Real estate crowdfunding: what are the risks and how to manage them

Real estate crowdfunding is a form of investment and as such it offers opportunities for profit, but also risks. Those who know the risks are already halfway there because they are able to anticipate them or at least deal with them.

The objective of this article is to present the main risks associated with real estate crowdfunding in order to learn how to prevent them as well as manage them.

In fact, proper information and continuous insight enable any investor in the real estate sector to seize the best opportunities where to deploy his or her capital and from which to make the most of it in terms of returns.

Introduction to real estate crowdfunding

From crowdfunding that began as a way to raise funds among individuals to finance a wide variety of projects, in just a few years we have moved on to the structuring of an alternative capital-raising model involving businesses and investors interested in new forms of investment income.

Beginning in 2013, the National Commission for Companies and the Stock Exchange (Consob) decided to regulate crowdfunding, which has since taken on many facets, issuing a resolution that has been improved and updated several times in subsequent years. A real regulation that gave birth to a public Registry to which brokerage platforms must register in order to operate in Italy.

What is real estate crowdfunding

Real estate crowdfunding also has its risks, albeit calmed by the use of lower economic resources than the purchase of a property, as well as shared with other investors.

Real estate crowdfunding is thus a "specialization" within the model of financing from the masses( crowd meaning crowd, plus funding meaning financing), through which financial capital can now flow from investors interested in real estate who previously had, for various reasons, the road foreclosed.

Real estate crowdfunding is a type of investment that allows individuals and businesses to finance real estate projects with relatively small capital stakes, in order to obtain a potential financial return in the end.

Businesses in the sector, on the other hand, find through this channel of investment in real estate a new source of supply of capital needed to finance and implement real estate construction or redevelopment projects.

Upon completion, the property is put up for sale and the proceeds divided by the investors' shares, with interest added to form the profit for those who financed the work.

Advantages of real estate crowdfunding

The first advantage lies in the formula itself. Real estate crowdfunding is a form of direct investment in real estate. The investor comes face to face with the company that will redevelop the property. Of the latter, he knows in advance the geographic location, the time frame, and the estimated construction costs.

This is an entirely different approach than investing in a publicly traded real estate company whose shares are purchased, where it is difficult to come to know with the same degree of detail the projects in which investments have been made.

Another no small advantage, the investor interested in real estate does not have to deal with the direct buying and selling (and eventual renovation) of the property with all the associated costs and risks. Real estate crowdfunding makes it possible to distribute the costs among all participants and to defer to the proposing company the bureaucratic and tax aspects related to the management of the property.

Another advantage, the possibility of being able to invest one's capital in several projects and not all in one property as is the case when buying a real estate unit on one's own.

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Risks of real estate crowdfunding

Real estate crowdfunding also has its risks, albeit calmed by the use of lower economic resources than buying a property, as well as shared with other investors.

1. Risks of issuer default

Among the first risks to be assessed we find the following. The real estate company proposing the project, and holding responsibility over the execution of the work, could go bankrupt and be insolvent to its creditors, including investors.

Bankruptcy may have many original causes, including legal obstacles that occurred during the renovation or construction work, construction costs significantly higher than those anticipated at the design stage.

Sudden adverse economic conditions (endogenous and exogenous) can also lead to issuer default.

2. Liquidity risks

If during the construction phase, material costs were to rise, this would effectively create a stress condition to the available liquidity at the head of the construction company.

Not only that. Any liabilities accumulated during the entire life of the project could put the proposing company in difficulty, which could exacerbate the situation should there be a devaluation phase in the real estate market.

3. Real estate valuation risks

Incorrect valuation of the property could result in its overvaluation compared to the value actually assigned by potential buyers.

To avoid this condition and others, real estate valuation risk must be incorporated into the project from its planning and requires an analysis based on an economic-financial methodology, which cannot exclude uncertainty. Uncertainty due to the sudden upward change in interest rates on the cost of money, inflation, geographic market, and type of property (commercial, residential, industrial).

How to manage the risks of real estate crowdfunding

If those just listed are the risks associated with real estate crowdfunding, how can you reduce or avoid them as much as possible? Here are some broad guidelines that can help the investor in discerning between promising and truly successful projects.

1. Diversification of investments

A fundamental rule related to any investment suggests diversifying the money invested. In real estate crowdfunding, the strategy translates into placing one's finances not on one project, but in more than one real estate project.

If we have 10,000 euros to invest, for example, the sum could be divided into four portions and invested on as many real estate crowdfunding projects, rather than on just one project.

2. Issuer analysis

Before investing in any risky instrument, it is a good idea to gather information about who is issuing the financial product, or the proponent and/or issuing company.

Those who invest in the shares of a company listed on the Milan Stock Exchange, for example, inform themselves by reading the financial statements or gathering ratings and opinions from industry newspapers before buying the stock.

3. Study of the real estate market

Although real estate crowdfunding does not commit the investor to the direct purchase of a property, one should not disregard making market insights.

Assume that you want to invest in a real estate crowdfunding project related to a real estate unit located in a residential area of Florence. Before investing, it might be very useful to know the real estate market in that area and to understand whether there is a correspondence between the conclusions of the self-study and the estimates of success exhibited by the issuer.

Conclusions

Real estate crowdfunding has opened the door to investment in real estate to a wide range of people. Even those who do not have tens and tens of thousands can now invest in real estate, and they owe this to the crowdfunding model that allows multiple parties to join forces.

Tips for investing in real estate crowdfunding safely

In addition to a 360-degree check of the entire real estate project (insolvency risk of the proposing company, real potential of the geographic area, etc.), it is of paramount importance to approach the right brokerage platform.

In this respect, a good practice to put into practice is to check the history of real estate projects proposed by a real estate crowdfunding platform and verify the success and failure rates.

In fact, not all platforms are equal and equally capable of selecting the best real estate projects.

Advantages of investing in real estate crowdfunding with Mamacrowd

By investing with Mamacrowd, the investor operates on a Consob-regulated equity crowdfunding platform. Mamacrowd presents a selection process aimed at assessing the suitability of the proposer's project, and only those who pass the rigorous selection phase gain access to the publication of the capital raising proposal.

The platform makes in-depth evaluations aimed at multiple aspects, including: the life stage of the proposing company; the people who make up the company; entrepreneurial skills; and assessment of the project's real potential for success.

In terms of costs, however, the investor has no cost to bear. The invested capital will not be affected by fees.

Finally, on the revenue side on real estate crowdfunding investment, projects proposed by Mamacrowd have an average return of between 12 percent and 15 percent. This is a high percentage return compared to many other types of traditional real estate investments.

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