While these opportunities can be appealing, it's important to understand what you're committing to and the level of risk involved. This article explains real estate crowdfunding and key factors to consider when making investment decisions.
What is real estate crowdfunding? Real estate crowdfunding lets multiple people pool their money to invest in proposed real estate projects. Instead of owning a property outright, investors own shares in a company involved in the project, with potential returns paid out later, often after several years. These crowdfunded investments fall into two categories:
Equity investments: You own equity shares in a company, which may increase or decrease in value over time. When the shares are sold, you receive the value of the shares.
Debt investments: You lend money to a company through a loan. You earn interest over time, and when the shares are sold, the amount you lent should be returned to you. Debt can be secured against the property or unsecured. It's important to know that you won't own the property directly. Instead, your investment depends on the expertise of the company developing the project.
Here are some questions to ask before getting into this type of real estate opportunity:
Who owns the property, and who manages it? Check if the property's title is held by the company you are buying shares in or another entity. Understanding the ownership structure will help you assess the risks associated with your investment.
Are the expected returns realistic based on current market conditions? Be cautious of overly optimistic projections. Even completed projects can face cost overruns, and actual returns may not match initial projections. There is no such thing as a guaranteed return; market conditions can change.forces and other unpredictable factors influence investment outcomes, especially for long-term investments. How much debt is on the property, and what is the repayment plan? Projects with a lot of debt can put your investment at risk since debt is paid back before equity. Check how much debt the project needs and if it comes from private lenders, who usually charge higher interest rates than traditional banks. Unsecured debt is riskier than secured debt. When there are multiple lenders, the position of the debt on the property's title affects the loan's risk level. Lower-priority debt is riskier because higher-priority debt is paid first. How experienced is the developer or project manager? A developer's track record is crucial for project success. Developers with experience in completing projects and returning money to investors are usually more reliable. On the other hand, new developers or those with many unfinished projects might not have the experience needed to handle challenges. New developers often face a learning curve and might be overly optimistic aboutreturns and timelines, while seasoned developers may be more realistic and less likely to overpromise. Is the crowdfunding platform registered with the Alberta Securities Commission or operating under an exemption? Some crowdfunding platforms are run by registered dealers who help private companies raise money. Other platforms, which focus solely on crowdfunding, operate under an "exemption" from registration. These exemption platforms have been reviewed and approved by the Alberta Securities Commission but cannot provide investment advice or determine if an investment is suitable for individual investors. They can only accept a maximum investment of $2,500 per person. Check the platform’s status on CheckFirst.ca to see if it is registered or operating under the crowdfunding exemption. Is the company raising money open about its operations? Transparency is crucial. If the company cannot explain how funds will be used or refuses to provide supporting documents, consider this a warning sign. Look for information about fees, ownership structure, project management, and how the funding is allocated. What fees and costs will you pay? Real estate management often includes various fees for property management and administration, which can reduce your returns. Ask for a complete breakdown of fees, find out who benefits from them, and ensure they are reasonable compared to industry standards.Are there conflicts of interest? Investigate related-party transactions, such as properties bought from affiliates of the company raising money for the project. Check if an independent third party has assessed the property's sale price as fair, and examine the relationships between property developers, property managers, and the company raising funds for the real estate project. Close ties could lead to biased decisions that negatively affect investors.
Beyond these considerations, understand that while real estate crowdfunding offers a unique way to invest in property, it comes with risks. These investments are often illiquid, meaning you can't access your money quickly. Returns are not guaranteed and depend heavily on project management expertise, the project's success, and the broader real estate market.
Before investing, ensure you understand how this opportunity fits into your overall financial goals and risk tolerance. Doing your due diligence is crucial. Take the time to research each opportunity, ask important questions, and consult with a registered financial advisor if needed. Your investment decisions should help you build a strong, diversified portfolio while protecting your financial future.