume that your goals and the platform owner’s goals line up. Surely they want to make money off real estate investments, right?
In reality, their goals could be very different. A common goal for any internet platform is to generate buzz and attract as much money as quickly as possible. This attracts buyers and means a quick payout for platform owners. When you realize that entrepreneurs behind crowdfunding real estate platforms are not as interested in sound investments as they are in turning a quick profit, the whole thing looks less interesting.
3. These Are Secured Investments
Whenever you invest, you might assume that investment is secured. That seems par for the course. But it is not always guaranteed. Crowdfunded real estate is unsecured, and what that means for investors is that if the platform goes under, you could lose everything.
Crowdfunding investment is still the Wild Wild West of investment strategies. As with the Wild West, a few people stand to get very rich, but most people are taking a real risk of losing everything.
4. Investments Are All the Same
There are different risks that come with equity investments as opposed to debt investments, and both larger investment choices include many individual options. Yet when you look at a crowdfunded real estate investment platform, you would think all investments are largely the same.
If you don’t fully understand the structure, how you recover your investment, when you will receive your payout, and how much to expect, you are stepping out blindly and risking your money when you do not need to. The smart investor does a lot of research to understand the deal they are about to get involved with, but real estate crowdfunding platforms make that kind of detailed research all but impossible.
5. The Future of Crowdfunded Real Estate Is Clear
Actually, the opposite is true. If this were just like any other investment, we could predict what will happen. That is not the case. In 2012, the JOBS Act made crowdfunded real estate investment possible, meaning there is little precedent on which to base your predictions.
This is new territory for everyone, and government regulations could change at any point, either in favor of crowdfunding investors or against them.
6. All Platforms Are the Same
There are a few crowdfunded real estate platforms that work hard to provide a good product, but how do you know which ones are legit and which pose a serious risk? You can only rely on reviews from tech blogs and social media, and while these might be well-intentioned, they are not always reliable.
The main concern with online reviews is whether the reviewer really knows enough to give a good review. Just because someone had a good experience signing on with the platform and making their initial investment does not mean the platform is a good long-term investment choice.
7. Defaults Are Straightforward
There’s always a possibility for loans to go bad, and even in the best of situations, this means a lot of time, effort, and cost to recover your funds. But what happens when you’re involved with dozens or even hundreds of other investors? Who deals with litigation? Who represents your interests if there is an issue?
Some platforms deal with this in the fine print by specifying that if you do not recover your funds within three years, you automatically forfeit them. Most investors are not looking for this kind of fine print.
8. There’s a Plan In Place for Lawsuits
Consider this scenario: you and a dozen other people invest in an apartment complex. The crowdfunding platform hires a property management company, choosing the cheapest manager they can get. The management company hires people to do maintenance work, but they do not vet them very well, and one person steals from tenant properties.
When the tenant sues, who is responsible? When the tenant finds out there are 20 owners to the property, will that make them more or less likely to seek a high-value settlement? This is just one risk you take when you leave the details of your property investment in someone else’s hands.
How to Do Investments Right
Know Your Market
To understand your investment, you must know your market. Look for areas with consistent job and population growth but a low cost of living. This is where you’ll find the lowest prices and the best return on investment.
Get Good Advice
Before you buy a property, spend some time thinking about your risk. In a worst-case scenario, can you cover your losses? What if it takes three months to find a renter or the whole sewer line needs replacing a month after you buy? Keeping these risks in mind, make sure you do not buy beyond your means.
Learn the Ropes
You could pay a property manager to take care of everything for you, but the smart move is to invest the time and energy it takes to familiarize yourself with the property and local regulations, and how to deal with tenants. Learn the ropes right from the beginning. The more you invest in understanding your property, the faster you’ll learn how everything works. Armed with that information, you’re ready to make smart decisions and move on from smaller investments to bigger properties.
Skip the Risks and Invest the Smart Way
Crowdfunded real estate carries significant risks. While all investments come with some risk, you can minimize yours by doing it the right way. Direct investment helps you build your skills along with your equity. To learn more about the benefits of direct investment, tune in to The Creating Wealth Show podcast.