In the past, buying real estate was relatively straightforward – people who wanted to buy a new home went to the bank and arranged for a mortgage based on the cost of the home, their income, and other relevant factors. In these days of high real estate prices and tightened regulations, however, crowdfunding is becoming an alternative source of money for people who fail to qualify for traditional loans. Although the option has many potential benefits, the potential pitfalls mean that both lenders and borrowers need to be very careful.
In recent years, crowdfunding has become a popular way of financing various projects by drawing on a network of friends, relatives, or complete strangers to raise “small amounts of capital from a large number of individuals” for particular purposes. The practice is already popular in other parts of the world, where property crowdfunding already reached over $1.01 billion in 2014, and first officially reached Canada with the crowdfunding of a shopping mall in Mississauga through NexusCrowd Inc. If that project is successful, it will likely be just the beginning for real estate crowdfunding in Canada.
Although this particular model of funding is new to Canada, finding alternatives to traditional bank loans is nothing new. According to an article in the Alternative Free Press, one such alternative is a form of private lending in which homeowners borrow money from their own equity to lend to prospective buyers, especially to those people who would be ineligible for traditional loans.
Many prospective homeowners who lack the savings and economic prospects to follow the standard route of obtaining a bank loan might be tempted to try something like the crowdfunding option. Yet that route has its dangers, as real estate expert and former lawyer Norma Walton explains.
Norma Jean Walton notes that crowdfunding has already been a reality for some time, as prospective home buyers with insufficient means for a down payment have relied on family and friends to raise the money. This, however, “has its own challenges and considerations,” such as the temptation to buy a more expensive house than one can afford.
As the cofounder and CEO of both Rocket Properties Ltd. and Penny Lane Properties in Toronto, as well as an asset manager of Blue Parrot Properties, Toronto’s Norma Walton has extensive experience in real estate. She is also a former lawyer who knows that “understanding the larger trends in a real estate market as complex as Toronto’s is a difficult task and takes plenty of experience and help,” as she states in her blog.
One of the problems is the high cost of property, especially in urban centres like Toronto. Housing costs reaching as high as a million dollars for a detached home has led many people to move to smaller cities, like London, where beautiful houses sell for as little as $300,000. Another challenge associated with today’s real estate market when it comes to crowdfunding is that investors do not own the property and therefore have little or no control over their investment. That’s because the owners and occupants of the building normally make the decisions about upkeep, renovations, and eventual sale.
So far, real estate crowdfunding in Toronto and in surrounding areas is mainly limited to accredited investors with experience in working with this form of investment. Six provinces already have rules in place to deal with these types of investments, and the Ontario Securities Commission is planning to release its own set of rules later in the year.
Ideally, crowdfunding regulations would help to protect investors, considering that they do not own their investment and they do not receive the same tax considerations and high returns as Real Estate Investment Trusts (REITs). With proper oversight, crowdfunding could help homeowners and investors to make the best possible use of their resources to give people new and exciting financial options in the Toronto area and beyond.
If current real estate trends continue, crowdfunding is likely to become an option for people trying to enter the real estate market, but people should be aware of the risks before they participate in this practice.