This might come as a shocker to you because I’m not risk-averse and I love diversifying my portfolio, but in my opinion, real estate crowdfunding companies are bad investments. If you read other investment or personal finance blogs you will find a trend among authors suggesting real estate crowdfunding websites such as Fundrise, RealtyShares or Realty Mogul. They have their reasons for suggesting these and I will explain why later.
The purpose of the Halfbare blog is to peel back the layers of personal finance and investing for you, exposing the nitty-gritty and uncomfortable truth. Hence, why I picked the name – it’s provocative, it gets the people going. In this particular case, I will expose why Fundrise and other real estate crowdfunding companies are bad investments.
Bad Investment Idea
First thing, if you haven’t maxed out your tax-advantaged accounts like your 401(k), TSP for servicemembers, or a Roth IRA, you shouldn’t be diversifying into taxable investments. If you have maxed out those accounts and are looking for a “short-term” investment, this isn’t for you. The fees alone make it worthless as I will explain later.
With investments in mind, I will expose a few topics about real estate crowdfunding:
- How you don’t own anything
- Cost & fees
- Liability
- Better investment alternatives
All pointing towards how real estate crowdfunding is a bad investment.
You don’t own anything
When I buy shares in the stock market, I am buying a share of the company’s assets and its profits. In fact, I am a part-owner of the company. I can attend stockholder meetings and even cast a vote. I am holding onto something tangible (even though its located on a brokerage account) that I can hold or sell at any time. That is not the case with real estate crowdfunding.
Real estate crowdfunding companies lure investors into buying private commercial and residential properties by pooling their assets through an investment platform. So, essentially, you’re loaning your money to a company to buy a property that they will own, that you won’t, and in return, provide you dividends. The underlying asset is the property, which the company owns, not you, by using your money along with many others to buy it. It seems kind of odd, right?
In perspective, you’re loaning the company money which you must pay a fee to do so, so they can buy and own a property asset – in return, they pay you in “dividends,” which is essentially them paying you interest for the loan, whereupon you pay another fee to them to withdraw your original loan amount PLUS the interest they paid you. Are you confused yet?
Just imagine buying a house you plan to rent out. You don’t have the money on-hand and decide to let two other people give it to you while charging them a 1% fee. That’s weird, but they happily pay it. Once you have collected the money to purchase the house, you buy the house, which is the underlying asset that you now own and find renters. The renters pay you $1,000 each month, whereupon, you give $100 each month, or 20% combined, to the two people who loaned you the money. You pocket the $800 (80%) each month. That’s what you’re doing with real estate crowdfunding “investments.”
Now, let’s discuss the costs and fees.
Cost & Fees
They do give you a return on your money (after they charge you 1% to borrow it). In the last six years, they have reported a 10.58% historical annualized return average. That’s not something to bat an eye at, and any savvy investor might pause at those numbers. However, when you did deeper, and particular into their fee structure, those gains quickly dissipate.
They charge an annual advisory and management fee of 1%. However, according to their website:
We could potentially charge other fees, such as development or liquidation fees, for our work on a specific project.
Which they do, according to platform users. Fundrise charges investors 1% to 2% for organizational and offering costs to bring eREITS and eFunds into existence. In addition, there’s a potential development fee of up to 5% of total development costs, excluding land. Also, when they sell a property, there may be a potential disposition fee of 1.5% of the gross proceeds, after repayment of property-level debt.
All in all, most platforms users report paying 3%-5% in annual fees. Ok, not bad – minus the 5% from the 10.58% average return and you’re still at 5.58%. This doesn’t include the taxes you will owe once you withdraw your realized gains. But wait, there are more fees!
Fundrise penalizes investors that withdraw their money before 5 years. Remember when I said real estate crowdfunding is not designed as a short term investment?
The “early” withdraw fees:
- None for the first 90 days
- 3% if shares are owned for less than 3 years
- 2% if shares are owned 3 – 4 years
- 1% if shares are owned 4 -5 years
- None for shares held for at least 5 years
Just continuing to chip away at that 10.58% return. What’s even funnier, is the fact they don’t include those fees on their pricing page (seen below).
Another hilarity is the pricing provided for “traditional investments” for index/mutual funds, ETFs. 0.12-1.2%, uh, which index are they looking at? Oh, wait they mention Vanguard and iShares…
Vanguard Fees: (the most popular ones)
- $VOO = 0.03%
- $VYM = 0.06%
- $VDC = 0.10%
- $VIG = 0.06%
Of the most popular Vanguard ETFs, I couldn’t find one in the range of 0.12 – 1.2%. Maybe, I’ll have better luck with iShares?
- $IVV = 0.04%
- $AGG = 0.05%
…….. and I am done looking. Most broker platforms are now offering free trades, and low expense ratios, or even zero expense ratios. Oh, also I forgot to add that if you establish an IRA with them, you pay an annual asset fee of $125 to Millennium Trust Company.
Now, let’s find out if they’re liable if something goes wrong.
Liability
Besides the two reasons I stated above, these platforms, in my opinion, are no more than peer to peer lending platforms. Instead of loaning money to others, I am loaning to a company so they can buy properties and give me something in return – “the easiest way to buy residential and commercial real estate” – and a little interest on the side.
Now as a savvy investor, I reviewed their terms of service. 100% of the platform users I discussed Fundrise with, never read the fine print. Well, it’s also hard to find as you can see below.
There were a few lines out of the thirteen pages that were shocking.
Fundrise reserves the right to modify or discontinue, temporarily or permanently, the Service (or any part thereof) with or without notice. You agree that Fundrise will not be liable to you or to any third party for any modification, suspension or discontinuance of the Service.
They can close up shop without any notification and guess what? They aren’t liable. Here’s another one:
Securities sold through private placements are restricted and not publicly traded, and are therefore illiquid. Neither the U.S. Securities and Exchange Commission nor any state securities commission or other regulatory authority has approved, passed upon or endorsed the merits of any offering on this Site.
They are not regulated, nor endorsed. Meaning they have no oversight. Are you feeling queasy yet?
One thing I learned quickly about investing was to have protection. Banks have FDIC which is:
The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the United States government that protects the funds depositors place in banks and savings associations. FDIC insurance is backed by the full faith and credit of the United States government. Since the FDIC was established in 1933, no depositor has lost a penny of FDIC-insured funds.
That provides me the reassurance that my money is protected. Even brokerage platforms such as Vanguard, M1 Finance, Charles Schwab, and Robinhood are SEC-registered, and members of the Financial Industry Regulatory Authority (FINRA). In addition, they’re members of the Securities Investor Protection Corporation (SIPC), which means stocks and options in your brokerage account are protected up to $500,000.
What do Fundrise and other real estate crowdfunding platforms offer? Nothing. No insurance and no reassurance. Even FINRA posted an alert to investors about the risks of real estate crowdfunding platforms.
Let’s review some better, in my opinion, investment options.
Investment alternatives
Again I will reiterate. Do not invest anywhere else unless you have maximized your tax-advantaged accounts. Now moving onward.
As I stated in the beginning, I am not risk-averse. One example – I invest in crypto – I believe crypto can and will hold future value. It’s very volatile and risky, but I am willing to accept my fate. With that said, I wouldn’t touch real estate crowdfunding because there are better alternatives.
Index Funds and ETFs
Do you remember how I said Fundrise boasts a 10.58% historical return? With the exorbitant fees, that’s reduced to 5-7%, and that’s on the high side. What if I told you that the S&P 500 has an average annualized return of 10% since its inception in 1927? It’s true – pretty outstanding returns. Alone in 2019, the S&P 500 Price index returned 30.43%. Include dividend reinvestment, the S&P 500 returned 33.07%.
Buying index ETFs are free on most brokerage platforms and have very low expense fees – ranging around 0.03%-0.05%. Index ETFs are designed specifically to replicate a benchmark index such as the Dow Jones Industrial Average, Nasdaq 100, or S&P 500. They’re the most popular and widely approved asset by experts because they provide instant diversification to any portfolio.
Dividend Stocks
Why not buy real estate investment trust stocks? A real estate investment trust (REIT) is a company that owns, operates or finances income-producing properties. Instead of loaning money to one, why not own shares of one? REITs provide some of the highest yields, with potential growth opportunities. Affording you the ability to reinvest dividends and stay liquid – selling the stock whenever you want.
Another option is buying the dividend aristocrats. The Dividend Aristocrats are S&P 500 index constituents that have increased their dividend payouts for 25 consecutive years or more. These companies have continued to grow each year which has allowed them to increase their dividends. If you’re looking for a steady stream of income, or the ability to continually reinvest your earnings, these are the ones.
Other tax-advantaged accounts
If you’re looking for additional tax-advantaged opportunities, there are few.
529 Plans are popular for families to afford college tuition, books, supplies, and boarding. An annuity is another option. You pay or invest your money in an annuity upfront, and in return receive guaranteed future payments. Need help affording healthcare? Health Savings Accounts, or HSAs, are tax-advantaged savings accounts used to pay healthcare expenses.
Whatever the case may be, there are plenty of better investment alternatives – and I only scratched the surface.
Affiliate Links
Remember when I mentioned that bloggers like to promote Fundrise and other real estate crowdfunding websites? Just like this blog and many others, affiliate links are used to generate revenue. That glamorous handbag review you read about on a lifestyle blog, providing you a convenient link to Amazon – yes, they made a few $$ selling you that bag through their review, aka promotion, aka sales pitch.
Blogging isn’t free – I pay annual domain, SSL, and ad fees. But unlike some authors or website admins, I only provide affiliate links to products, services, or websites I believe are helpful or use myself. Real estate crowdfunding websites are not one I would exploit to uneducated investors. They pitch that real estate crowdfunding is the fastest and easiest way to invest in commercial and residential properties – even ranking them as 5-star investments. As discussed earlier, the fees are exorbitant, you don’t own anything, and your investment is illiquid – if you do withdraw your funds, you’re charged a fee.
These bloggers will provide you a link to Fundrise or Realty Mogul in hopes you will sign-up, where they receive a flat fee (let’s say $50) or a percentage of whatever you invest (like 3%). Don’t fall for the trap.
Final Thoughts
Not much to add except stay away from crowdfunding investing platforms, they are bad investments. Read the fine print and be skeptical of 5-star reviews from various bloggers. If you already invested money into a platform like Fundrise, no worries, lesson learned. Happy investing!