Real estate crowdfunding

In short

A friend of mine once told me she wanted to own a piece of an apartment building but could not afford the down payment. If you have felt the same pull, real estate crowdfunding lets small investors chip in alongside others. Each person puts in a modest sum, and a company pools the money to buy or build a property or fund a loan. Your money can stay locked up for years, and you may not be able to sell early. The platform takes fees, and those fees come out before you see a dime. Read the offering documents slowly, and ask what you would owe in taxes. Money you might need next year does not belong in a deal like this, and the platform will not hand it back on request.

The whole of it

What it is

I once watched a neighbor try to buy a rental house with three of his cousins, and it nearly broke up the family reunion. Crowdfunding tries to do that same thing without the quarrels. You have probably heard of buying shares in a company. This is a cousin of that idea, where you buy a small stake in a property or a loan instead.

There are two main flavors. In equity deals, the investor owns a share of the property and gets a cut of the rent and any sale profit. In debt deals, the investor lends money to a developer and is paid back with interest. Equity can pay more when things go well and lose more when they do not. Debt often has a fixed payment, but the borrower has to repay, or the investor suffers.

A platform runs the whole show. It finds the deals, collects the money, and manages the paperwork. That convenience has a price, which we will get to.

How it works

If you are holding a few thousand dollars and wondering where to start, here is the usual path. A person opens an account on a platform and answers questions about income and net worth. Then comes browsing the offerings and picking one. After that, the money gets wired, and the waiting begins.

The law shapes who can join. Some offerings are open only to accredited investors, a term the Securities and Exchange Commission defines by income or net worth. Others are open to everyone under Regulation Crowdfunding, which the SEC also oversees. Under that rule, a company can raise only up to a yearly cap from the public. Each person also faces a limit on how much they can put in. The offering page and the SEC's own site list those caps, so check the current figure there.

Most deals are held through a special company set up just for that property. You own a piece of that company, not the building itself. The platform or a sponsor makes the day to day choices. A small investor rarely gets a vote.

Once the money is in, you wait. Rent or loan payments may arrive monthly or quarterly. Some deals pay nothing until the property sells. Hold times vary by deal, so the offering document is the place to look. Early exits can be hard to come by. There is seldom a market where an investor can sell a stake. Hold that thought.

The numbers, and where to find yours

Money talk makes people squirm, so let me be plain. Every deal has costs, and they sit in the fine print. Look for an upfront fee, a yearly management fee, and a cut of the profit called a carried interest or a promote. The offering document lists them all. Under Regulation Crowdfunding, that document is called a Form C.

The minimum investment varies by platform and by deal. Some ask for a few hundred dollars. Others ask for $10,000 or more. A non accredited investor faces a limit set by income and net worth, and the SEC publishes how that limit is set. For the current figures, see the current figure, which the official source publishes each year and the current figure, which the official source publishes each year.

Taxes matter too. Rental income and interest are generally taxed as ordinary income. Equity deals often send a Schedule K-1, which can arrive late and complicate a return. Debt deals often send a Form 1099. Your tax rate depends on your own situation, so look at IRS.gov or ask a tax preparer. For the income level that makes a person accredited, see the current figure, which the official source publishes each year.

A worked example

Let me tell you about a woman named Dana. She earns $52,000 a year. That income is below the accredited investor test, so she joins a Regulation Crowdfunding deal, which is open to the public. She had saved $5,000 that she did not need for at least six years. She picked an equity deal in a small apartment building. She put in $2,000 and kept the other $3,000 in savings.

The platform charged a 1 percent upfront fee. That is 1 percent of $2,000, which is $20. So $1,980 went to work in the deal.

The deal also charged a yearly management fee of 1.5 percent. On her $2,000, that is 1.5 percent of $2,000, or $30 a year. Over five years, the fees come to 5 years at $30, which is $150. Add the $20 upfront fee, and her total cost is $170.

Now say the building paid out a 6 percent yearly return on her $1,980. That is 6 percent of $1,980, or $118.80 a year. Take away the $30 management fee, and she keeps $88.80 a year. Over five years, that is 5 times $88.80, or $444.

She also got her $1,980 back when the building sold, in this happy case. So her total in hand was $1,980 plus $444, which is $2,424. She started with $2,000. Her gain is $424, before taxes.

See how the fees ate a share of the gain? Without them, she would have kept 5 times $118.80, or $594, a difference of $150. Fees are quiet, but they add up.

Now picture a worse day. The building loses value, and the sale brings back only $1,200 of her $1,980. She would have lost $780 of her principal. The same fees still applied. That is why the money Dana set aside was money she could afford to leave alone.

Where it goes wrong

I have a soft spot for good news, but honest talk serves you better. These deals can go sour in a few ways.

First, the property may do poorly. Rents fall, repairs run high, or the neighborhood changes. Equity holders are paid last, after lenders and costs.

Second, the sponsor may make bad calls. You trust a stranger with your money and your future. Check their track record, and be wary of glossy promises. Past results do not guarantee what comes next.

Third, you may be stuck. There is often no easy way to sell. If a car repair or a layoff hits, your money stays put. Liquidity, which just means how fast an asset turns into cash, is low here. Cash for next year's bills belongs somewhere you can reach it.

Fourth, the platform itself can fail. If it shuts down, getting your records and your payments can turn messy. Ask who holds your money and what happens if the company closes.

Fifth, the fees may be higher than they look. Read every line. A deal that looks like an 8 percent return can shrink a lot after costs.

Last, the paperwork can trip you up. Late tax forms and unclear terms are real. Keep every document in a folder you can find.

Questions to answer before you leave this page

Could you leave this money untouched for the full hold time, even if life gets hard? Is every dollar you plan to invest money you will not need next year? Do you know every fee the platform charges, from the first day to the last? Have you read the offering document, including the risk section most people skip? Who runs the property, and what is their track record, in plain terms you can check? Do you know whether you are an accredited investor, and what limit applies to you under the SEC rules? What happens to your money if the platform closes or the sponsor walks away? How will the income be taxed on your own return, and have you asked someone who knows? And would you still feel fine about this choice if the whole amount were lost?