Debt vs. Equity Real Estate Crowdfunding

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Contributor, Benzinga
November 4, 2022

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The concept of real estate crowdfunding took a huge leap forward when the federal government allowed non-accredited investors to put money into crowdfunded real estate investments. Suddenly, investors who had previously been locked out of investing in real estate like the “big bosses” were not only in the game, they could choose between debt and equity crowdfunding.

While equity crowdfunding and debt crowdfunding are both great ways to invest in real estate, you’ll need to account for the significant differences between them. Understanding those differences will go a long way toward helping you decide which type of crowdfunded real estate investment is right for you. 

What Is Crowdfunding?

Real estate crowdfunding is exactly what it sounds like: an open opportunity for a group of people to invest in a particular real estate deal or offering. Aside from the fact that you don’t have to be an accredited investor to avail yourself of crowdfunding opportunities, the concept of real estate crowdfunding differs from buying stocks and bonds in many ways. 

For instance, you don’t need a broker to buy into a real estate crowdfunding opportunity. Not only are most crowdfunding platforms set up to be user friendly, they offer investors a chance to choose exactly where their money goes. Many real estate crowdfunding platforms offer a menu of sorts with a wide range of different investments to choose from.  

These wide-ranging options don’t mean crowdfunding platforms are a free-for-all, either. Every real estate crowdfunding platform has specific rules about how long you will have to wait to realize a profit, the minimum investment amount and other factors. These rules vary based on the individual investment opportunity and what kind of capital it requires to get up and running.  

Another huge difference between real estate crowdfunding and stocks and bonds is the proximity investors can have to the fund managers. Most real estate investment trust (REIT) offerings are pre-selected by a fund manager that you will have no contact with regardless of how much money you put in. By contrast, it’s not uncommon for investors who participate in real estate crowdfunding platforms to develop their own relationship with the fund’s manager or owners.

What Is Debt Crowdfunding?

Debt crowdfunding is when multiple investors pool their funds to purchase debts (mortgages) or bonds secured by a property (or multiple properties). This feature makes lenders out of debt crowdfunding investors. What they get in return is an investment that is secured by property (or properties), which minimizes investor risk. After all, even if the borrower defaults, the debt crowdfunding platform can still recoup their losses when the delinquent property is sold after foreclosure

Aside from having their debt secured by real estate, you can take advantage of other benefits to debt crowdfunding. Chief among them is that as a lender, you get paid first. Borrowers and building owners will pay off their mortgage before any other expense. That means you get your money faster.

Secondly, debt crowdfunding offers a regular payment schedule. Unlike equity crowdfunding, debt crowdfunding investments typically mature or pay dividends within 12 to 24 months of the original investment. In fact, many debt crowdfunding investors yield investor dividends on a semi-annual or quarterly basis. This feature makes debt crowdfunding a great investment for people who don’t want to tie up their money for too long.

Be sure to consider other factors that could affect profit for debt crowdfunding. The fees associated with debt crowdfunding deals can be significant. Also, there is always a risk of loss in holding debt, even if it’s secured. A rash of defaults during a significant economic downturn or even having a number of mortgages paid off early by borrowers could result in losses for the investor.

What Is Equity Crowdfunding?

In equity crowdfunding, investors buy an equity share in a property (or several properties), as opposed to the debt secured by those properties. This action makes anyone who buys into an equity fund part owner of the property or development they’ve invested in. Equity crowdfunding has more risk because nothing secures the investor’s money, but you can tap into some tangible benefits of equity crowdfunding investments. 

First of all, the higher potential risk means higher potential payouts. In fact, this deal features no caps whatsoever on the payout potential of an equity crowdfunding investment. If the market gets hot in an area where an equity crowdfund is holding several properties, the investor return could easily earn dividends between 15 and 20%. It could even be higher. This profit potential is in contrast to a debt crowdfunding deal, where the payout will be limited to profits made off loan interest. 

In addition to the increased profit potential, equity crowdfunded deals have a lower fee structure and offer several tax breaks to the investors. Many equity crowdfunded investment dividends are classified as “pass-through” income, which is eligible for a 20% tax write-off (at least until 2025). Investors who buy into equity crowdfunding are also able to claim a proportional share of any losses written off by the fund to depreciation as a write-off on their own taxes. 

Some investors may also prefer the idea of investing in a physical property, as opposed to holding notes. However, it’s important to consider that equity crowdfunding deals are typically long-term investments. Unlike debt crowdfunding, where investments may mature in as little as six months, equity crowdfunding deals can take years to pay dividends. So, any investor in an equity deal must be prepared to see their investment go illiquid for an extended period of time. 

Which Investment Is Best?

The answer to the question of what is better between debt crowdfunding and equity crowdfunding is a different one for every investor. If you’ve got some extra capital and you’re looking for something relatively short-term with a lower risk profile, a debt crowdfunding investment might be perfect for you. On the other hand, if you’re looking for a long-term investment with some tax breaks and a large potential return, equity crowdfunding could be your cup of tea. 

It also depends on your personality as an investor. It’s not at all uncommon to develop personal relationships with fund managers and property owners of equity crowdfunding deals. Then there is the elevated level of control that comes from being able to pick your properties in an equity deal. You will very likely never meet the manager of a debt crowdfunding deal, and you may not be able to pick the loans you buy. But that ease of operation could well be perfect for you.

The beauty of this is that there are enough equity and debt crowdfunding platforms out there for you to tailor your own strategy. You’re free to put a little bit of money into one and a little bit of money into the other until you figure out what you’re most comfortable with. If your needs change at some point in the future, you may well switch preferences from one investment to the other. 

Benzinga’s Best Real Estate Crowdfunding Platforms

If you like what you’ve read about real estate crowdfunding and it sounds like something you’d like to get into, you can find a list of Benzinga’s best real estate crowdfunding platforms here.

The Brave New World of Real Estate Crowdfunding

Real estate crowdfunding platforms have created a brave new world in real estate investing. It used to be almost impossible for non-accredited investors to participate in equity or debt deals of any kind. Now, they can literally choose between which types of deals they’d like to do. No matter what your individual preference is, you should consider the risk and invest according to your individual needs. And remember that no matter what investment path you choose, Benzinga has a wealth of information to help guide you along the way. 

FAQ’S

Q

Is crowdfunding for debt or equity investments?

A

Crowdfunding opportunities are available for both debt and equity investments. Numerous investment platforms of both types exist, allowing investors a chance to pick between the 2 or invest in both debt and equity at the same time. Traditional non-traded REITs are usually equity investments and only available to accredited investors.

Q

Is real estate investing a good investment?

A

Some of the world’s richest people earned their money with real estate investing. It can be a good investment if you do your due diligence before investing.

Q

Is real estate investing passive income?

A

Real estate investing can be considered passive income if you invest in RETs where other people deal with tenants and the various issues that come up in rentals.

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