A Beginners Guide to Crowdfunding In Real Estate
If you’ve ever donated money through a GoFundMe or Kickstarter campaign, you’ve participated in a phenomenon known as crowdfunding. Crowdfunding, which has been around for several years now, uses online technology to raise large amounts of money from thousands of individual donors who contribute small amounts.
While crowdfunding has commonly been used to raise money for charitable or creative ventures, it’s becoming more and more popular in the world of real estate investing. In this real estate crowdfunding guide, I’ll explain what it is, how it works, and how you can get involved.
What Is Real Estate Crowdfunding?
Each year, housing prices in Canada continue to rise. While the bubble will inevitably burst at some point – the cost of purchasing a primary residence or an investment property continues to outpace wage increases, putting real estate out of reach for thousands of Canadians.
Real estate crowdfunding is all about accessibility – giving Canadians of all income levels access to the Canadian real estate market by splitting property ownership amongst hundreds, even thousands of individual investors.
How Does Real Estate Crowdfunding Work?
While the business model can vary, here’s how real estate crowdfunding works:
A primary investor purchases an investment property. It could be a single dwelling, an apartment complex, a commercial building, even raw land. They then break the investment amount into thousands of units. For example, a $500,000 investment might be broken down into 500,000 units @ $1 each.
Using an online platform, they sell the units to hundreds, or thousands, of Canadian investors. This way, you can participate in the Canadian real estate market without purchasing or managing the property yourself.
Advantages to Real Estate Crowdfunding
Like anything, there are benefits and drawbacks to crowdfunded real estate. Let’s start with the positives.
Small Minimum Investment: Perhaps the biggest draw to crowdfunded real estate is the low barrier to entry. You can own a share of a physical Canadian address for as little as $1. You don’t need to worry about coming up with a down payment, obtaining mortgage financing, or dealing with the hassles of owning your own investment property.
Passive Income: The income that’s derived from crowdfunded real estate is purely passive. In other words, there’s very little work involved. Once you’ve purchased your share, you just sit back and collect the income, if and when it arrives (more on that later.)
Portfolio Diversification: You know the saying, “don’t put all of your eggs in one basket.” Perhaps nowhere is that more true than with investing. The stock market will rise and fall, so you want to spread your investment portfolio among various asset classes, to lower your risk. One of those asset classes is real estate.
If you’re primarily invested in stocks and bonds, including ETFs or mutual funds, crowdfunding a real estate investment can be a simple and affordable way to diversify.
Drawbacks of Real Estate Crowdfunding
Real estate crowdfunding isn’t without its share of drawbacks. Here are some things your should consider before you buy into a real estate property.
You could lose your entire investment: While spreading the units of a real estate investment across hundreds of unitholders lowers the risk for each individual investor, crowdfunded real estate properties could drop in value, and you could lose all of the money you invest. That’s why you should never invest money that you can’t afford to lose.
It’s not a short-term investment: Unless you’re flipping houses, real estate should never be considered a short-term investment. The same goes with crowdfunded real estate. Expect to lock-in your investment for a minimum of three to five years. You might not receive any income from your principal contribution during this period.
Crowdfunded real estate is illiquid: Even with crowdfunding, real estate doesn’t have the same liquidity of cash or stocks. You can’t login to your online investment account, hit the SELL button, and get access to your funds within the same day. As I mentioned previously, potential investors should consider any real estate purchase to be a medium to long term investment.
Investment income is taxable: Unlike investments that you hold in a TFSA or RRSP, you are required to report crowdfunded investments as income, so you will pay taxes on the money you earn.
Who Is Real Estate Crowdfunding Best Suited For?
Crowdfunding with real estate could be a suitable option if you’re looking to diversify an existing stock market portfolio, prefer a low minimum investment amount, and are willing to lock-in your money for a few years. Even if you have larger amounts to invest, if you don’t like the idea of managing your own real estate building or development projects, or being a landlord, crowdfunding may be worth considering.
However, before you invest, make sure you understand the risks and the limitations and exercise due diligence. Returns on real estate properties are not guaranteed, and no matter how strong the market appears to be, things can change quickly.
Real Estate Crowdfunding in Canada
At the moment, the most prominent player in Canada might be addy Invest. The real estate crowdfunder has been around since 2018, and is available to residents of British Columbia, Alberta, and Ontario. Co-founders and business partners Michael Stephenson, Stephen Jagger, and Jeff Booth started the company after having to leave some friends out of a real estate investment because of a minimum $50,000 buy-in.
You don’t have to be an accredited investor to get started with addy. As long as you’re willing to pay a $25 annual fee (a 5-year, $500 membership gets you some added perks), you can buy $1 units in as many addy properties as you’d like, up to a maximum of $1500 per property. Find out more in our addy Invest Review.
Alternatives to Real Estate Crowdfunding
If you want to invest in residential or commercial real estate, but you’re not sure that crowdfunding is the right solution, you may want to explore REIT investing. REIT stands for Real Estate Investment Trust, and they offer some of the same benefits of crowdfunding, although the two models are very different.
A REIT is a pooled investment, kind of like a mutual fund, but it trades like a stock on the exchange. You can buy REIT shares in the same online brokerage account where you hold your stocks and ETFs. You can also invest it inside a registered product, like a TFSA or an RRSP. You can’t do that with a crowdfunded investment. For more information, check out our list of the top Canadian REITs.
Final Thoughts on Crowdfunding with Real Estate
Opportunities in real estate crowdfunding are likely to grow in the coming years. The good news is that you now have a foundational knowledge of how it works. Do I recommend it as an option for your investment portfolio? It depends.
If you’ve done the proper due diligence, can handle the drawbacks (risk, illiquidity, etc.), and the crowdfunding benefits align with your investment strategy, then you may want to consider experimenting with a very small percentage of your overall portfolio. I wouldn’t recommend anything higher than 3%-5% in total. Also, don’t forget about REITs as an alternative to crowdfunded Canadian real estate.