9th August 2023
Property Crowdfunding is a way for property developers to raise the money they need to develop property projects. This money is usually raised from lots of individual investors.
In equity based property crowdfunding investment deals, the investor (you) is typically buying shares in the company that owns the “property”. The “property” can be a plot of land, a building or other property asset. In essence, the investor (you) becomes a part owner of the company (also known as a shareholder of the company).
Returns can be received in the form of dividends and/ or capital growth. Dividends can be paid throughout the project (based upon rental income for example) and capital growth is usually received at the end when the project is sold or re-financed. In this case your shares will be bought from you in exchange for money (if things have gone well, this is your initial capital and the extra return you would have made).
If the project does well and so the company becomes successful and increases its value, so will the investor’s share in that company – i.e. you would make money. If the project does badly and so the company does not perform as well as expected, the value of the share may go down. In this case you could lose some or all of your money.
With equity based property investments, other finance providers (e.g. lenders) are likely to be paid back before shareholders (you, the equity crowdfunding investors) receive their capital and projected returns. This is one of the reasons why equity crowdfunding is considered a higher risk investment than peer to peer lending and therefore usually offers a projected higher return.
Let’s look at an example.
A company wants to raise £1.1m in total to refurbish an old building into flats.(£500,000 to buy the building and £600,000 to refurbish it). They estimate that after finishing the refurbishment, they’ll be able to sell the property for £1,500,000. They raise £300,000 as a loan from lenders and £200,000 as equity from property crowdfunding investors. The company also puts their own money in the project (in our case £600,000).
If they deduct the costs involved (£500,000 to buy the property and £600,000 to pay for the work that needs to be done) from the estimated sale price of £1.5, they will have made a profit of £400,000. That’s a 36% profit on the project (profit/cost – £400,000/(£500,000+£600,000). This is the expected return on the project – 36%.
As an investor, you can take part in the project, by buying a share of the company that owns the project. The company wants to sell £200,000 worth of shares (because they want to raise £200,000), which you can buy, in some cases from as little as £100. At the end of the project, you will receive your share of the profit, as well as your initial investment back. In this example, we’re expecting a return of 36%. Which means that if you invested £1,000, you’d get back £1,360. If the project runs for two years, that’s 18% per annum return. If the project extends to three years, that’s 12% per annum return.
Sometimes, projects go according to plan and the company can deliver at the cost they anticipated and sell at the price anticipated. But sometimes, they don’t and the costs are higher and/ or the selling price is lower, which will impact your expected return. You should bear this in mind if you choose to invest in property crowdfunding. You may wish to include time and expected return buffers in your calculations. What do we mean by this? Well if for example you expected the project to finish in 12 months, you might plan for it to finish in 18 months instead. If the expected return is 36% per annum, you might plan to only get 20% per annum.