What nobody tells you before investing in crowdfunding

06 Jul '16

crowdfunding-ch

We share Mariano Capelino’s article about crowdfunding in Apertura.com

Read transcription below | See original note

What nobody tells you before investing in crowdfunding

Also, questions you must ask before opting for this type of initiatives.

It seems that real estate crowdfunding is becoming the trend nowadays. It is a very interesting and convenient financing tool for those who deal with it. On the other hand, it is an attractive investment for the small investor, but many times it is not so profitable or safe as it seems.

In general, these are the 4 aspects which attract the investor:

•    The offered property, which is generally important and Premium
•    The possibility of investing with low cost, in some cases, with as little as 1,000 dollars
•    Very attractive profitability projection
•    The reputation of the institutions involved in the operation: banks, administrators, auditors, developers, among others

Thus, the crowdfunding offers the investor an excellent real estate asset on a safely basis. This is the case many times, but you should also take into account that an excellent piece of property does not always guarantee a safe and profitable investment.

A very important matter to be considered is the opportunities that occasionally can be grasped in the fine print. It is important to understand whether the business operation will involve high indebtedness.

Some crowdfunding operations – not all of them- offer the possibility of obtaining, for instance, 80-90 percent of the capital through a bank for the purpose of acquiring or developing the property. The pending 10-20 percent is the amount to be financed by the individual investor. This is so because the bank is not willing to finance 100% of the amount. They want some margin – in this case, 10 – 20 percent- to absorb any possible downward price correction of the asset. That percentage is not financed either by large investors or the developer itself. Therefore, the small investor finances what the experts don´t.

The key question here is the following: who is taking the risk if the final business is adjusted 10-20 percent thus reducing the projected income? The answer is simple: the risk is run by the individual investor, because the first one to be paid is the bank. Thus, the small investor may lose part or all of his capital in this type of crowdfunding operations. This may happen simply because the projected sale value is lower in that market, because of non-competitive construction or land costs involved, because of an increase in indebtedness costs, due to estimation errors or other reasons.

There are other crowdfunding operations not involving leverage but offering an asset whose price is quite above its valuation, usually in recession markets and with downward price correction. In this case, the offer is aimed at achieving return at an asset value which will eventually be unreal, as this will never take place in the projected terms.

In short, proposals may look attractive and safe, as investing small amounts of money supported by big premium-quality real estate projects with excellent locations is tempting. But you must be very careful with the proposals offered, especially, those with profitability projected by the developer which widely exceeds the real possible profitability that can be obtained in the market. If this is the case, which is highly probable, a large part of the capital can be lost.

In plain text, an excellent “concept” has been developed to attract small investors, which otherwise would not be part of emblematic buildings in the largest cities of the world or premium real estate developments. But it is necessary to be very careful and see the conditions offered, because it is possible to lose money. In these cases, small investors are selected because those who invest higher amounts are aware of the fact that the risk-benefit equation of this type of operations may not be convenient.

Some questions that the potential investor should ask before investing through crowdfunding operations:

  1. What happens if the sale values are lower than the projected values?
  2. What happens if the investor wants to exit the operation earlier?
  3. What happens if the sales terms are not the ones agreed upon?
  4. What happens if the estimated capital is not gathered?
  5. How does the investor recover his capital?
  6. What happens if, in the end, the business income projections fall 10%, 20% or 30%?

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