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What’s In A Word: Real Estate Crowdfunding

People around houses

  |  By Chris Shanahan, CISP®

It's no secret that crowdfunding is changing the way that investors raise funds and nowhere is that more true than with real estate.

Real estate crowdfunding is estimated to grow 2.5 times to $2.57 billion this year, making it one of the fastest growing industry segments of crowd capitalism, according to industry research firm Massolution. In 2014, real estate campaigns ranged in size from less than $100,000 to over $25 million, and North America ranked as the largest region by funding volume, grabbing a 56% market share.

But before putting money into a deal, it's important to know what you are getting in to. When it comes to real estate crowdfunding there are two types -- equity and debt crowdfunding – and each type functions differently in a portfolio.

If you are considering using your self-directed IRA to invest in a real estate crowdfunding deal, here are some differences to be sure to understand:

  Real Estate Equity Crowdfunding Real Estate Debt Crowdfunding

What you get for your investment:

You will be receiving an ownership stake in return for your investment. Typically, participants in real estate equity crowdfunding purchase shares in a special-purpose vehicle, like an LLC, that pools investor money to buy property or fund a development project.   You are lending money that will be used to fund a real estate project. Very often a crowdfunding portal first “prefunds” a loan to a developer. You then invest in a borrower payment dependent note (BPDN) between you and the portal, which guarantees you a stated interest rate and term. The note is dependent on payment of the underlying loan between the portal and the developer, and you do not own the underlying property. 
Secured vs Unsecured: Unsecured Secured 
Holding Period:

Longer holding periods that can range up to 10 years or more

Shorter holding periods that can range, on average, from 6 months to 12 months
Risk: Higher potential risk since the investment is unsecured. In the case of bankruptcy, equity holders receive residual value of the investment after debt-holders are first paid back. Lower potential risk because the investment is secured. In the case of bankruptcy, debt holders are repaid first.
Asset being held:

Typically bigger projects with large capital budgets, such as hotels, commercial real estate, large multi-family complexes

Tend to be smaller projects with quicker construction periods, such as single-family or multi-family renovations and flips

As the chart lays out, there are some pretty stark differences between the two types of investing and each one can play a very different role in your IRA. Equity crowdfunding opportunities, which often require longer holding periods for commercial projects that may take years to develop, can align well with your retirement funds, which tend to have inherently longer time horizons. Debt crowdfunding offers the opportunity to hold a fixed-income type of product in your retirement account that has the potential to deliver monthly cash flow. Investing in these opportunities through your IRA allows you to do so with tax advantaged dollars.

To learn more about investing in real estate using your IRA, please download our guide here.