The latest trend for people trying to raise money for ventures of all types is called crowdfunding or crowdsourcing — where people pool their money to support projects ranging from books, movies and other artistic endeavors to software development and Internet startups.
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And of course, it would only seem natural that some entrepreneurs would bring this type of capital raising effort to private real estate deals. In fact, thanks to changes in federal laws related to raising capital, the crowdfunding options for investing in real estate are open for business!
But is placing your hard-earned cash into a crowdfunding real estate deal a smart and safe way to invest your money? Will you earn money? While it is possible, the odds are highly against you.
First, real estate investing, and particularly development deals, is very high risk. Many things can go wrong with real estate, causing significant financial pain and losses to owners. And these crowdfunding deals are primarily for commercial investments, which are the riskiest.
Here’s the most important thing to remember: Good developers and investors with proven track records will propose quality development or acquisition projects and can get cheap financing from banks that compete vigorously for such deals. That’s going to give the investors the most profit — and maximizing profits is their goal.
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So what type of developer or investor would chase crowdfunded capital from the general public? These are typically inexperienced developers and investors, or ones with limited financing options due to pitching low-quality, high-risk deals. Some may have even lost prior investors’ money.
Proof is in the details
Even if the crowdfunded deal you are considering is via an experienced developer or investor, there’s still a chance that the deal will go sour. In some cases, the developer will take large fees out of your “investment,” or your money could be stuck in a deal for years, if not a decade or longer.
And of course, scammers could be thanking you for investing in their new wealthy lifestyle.
Therefore, if you are going to invest in any private real estate deal, you should require the “sponsor” who is pitching the deal to provide you with the following:
- An offering showing how much equity the sponsor has at risk in the deal.
- An analysis of how this deal will make money and how the project fits in to the area.
- Extensive documentation and proof of the sponsor’s past history doing deals, including bank and past investor references. It would be smart to review a copy of the sponsor’s credit report to verify past borrowing and repayment history, and even requesting tax returns would not be out of bounds.
The road of once-promising real estate deals is littered with the carcasses of half-built developments, emptied bank accounts and people hoping that one day they’ll get their money back.
Don’t gamble any funds on a private real estate deal you don’t control, unless you can afford to lose all you money.
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Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions. He is a past lecturer at San Diego State University and teaches continuing education to California real estate agents at The Career Compass.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.