Investors have always liked real estate for the opportunity to own real property and invest in something familiar that generates returns. Will the crowdfunding model for real estate prove as popular? I think it should, for three key reasons: increased accessibility, greater transparency and significantly fewer geographical limitations.
Real estate crowdfunding allows the average Joe to access markets previously available only to executives and institutional investors. Investors can research real estate investment opportunities from home in little time and at minimal cost and connect with developers online—something the developers like because it saves them the time and money previously spent finding and pitching to potential investors.
When developers seek investors, the first step is supplying them with all the relevant information about what their money will accomplish and how it will do so, from day one. The kind of information a potential investor would previously get by scheduling one or two meetings with a developer is now instantly available online. This increased transparency establishes a level of trust among investors and developers that was harder to achieve in the past.
Location, location, location? No more
Perhaps the best part of real estate crowdfunding is the ability to buy and manage property that's 20 states away from where you live, without ever having to set foot there. Now investors can make the best investment to suit their needs, regardless of the landscape of their local market or ability to visit properties.
One of the basic rules of investing is diversification: Never put all your eggs in one basket. With stocks and bonds, it's fairly simple to achieve diversification, but with real estate it's harder. A traditional real estate investor has access only to local deals and may only have access to a particular type of deal—commercial, residential, single housing or multifamily, etc. There's a few reasons for this: It's difficult to understand and know real estate markets and, furthermore, to know the deals that are in play at any given time.
There are traditional ways to diversify in real estate, including real estate investment trusts (REITs) and real estate funds. Real estate crowdfunding provides not only a way for investors to achieve both geographical and asset type diversification but allows the investor to control where their money is being invested specifically.
When looking at the most popular real estate crowdfunding platforms, you'll find a variety of deals—equity, preferred equity and debt deals. In equity and preferred equity deals, money raised from crowdfunding gives investors complete or partial ownership. In debt deals, or crowdlending, money raised simply finances a deal, meaning investors give money without gaining ownership of property.
The length of deals, as well as the amount they require, varies. We are seeing deals from six months up to 5 years and loans of $100,000 to an equity raise of $15 million. A wide range of deals translates to a wide range of investors who benefit from the ability to find an investment that aligns with their budget and goals.
Getting started in real estate crowdfunding
Beyond traditional real estate investor due diligence (property assessment, market condition, financial underwriting), it's important to highlight a few additional steps that real estate crowdfunding investors should take.
1. Know your objective: Making money isn't good enough.
Investors should have a clear objective for the transaction. Long-term appreciation, cash-flow yield, real estate financing. There are too many deals, and the more clarity an investor has, the easier it will be to identify the best opportunity.
2. Know where you fit into the deal: Not all investments are created equal.
Developers are still figuring out how to incorporate crowdfunding into their funding mix. Investors should pay attention to what type of shares they are getting and how those shares compare to other sources of funding in the deal. For example:
Is it a debt deal or an equity deal?What are the rights granted in this investment?Is it senior or subordinated to any other investor?Is the real estate proportional to my investment, or do shares of a company own the real estate?
3. Know who is running the deal.
One of the pitfalls of crowdfunding is that you never meet the sponsor or developer face-to-face. Therefore, investors need to make sure they ask all the questions they can about the sponsor and his past experience. Sponsors looking to raise money on crowdfunding are expecting investors to hit them with some tough questions.
4. Know the role of the crowdfunding platform.
Part of the success of the investment depends on who controls the money and how they raise it. If a platform participates in the deal or if they only charge a fee, it changes the incentive for the platform and the type of deals you are likely to see.
5. Trust no one.
Just because someone puts a deal on a website does not mean it's legitimate. Investors should require platforms and sponsors to validate claims and experience through third-party verification services that can help investors become more comfortable with deals.
—By Jordan Kavana, founder and CEO of Transcendent Investment Management and a member of the CNBC-YPO Chief Executive Network
CNBC and YPO (Young Presidents' Organization) have formed an exclusive editorial partnership consisting of regional Chief Executive Networks in the Americas, EMEA and Asia-Pacific. These Chief Executive Networks are made up of a sample of YPO's unrivaled global network of 20,000 top executives from 120 countries who are on the front lines of the economy. The opinions of Chief Executive Network members are solely their own and do not reflect the opinions of YPO as a whole or CNBC.