Property Crowdfunding – Risks And Rewards
Crowdfunding is a low cost way for aspiring landlords to get on the buy-to-let ladder. Steve Sims highlights the risks and rewards.
Aspiring landlords who don't have the resources to put a foot on the property ladder are looking at crowdfunding to grab a slice of the buy-to-let bonanza.
Crowdfunding is a way to buy a share in a private rented home by joining forces with other investors, but what are the risks?
The typical investment scenario is a crowdfunding investment manager sets up a company and buys a property to rent out. Shares are sold in the company, with investments ranging from just £50 to several thousand pounds. The investment manager runs the property, carrying out any refurbishment, finding tenants, collecting the rent and handling any repairs or other issues.
Meanwhile, the investor sits back, collects their share of the rent as dividends and when the property is sold, collects a share of any capital gain in the value of the home.
In theory, property crowdfunding sounds simple and companies pitching deals are springing up every month. In practice, the financial rewards are not so great.
Paying the middleman
As with any investment, where a middleman sits between you and the money, some of the cash is taken as management charges which immediately dilute the return on investment.
Investors also have little say on how the property is managed, so the manager can commission repairs that come out of the rent regardless of the cost. The risk here is the manager has a financial stake in the company carrying out the repairs or accepts an inflated quote that includes an undisclosed commission.
Crowdfunding companies have different approaches to voids – the times a property is without a tenant. For most, no rent coming in means less rental profit, so smaller dividends for investors. In some cases, if the manager hasn't built up a war chest from the original investment or money held back from rents to cover financing the property during voids, the investor could have to inject more cash to pay the day-to-day bills.
Taking your money out of a crowdfunded project is also risky. In many cases, you have to find another investor to take your place or wait for others to buy your shares. Often, the price offered for shares isn't the same as the selling price the home might achieve.
As the shares are in unlisted companies, they are often doubly hard to sell.
Tax on profits
Crowdfunded deals are also subject to tax.
Investors pay income tax on any rental profits. This isn't so much of a problem for a basic rate taxpayer (20%) as any dividends paid by the company will not attract further tax, but higher rate taxpayers will pay income tax at 32.5% on their dividends.
The company will also pay corporation tax on any gain in the property value when sold.
City regulator’s concerns
Another risk is what happens to investor cash if a property crowdfunding company goes bust?
Investment-based crowdfunding is monitored by City watchdog the Financial Conduct Authority (FCA).
The FCA says the deals should only be pitched to sophisticated or wealthy investors and that investors shouldn't expose more than 10% of their net worth to crowdfunding investments.
As property crowdfunding is a new investment phenomenon, the FCA hasn't had time to see how things work out in the long term, so no one yet knows just how profitable or risky these investments might turn out.