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Real estate crowdfunding: what you need to know as an investor
Real estate crowdfunding has attracted much hype since its emergence over the last few years – and for good reason.
With the right opportunities on the right platform it can be a fantastic way to increase your wealth and diversify your portfolio.
Enabling investors to back a wide range of property projects and target profit on their rising value (or in some instances, rental yields), one of the reasons behind its popularity with investors is partly because of changes impacting on the traditional property investment approach.
Recent adjustments to buy-to-let tax legislation in the UK have dampened some of the appeal of real estate investing through established channels.
Two years ago, a new 3% stamp duty on buy-to-let properties was announced by the government. Also, the ability of landlords to offset mortgage interest payments on buy-to-lets against their rental income to reduce tax is to be phased out by 2020.
Such changes have left many investors questioning whether the responsibilities of being a landlord and some of the risks of this form of property investment are worth it.
For example, Rightmove reports that the average time taken to sell the small properties favoured by buy-to-let investors hit 58 days in September, up from 55 in September 2017.
Although a seemingly slight variation, Rightmove’s director Miles Shipside noted:
“With the government using the tax system to try and help first-time buyers while deterring out of favour landlords, prices in this sector have been subdued as intended.”
As buy-to-let investing becomes less appealing, property crowdfunding is on the rise. The £15m crowdfunded, 40-unit project announced in October 2018 for Altrincham, Greater Manchester, shows the scale of opportunities. This project alone will see thirty-one apartments, eight townhouses and a commercial unit being built, all thanks to the ‘crowd’.
The risks and returns of real estate crowdfunding
Aside from changes to tax legislation elsewhere, another driver in property crowdfunding’s growth is the fact it comes with no landlord-related hassles.
Investors can take advantage of the strong returns synonymous with the relatively robust property sector, with none of the responsibilities.
While there aren’t specific tax breaks open to property crowdfunders, this type of investment can be highly tax efficient for many investors.
For example, if you invest in a project that will build and sell a development, returns tend to be realised as growth rather than income.
This means you receive a share of the development’s profits after all the fees have been paid. Your income is therefore taxed as a capital gain instead of income – not to mention the fact that you have realised a capital return without having to retain an asset for several years.
The risk of delays to the sale process is mitigated by its possible rental appeal. If the property unexpectedly cannot be sold immediately for a profit, it may take on paying tenants to generate returns until a future sale.
For new and experienced investors alike
The risks of property crowdfunding can be lessened in other ways, too. Firstly, the low minimum investment level means investors can test the market with small outlays, perhaps while they build up their expertise.
Secondly, because many platforms are quick and easy to use, a diverse portfolio can be built up swiftly. This enables risk to be spread across a spectrum of opportunities on multiple sites.
Although the minimum investment level on some sites is very low, it is important to recognise that much larger amounts are also regularly invested. Many sophisticated investors with significant sums to put into property projects are just as engaged in property crowdfunding as novices - the former may be looking to bring added balance to their portfolio that might also include enterprises, stock market investments and their own properties.
A variety of crowdfunding opportunities
Real estate crowdfunding’s appeal is universal and the abundance of opportunities and platforms means there is often a project to suit all financial requirements.
Although still maturing as an investment option, property crowdfunding is regulated by the Financial Conduct Authority (FCA) and users do have some protections in the event of a platform or project hitting trouble.
For this reason, in the UK, only relevant companies on the Financial Services Register should realistically be used. Not only will these platforms adhere to the FCA’s strict rules, but users in certain instances may be able to claim any lost monies through the Financial Services Compensation Scheme (FSCS).
But regardless of this, a crucial consideration for investors is how much to invest.
Clearly you should not risk more than you can afford. You must also be willing to accept whatever degree of illiquidity comes with your investments.
An investment in a project to develop and sell properties will likely involve a wait of at least 18 months until the capital growth can be realised. Reputable platforms with a strong track record in delivering returns to investors will be transparent and realistic about exit plans.
Projects linked to debt interest usually offer more regular returns. This option, often seen in the form of property bonds or peer-to-peer lending, involves capital being raised by a crowd of investors which is then loaned out to various projects.
Whether you are a seasoned investor or a beginner, you should have a clear understanding of the investment and returns model on any platform you choose to invest in.
The mechanics behind an equity-based property crowdfunding opportunity usually involve a special purpose vehicle (SPV). These are standalone entities in which the property is effectively held. Through this, shares in the project can be allocated to investors and returns handed out accordingly.
Choosing the right opportunities
With so much choice in the market, selecting the best real estate crowdfunding platform for your needs isn’t always easy.
Much of the decision comes down to personal preferences and requirements. Do you easily understand how its investment and returns model works? Do the terms suit your budget and goals? Does it have a user-friendly dashboard?
Alongside these factors, there are also some must-haves to look out for.
For instance, are you happy that the company behind the platform has a thorough due diligence process? This largely includes the due diligence it carries out on each opportunity in terms of its likely sale or rental value and any locational factors which may affect it. For debt crowdfunding opportunities, due diligence on the debtor is also vitally important.
Also a foremost consideration is the company's track record in creating compelling opportunities that deliver or eclipse the returns promised at the outset. Partially, this involves securing the opportunity competitively and ensuring it has all the ingredients to achieve capital growth and/or healthy rental yields. Customer reviews and feedback may be a useful gauge here.
Another differentiator, which may be important to the more experienced investor, is the level of input investors have into the opportunity. In most real estate crowdfunding cases this is zero; opportunities are managed by the platform and the company behind it, utilising their expertise to seek the best possible returns. However, groups of investors also engage in equity crowdfunding in property independently, giving them control of decisions relating to the asset, such as when to sell. If you are adept at property investment, this option may be one to explore.
Understanding real estate crowdfunding
The potential of real estate crowdfunding is considerable. As with any asset class, there are risks, but the accessibility of the opportunities, the targeted returns and the various opportunities make it a genuine option for many property investors, new and experienced alike.
And whilst we've looked at some of the key points, it's only been on a high level and there is a considerable amount more to be learned about this vast and growing field.
An interesting and exciting area, taking the time to understand the potential of real estate crowdfunding can quickly make it a favourable option for many property investors.