For investors interested in real estate but lacking the experience or capital to acquire property themselves, syndication and crowdfunding are two options to gain exposure. Real estate syndication, or pooling funds with other investors to purchase property, has been used for decades. Crowdfunding, enabled by technology and recent legislation, allows individuals to fund assets or projects through small contributions from many parties. While both options provide a path to investing in real estate, there are differences in how they operate and risks to consider with each approach.
Understanding Real Estate Syndication
A real estate syndication is when multiple investors pool their funds and invest as a group in a single property. Typically, an experienced real estate firm, called the sponsor or syndicator, will source property and open up shares of ownership to private investors. The syndicator handles all management and operations of the asset. Investors act as limited partners in the partnership and earn returns from rental income distributions and profits once the property is sold.
The syndication structure allows individuals to invest in larger commercial properties that would otherwise be inaccessible. The main benefits of real estate syndication include:
- Professional management: Investors benefit from the syndicator’s knowledge and experience in acquiring and managing the property.
- Risk mitigation: Syndication spreads risk across multiple investors since one individual is not responsible for the entire investment. Proper due diligence by the syndicator also minimizes risks.
- Tax advantages: Investors may benefit from tax deductions related to the investment like depreciation and mortgage interest. The syndicator handles and provides the necessary tax reporting.
- Potential for returns: Strong cash flow and property appreciation could generate attractive returns, although returns are not guaranteed. Returns are often higher than average stock market returns.
Exploring Real Estate Crowdfunding
Real estate crowdfunding, enabled by recent technology and legislation, allows individuals to invest in private real estate deals through online platforms. Sponsors list investment opportunities on the platforms with required funding terms. Investors can then review the listings and invest small amounts, often as little as $1,000 or $5,000, to collectively fund the deal. Most platforms require accredited investor status to participate, but a few accept non-accredited investors as well.
Some benefits of real estate crowdfunding include:
- Low investment minimums: The ability to invest a small amount of capital allows nearly anyone to gain exposure to private real estate deals that were once only available to high-net-worth individuals.
- Online access: All investment activity, from signing up to funding projects, is done through digital crowdfunding platforms. This makes the process very convenient and accessible.
- Diversity: Platforms offer opportunities across different real estate sectors, geographies, and risk levels. Investors can deploy capital across multiple deals to diversify.
However, there are significant risks to consider with real estate crowdfunding:
- Limited due diligence: With simplified online investments, the depth of due diligence on properties and sponsors may be less than in traditional syndications. This could expose investors to higher risk.
- No control: Investors must rely fully on the sponsor to acquire, renovate, lease, and manage the property as the crowdfunding model does not provide any ownership control or input.
- Untested model: Real estate crowdfunding has only been enabled at a large scale recently. The long-term viability and functioning of some platforms and structures are still untested. Regulations are still developing as well.
- Fees: Platforms and sponsors charge substantial fees, especially compared to traditional syndications. Higher fees reduce overall investor returns.
- Non-accredited risks: For non-accredited investors especially, lack of transparency into investments and the potential risks involved is problematic. Default rates among some platforms are a concern.
Which Option Is Better?
Both real estate syndication and crowdfunding have advantages and disadvantages for investors to weigh based on their own needs and risk tolerance. In general, syndication may be preferable for larger investment amounts, control over selecting specific deals, and establishing relationships. Crowdfunding can be a simple way to invest smaller amounts across multiple real estate assets. But lower liquidity, higher risk, and higher fees are significant drawbacks to crowdfunding relative to traditional syndication. For any real estate investment, ensure you understand all terms and risks involved before deploying your capital. Discussing options with a financial advisor is also advisable.