Like many investors interested in learning about ways to invest in real estate crowdfunding deals, you are probably wondering what kind of potential returns you can earn by investing in these offerings. The answer to this question depends in large part on what kind of investment the offering is: equity or debt.
When you invest in an equity offering, you become a part owner of the underlying property. To get an idea of the returns you might potentially earn from an equity offering, look at the projected internal rate of return (IRR) for the offering you are interested in. IRR is a measure of returns that takes into account both the cash flow that the property may generate, as well as the proceeds from the sale of the property. In other words, IRR is what the sponsors project the return will be, based on the cash flow generated by the property during the hold period and the income from the sale of the property at the end of the hold period.
How much money you make from an equity offering also depends on how well the offering performs relative to the expectations of the sponsor. Were costs kept under control? Were the sponsors able to rent the property out for what they expected? Were they able to sell it for what they expected? Equity offerings are considered riskier than debt offerings, which is one of the reasons why potential returns for equity offerings are often higher than interest rates for debt offerings.
When you invest in a debt offering, you are essentially lending money to the sponsor who will use it to purchase or renovate the underlying property. Debt offerings are far more common in the real estate crowdfunding space than equity offerings. Debt offerings are usually for single family residential properties; the sponsors often plan to utilize fix-and-flip strategy.
Debt offerings carry stated interest rates, so you will know up-front how much you can potentially earn. Unfortunately, it’s not impossible for the sponsor to default. Although, as a debt holder, you will have liquidation priority over many other claimants, including equity holders, that is no guarantee that there will ultimately be enough cash left to cover your investment.
As you continue to learn how to make money in commercial real estate, keep in mind that, whether you choose to invest in an equity or debt offering, it is critical that you conduct thorough due diligence regarding the underlying property and the sponsors.