Whether you’re new to real estate or are excited about the opportunity to become an investor for the first time, crowdfunding is easily one of the best routes to take right now. However, you’ll soon find out that there are two major versions you’ll have to choose from before you start seeing profits. While there are a lot of good things to be said about equity-based real estate crowdfunding, you should know that debt-based might be your best option at the moment.
Basic Definitions
Before we get too involved in the argument for debt-based real estate crowdfunding, let’s first make sure we’re on the same page about definitions. Those who are just beginning in this new form of investing will definitely want to make sure they understand how the various forms work.
Debt-Based Real Estate Crowdfunding
First, there’s debt-based real estate crowdfunding, which is where you essentially act like a traditional lender. Instead of going to a bank, the owner of this new property comes to you and you provide them the money they need with certain terms. Generally, this fixed interest is going to be less than what a bank would charge, which is essentially how you gain your competitive edge. This isn’t always the case though. Some borrowers may have bad credit and traditional lenders just aren’t an option.
Although you don’t actually hang on to the title for the property, that real estate is still used as collateral. This means less risk, which is also why debt-based real estate crowdfunding means lower returns than the alternative.
Equity-Based Real Estate Crowdfunding
The other option a lot of people go with is equity-based real estate crowdfunding. This method has you acting more like a proper investor, in that you don’t have a capped return of any kind. Instead, you make your profits from shares on what the investment produces.
Equity-based real estate crowdfunding tends be for commercial ventures, which is how you get the profit you need for uncapped returns. You might invest in a hotel, apartment building, strip mall, or any other type of property where customers pay for a location.
Unlike with debt-based real estate crowdfunding, you really don’t have any collateral for your investment. As soon as the debt is cleared, though, you own any residual value.
To a lot of people, equity-based real estate crowdfunding seems like the obvious choice. Sure, there’s more risk, but as long as you pick a good location for the investment, most would think that problem was largely cleared. Why, then, do so many prefer the debt-based option instead? Let’s now dive in.
Most Platforms Prefer It
For most of the same reasons we’re about to discuss, the majority of online platforms for real-estate crowdfunding support debt-based investment. That right there gives this method a huge lead. People want convenience with their crowdfunding and they also want to have the most options for which platform to trust. Debt-based investments give them both for the moment.
Rebuilding Neighborhoods
Not everyone is interested in real estate crowdfunding for its obvious potential in terms of profits. One reason a lot of people are venturing into this new world is because of how bad the economy has been over the last seven years and what that did to some of their favorite neighborhoods.
Thus far, real estate crowdfunding really hasn’t gotten its just due for how well it can help bring some of these neighborhoods back to life. People with money who want to see these areas get back on their feet can actually affect change without having to go through the bureaucracy that is typical of traditional lenders.
Only debt-based crowdfunding real estate really makes sense for residential homes. While equity-based investments can help with apartments, they also demand a lot more individuals or at least a lot more money.
It’s the Safer Bet
We already touched on this above, but it’s worth repeating: debt-based real estate crowdfunding comes with less risk. It’s tough to generalize how much less, but overall, you’re better off putting your money in a debt-based investment if you are risk-averse.
At the moment, a lot of people are very risk-averse too. Part of that is because our economy is just now bouncing back, so most people aren’t overly-enthusiastic about putting their savings on the market where it’ll be at risk. However, it’s also because real-estate crowdfunding is still so new. While it’s far from an unregulated industry, that still makes some people understandably nervous.
Until real-estate crowdfunding becomes something we all take for granted, most first-time investors will most likely prefer to go the debt-based route.
The Returns Are There
That being said, it’s not like investing in a house is so safe that you won’t be seeing any returns from it. In fact, the returns from this kind of investing can actually be very impressive. Where else can you find short-term opportunities that could show you 10% to 18% in returns, on average?
Also, there’s something to be said for the fixed return. Even if you’re fairly risk-tolerant, your fellow investors may not be. A lot of them may be just fine with taking that capped return because they can pretty much count it’s going to be there every month.
Traditional Investing Is Not Doing Well
Like we touched on above, some homeowners just can’t hope to get a loan from a traditional lender, meaning debt-based real estate crowdfunding is one of their only options.
The truth, though, is that a lot of tradiitonal lenders couldn’t make those loans if they wanted to. Even major developers have found the well a bit dry as of late. Without any hope in sight for the old way things used to be done, it makes sense that debt-based real estate crowdfunding would show up to save the day. This kind of demand is bringing out a lot of investors who are all too happy to oblige.
Debt-based real estate clearly has a lot going for it. While there is definitely an argument to be made for going with the equity-based kind, the potential shown by the former is too great to pass up at the moment.
Matthew Sullivan
@thecrowdventure
Image by Shutterstock
