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Equity vs. Debt in Real Estate Crowdfunding Investments

Few would question that investing in real estate can be very lucrative. Look no further than Donald Trump who has been running away with news headlines since he announced plans to run for president of the United States. The real estate mogul boasts funding his campaign with money he earned through his real estate holdings.

You may not become as rich as Trump through real estate investing, but new doors have been opened to so-called average investors that can help you tap into this profitable market. An act that became effective in 2013 provides for crowdfunding, and it paved the way for developers to raise investment capital from what had been an untouchable market – average, unaccredited investors.

If it interests you, it is imperative that you first understand the offerings the developer has available for you to get in on the project. The offerings are usually equity or debt.

 

 

In this piece, we will examine these two types of strategies, looking at the pros and cons of each. Also, we will provide you with the basics of how to get into this area of investment.

 · Some history

Before we get into equity versus debt offerings as they relate to real estate crowdfunding, let’s look at some of the history. As part of the 2012 JOBS Act (Jumpstart Our Business Startup), Congress created an exemption to permit securities-based crowdfunding. The intent was to help alleviate the funding gap and accompanying regulatory concerns faced by startups and small businesses in connection with raising capital in relatively low dollar amounts, according to the Securities and Exchange Commission.

From the 2012 JOBS Act came many measures aimed at loosening the reigns that had kept non-accredited investors from investing in areas like real estate.

Chance Barnett, the chief executive officer for Crowdfunder, was one of plenty of supporters for the measures spawn from the JOBS Act. His company connects startups that need funding with investors. He told VentureBeat that for the past 80 years, startups and small businesses in the U.S. had been prohibited by law to solicit the public for investment capital.

 · Risk Tolerance vs. Investment Goals

By their very nature, debt instruments offer less risk than equity investments because there isn’t as much volatility as there is with stocks. This means that the typical debt obligation is more stable than a stock. Debt obligations usually consist of stable issuers, such as mortgage companies, and those investments are secured by real estate collateral. Research shows that the bond and mortgage market have historically experienced fewer price changes than stocks.


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As with most investment decisions, investors must determine how much risk they are willing to tolerate before deciding between equity and debt crowdfunding for real estate projects. If the thought of the project facing major hurdles, such as clearances to be built, make you anxious, this kind of investing may not be right for you.

Zacks goes a step further and points out that just as important in deciding between debt instruments and equity investments are your investment goals:

Your investing targets may favor equity investments if you’re seeking striking growth or profit potential. Conversely, you might focus on debt instruments when you prefer consistent income and less risk. Tailor your investment actions to match your objectives and risk tolerance.

Equity investments typically carry high risks, thus the potential return on investing in them is high. On that same note, borrowing, or investing in debt instruments typically carry low risks, and the return on that investment is low. The type of offering (debt or equity) dictates the position you would hold as an investor.

 · Real estate opportunities created

The onus is on the real estate developer, or sponsor, to determine how to fund a project. When it comes to crowdfunding, the decision boils down to selling securities in the project through a debt or equity offering, notes EarlyShares, an online real estate crowdfunding portal.

Depending on their needs and the specifics of a given project, a real estate developer or sponsor may “crowdfund” a portion of the capital stack by selling securities in the project to investors through a debt or equity offering.

 · Use of Crowdfunding Portals

Also thanks to the JOBS Act of 2012, investors are able to browse online real estate crowdfunding portals to find investment opportunities This is the first time investors can take advantage of this kind of service, which includes being able to compare properties, and make “return driven investments, notes EarlyShares, which hosts one of the many online portals. According to its website, interested parties can make investments for as little as $5,000, without relying on their networks for referrals or paying high fees to intermediaries.


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PeerRealty is another example of an online portal that is making it easier for individuals to get into real estate crowdfunding. By using its real estate crowdfunding portals (or others that are similar), the company says accredited investors can buy shares in, or lend money to, private real estate projects and properties via real estate crowdfunding portals like PeerRealty. Debt crowdfunding will appeal to investors desiring fixed returns and reduced risk. Those who prefer equity crowdfunding seek the possibility of higher returns, albeit with greater risk. With a minimum investment of $5,000 for some deals on the PeerRealty platform, crowdfunding investors don’t have to be real estate moguls to invest like them.

 · With all that being said…

Traditional investors who had been unable to invest in real estate because they lacked the investor savvy or wealth, found themselves locked out of what is a lucrative market. Now they can play the real estate market like Donald Trump, and other moguls.

 
 





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