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Monday, July 15, 2024

How to Open a Real Estate Crowdfunding Account

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Investing directly in real estate traditionally required an investor to have a large amount of capital available. Real estate investment trusts (REITs) helped to open up real estate to more investors by combining resources via a pooled fund. More recently, crowdfunding has emerged as another way for everyday investors to add real estate to their portfolios. We’ll walk you through how to compare your options, cover your alternatives, and answer your most pressing questions. With an understanding of how to open a real estate crowdfunding account, you can choose the right investments that meet your goals and start investing. 

Alternatives to Real Estate Crowdfunding

Direct investments in real estate via private equity arrangements are considered a type of alternative investment. These are generally considered to be more illiquid and therefore higher-risk than publicly traded investment options. Crowdfunded real estate is not the only alternative investment, of course. Here are a few other alternatives that offer similar diversification away from the traditional market.  

Fine Art and Collectibles

Fine art, antiques, wine, and other physical property that gain value over time based on rarity and popularity are broadly categorized as collectibles. To invest successfully in collectibles, you need to understand the market for various items and be able to assess quality and authenticity quickly. Investors in collectibles need to plan for things like secure storage and insurance for their investments. 

Cryptocurrency

Cryptocurrency uses blockchain technology to create a virtual currency that doesn’t derive its value from a national government. Instead, these digital currencies are traded on a market maintained through cryptocurrency exchanges. Cryptocurrency is arguably on its way to becoming just another asset class but even then it is on the higher-risk, speculative side, similar to real estate crowdfunding. Cryptocurrency investments can be done directly through exchanges or an investor can take the more diversified approach of gaining exposure through an exchange-traded fund (ETF). 

Precious Metals

Precious metals like gold, silver, and platinum are also considered alternative investments. Gold and silver come in a collectible form as with coins and jewelry that sell above the melt price. Some physical forms, like bullion bars, trade closer to the spot price of gold and silver as a commodity. Investors can also get access to precious metals through ETFs, futures, options, and even shares of the mining companies pulling them out of the ground. 

Peer-to-Peer Lending

Peer-to-peer (P2P) lending is very similar to real estate crowdfunding in that it is a private capital market outside of traditional bank financing. Investors can become lenders on the platform and provide loans to other individuals. The borrower may not be able to secure traditional financing, so the rates on the loans may be higher to accommodate the higher risk of default. As with real estate crowdfunding, platforms play the key role in creating the market with providers like Prosper and Lending Club—although the latter has moved to institutional investment with no replacement for its individual investment option as of yet.23 The requirements vary state by state, but the income and net-worth requirements are generally not as onerous as they are to be an accredited investor.

How Does Real Estate Crowdfunding Work?

Investors pool their money to acquire equity or debt stakes in private real estate projects or operations. In exchange for the capital, the sponsor of the deal will either pay investors out of the rent income and proceeds of an eventual sale or via regular interest payments if it is a debt investment. The platforms that list opportunities play a critical role in vetting the investment and structuring it. 

Is Real Estate Crowdfunding Worth It?

Real estate crowdfunding is a higher-risk, higher-return investment. It is also less correlated with the financial markets, although it is still sensitive to the economic conditions where the properties are located. Real estate crowdfunding can provide investors with above-average returns and portfolio diversification, but it is best done with risk capital rather than making it a majority of any average investor’s portfolio. 

What Are the Disadvantages of Real Estate Crowdfunding? 

Real estate crowdfunding investments are higher-risk private investments. This means that in addition to the regular risks of total loss, if an investment fails, you may have issues around liquidity, fraud, and potential platform failure to consider. Investors in private projects also do not have the same guaranteed disclosures that more regulated investments have, making due diligence more difficult. Lastly, real estate crowdfunding projects face the same economic pressures as regular real estate investing. The cost of capital can go up in the form of interest rates, or inflation can drive up construction costs and suddenly a project costs more than planned. This can result in a capital call to existing investors or even dilution of equity via a secondary call for investment. 

Can You Invest in Real Estate Crowdfunding With a 401(k)?

A traditional 401(k) through a brokerage or bank is unlikely to allow you to invest in crowdfunded real estate deals. To use retirement funds to invest in this type of alternative asset, you’ll need to go the self-directed 401(k) route. While this is possible, it is recommended that you limit your exposure to alternative investments by only using risk capital. Putting all of your retirement savings into crowdfunded real estate is not part of a sound investment strategy. 

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