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If you have ever engaged in building a property, then you would know how financially demanding it can be. As a property developer, you usually need three things which are land, capital, and knowledge. Capital often proves to be the most difficult to acquire, and it’s mostly because the amount rises quite high.
This presented a problem for both developers and people who would otherwise like to become investors in property development. While some developers- especially new ones – suffered from the limitation, a solution was developed in the form of Crowdfunding.
Crowdfunding is hardly a new word as it has been making the rounds across countries and industry. Crowdfunding is simply when several persons come together to contribute financially to a project. The idea is that with each person contributing what they can afford, the set amount for the project can be reached much faster than if you were to wait for a single person to provide the entire amount. Crowdfunding has served so many industries, so why not real estate and property development?
Hence, crowdfunding for property development refers to accessing a pool of investors through a crowdfunding platform to contribute/invest in the development of a property. The investment here is all about building new houses and then making a profit from the gain in value rather than rental income. These investments can be made in both residential and commercial property.
Other real estate crowdfunding include investing in an already existing property to make a profit from the rental income and much more.
History of Real Estate Crowdfunding
While it’s understandable to think that crowdfunding is a new term and method of raising funds, history proves that it is not. For centuries, businesses have recognized the value of using a large pool of investors to reach their investment goals. The first public use of crowdfunding was as far back as 1714 for the Longitude Prize. At that time the British government was faced with a funding problem and used the idea of crowdfunding to wriggle out of it. With time, the practice of crowdfunding grew and evolved, making its way to the Atlantic. In the 19th century, bankers and financers needed capital for a railroad that spread across the nation and they solicited investors from the public. And so, the practice went on showing up in several projects that needed much funding.
Crowdfunding is said to have been first recognized – officially – in 2006, in an article in the Wired Magazine by Jeff Howe.
When it comes to real estate, crowdfunding real estate is as historical as the word itself. However, it was available only via private equity deals, which required large amounts of money, thus making it unavailable for the everyday investor. The investment lacked diversification.
In 2012, new legislation was passed allowing everyday investors to invest in real estate crowdfunding. This legislation was the JOBS Act, and it states that ‘through this legislation, accredited investors and non-accredited investors can invest in real estate crowdfunding’.
How Crowdfunding Works for Property Development
Crowdfunding presents several benefits for both the investor and the developer getting funded. It also has its disadvantages and risks. We will explore all of this below.
The steps to crowdfunding for property development often vary by platform. However, the general path is this;
- Borrower submits an online application
- The borrower/developer gets approval from the online crowdfunding platform
- The borrower establishes the details and creates the project.
- Qualified investors browse and review.
- Qualified investors invest an amount suitable for them
- When the project is funded, the borrower starts construction
- After development, the property is put on the market and investors receive sales proceeds based on the proportion of their investment amount.
An investor can invest in real estate crowdfunding using any of these two methods;
Equity crowdfunding where the investor contributes towards the purchase of an asset through a single purpose entity (SPE). The investors thereby own shares in the SPE, which in turn owns the asset. The developer or borrower will also own shares in the SPE with an operating agreement defining their rights and responsibilities. Investors share the percentage of profit from the sale of the asset.
RISK – Equity crowdfunding is thought to be riskier for investors as they are passively involved with the investment. This includes them at any risk of failure as their equity stakes’ value changes with that of the asset.
Debt crowdfunding is almost directly opposed to equity funding as here the developer receives capital from investors without sacrificing equity. All debt crowdfunding options are usually secured by the development of the property.
RISKS – Generally, there might be no risks in debt crowdfunding for investors. Investors are paid within 2 years or less and also receive a share of the accumulated interest on the project. This is paid by the borrower.
Pros of Crowdfunding for Property Development for Investors and Developers
- Diversification – Investors can split their funds across different properties.
- Ease of management – Developers take on management needs, so investors have peace of mind.
- Investors get to invest alongside professional and institutional investors.
- A quick way to raise capital for property development.
- A cost-effective method as online crowdfunding platforms offers lower overhead costs when compared with banks. This easily translates to lower interest rates for the borrowers/developers and fewer fees for everyone involved.
- Smaller or new developers can easily raise capital from qualified investors.
- Real estate crowdfunding platforms are highly flexible with the type of properties they list to investors, the type of real estate project, and the financing the investors can offer.
Cons and Risk of Crowdfunding for Property Development for Investors and Developers
- Capital can be lost.
- It’s near impossible to exit from a poor performing property.
- Decisions are based on the majority vote.
- For developers, some platforms do not release funds pledged if the total set amount is not reached. In such cases, funds are returned to investors.
How to Choose a Platform
There are several crowdfunding platforms to choose from each with their rules, application methods, and procedures. Here are the things to consider;
- Restrictions of the platform
- Your crowdfunding goals
- The platform’s structure
- The platform’s customization options.
Crowdfunding for property development can be a win-win for all involved. While it comes with a few risks and cons. The pros involved outweigh them. Finding the right crowdfunding platform, organizing a proper campaign, getting qualified investors, and finally finishing the project are the factors that can build up to several successful projects.