Investing on a Crowdfunding Platform or Directly with the Operator?
Since the passing of the Jumpstart Our Business Startups (JOBS) Act in 2012, it has become legal to invest in private real estate deals and other projects on crowdfunding websites. These sites connect investors with operators that have deals that they are raising capital for. There are many of these sites available and some have been more successful than others.
The alternative to investing directly with an operator of course still exists and this article will explore the pros and cons of each model.
The crowdfunding model is used to connect investors on the Internet with operators. It simplifies the capital-raising process for the operator. They can get most, if not all, of their capital directly from the crowdfunding company. This frees the operator to focus on finding deals and operating the properties.
The crowdfunding platforms also simplify the process of looking for deals for the investor. After registering for the website, the investor can browse different types of deals from different operators. Some platforms offer apartment syndications, private lending, and even cannabis growing operations.
The deals have been vetted by the crowdfunding platform and most of the operators are very experienced. Of course, it does not relieve the investor from doing their own due diligence.
The challenge with this model is that the investor in most cases needs to be accredited. Review this article for a refresher on what an accredited investor is. There is also an extra layer of fees associated with crowdfunding. The platform has operating expenses that need to be covered by fees to the investor or operator. This can lead to lower returns than deals done directly with the operator.
There were also a lot of crowdfunding sites that were launched after 2012; some didn’t have great business plans and have since failed, losing money for investors.
Investing Directly with the Operator
The traditional approach to investing directly with the operator has existed for years. When investing in this manner, a relationship with the operator will first need to be established. It could be through a personal relationship, i.e. the friends and family model, or through connecting with the operator via advertising or social media. The friends and family model, also known as the 506b exemption allows for non-accredited investors to participate, but the operator can not advertise the investments.
Alternatively, the 506c model allows for advertising but only accredited investors can participate.
Regardless of the syndication model, investing directly with the operator has the advantage of creating a direct relationship with the people operating the deal. Unlike crowdfunding or investing in stocks, the investor actually has an opportunity to get to know the people in charge. This allows for a closer personal relationship and a feeling of knowing who is managing the investor’s hard-earned money. Of course, the responsibility of performing due diligence falls on the investor. There is no third-party vetting process, so investors need to be very thorough in their process of ensuring they are investing with a reputable syndicator. Please refer to my article on evaluating sponsors for more information. There is also the challenge of finding and connecting with the operators. It does require significant work on behalf of the investor to identify and vet various syndicators, which can be a time-consuming process.
Fees are typically lower in the direct-with-operator investment model. There is less overhead which means the returns may be higher than investing in the crowdfunding model.
If an investor is looking for one-stop shopping with less up-front work, but also a less personal relationship with the operator, the crowdfunding model may work well. Alternatively, spending time connecting with and evaluating syndicators may lead to better returns and a closer relationship. It may also be the only option available for non-accredited investors who want to invest in private apartment deals.