Pooling of resources, passing the hat — call it what you will, but collaborative underwriting has probably been around for a couple of centuries. Never one to leave well enough alone, the internet has again risen to the role of game-changer, extending a global reach to individuals and companies looking for backers.
You have probably heard of the crowdfunder Kickstarter, which is a popular donation-based site, aimed primarily at creative projects. Backers who donate to such projects don’t become shareholders or expect any financial return. They may be more akin to patrons than to investors.
But investment-based crowdfunding sites have also emerged. I can’t say that I knew much about them, but I recently attended the annual Yale Alumni Real Estate Association’s National Conference where one of the sessions was devoted to this subject, with presentations by two of the top players in this field: Daniel Miller of Fundrise and Rodrigo Nino of Prodigy Network.
Although this method of funding real estate projects may be just a blip on the radar at present, it does appear that more and more real estate crowdfunding sites like these are cropping up and deals actually are getting funded. So just what is this all about and how is it supposed to work? I’ve tried to take what I learned at the Yale conference and have expanded on it a bit; and so, the following are a few observations from an interested outsider.
For the Project Developer Seeking Financing
Among the top arguments for crowdfunding a real estate project are these:
- It offers an opportunity to get a project financed more quickly and easily than it would through more conventional channels.
- By eliminating some of the middlemen usually involved, it can lower transaction costs.
The arguments seem credible, since most bank and institutional financing has become a test of endurance. Some crowdfunding sites offer both debt and equity investments, and most are quite specific as to the types of properties with which they deal. The process may not be entirely a walk in the park, because the typical site screens developers by taking them through a rigorous application and evaluation process.
For the Investor
One attraction for investors is that they typically don’t have to pony up a huge commitment to participate in a single project. Hence, they could spread smaller chunks of cash among several properties or even several developers, thus spreading their risk.
There would appear to be a few murky areas, however. Successful commercial real estate investors generally apply a laser focus on their due diligence. In a crowdfunded scenario one should expect that the developer will be doing that, carefully vetting the property and supplying detailed financial information and projections to the potential investor; but how much detail will they provide and can the investor independently verify that information? With the proliferation of crowdfunding sites, will there be consistency among them in the amount and quality of data they provide? A prudent investor must be certain at least to take a very careful look at the track record of the developer.
Investing through crowdfunding may have particular appeal to inexperienced investors. They should be particularly cautious, understanding that there is not likely to be any liquidity, that their cash could be tied up for a considerable time, and of course that there is no guarantee of an acceptable return or of recovering the initial investment. Sometimes deals simply fail.
How is Crowdfunding Even Possible?
It should come as no surprise that there are plenty of regulations that govern these investment offerings. It appears that most of the crowdfunding sites have been operating under SEC Regulation D, which limits general solicitation and restricts participation to “accredited investors.” These generally include investors with a net worth of at least $1 million (not including the value of their home) and income of $200,000 for the past two years, or $300,000 together with spouse.
One site, which at present seems to be unique, is Fundrise. They have been able to use an obscure SEC Regulation A that allows non-accredited investors to participate in community-based deals with investments as little as $100. There is apparently plenty of hoop-jumping for them to deal with, since this regulation also involves state approvals as well as a limit on capital that can be raised in a 12-month period.
In 2012, Congress passed the JOBS Act (Jumpstart Our Business Startups) and in September 2013, Title II of that act became effective. Title II allows general solicitation, but only to accredited investors.
Title III of the JOBS Act is called the “Crowdfunding Exemption.” Expected to work its way through the SEC rule-making process sometime later this year, it would allow non-accredited investors to participate in equity offerings. The proponents of investment crowdfunding see this as the real game-changer.
Crowdfunding could revolutionize how real estate investments are financed, but not everyone is convinced that it is the Next Big Thing. A recent BusinessWire article cites a number of concerns, including one that this writer has seen elsewhere: “Will crowdfunding expose innocent, small-time investors to fraudsters and scam artists?”
Both real estate crowdfunding itself and the regulatory environment that will govern it are in their infancy, so how this will all play out must be a matter of conjecture for now. On the one hand, the real estate industry — to put it as politely as possible — has a long history of being resistant to change. On the other, technology in the 21st century has had a habit of sweeping away things that we confidently viewed as permanent cultural fixtures. To be convinced, I need only to rummage in my basement to dig out my old rotary-dial wall phone and my case of incandescent lightbulbs.
Time will tell the story.
—- Frank Gallinelli
Read more in the recent press about real estate crowdfunding:
Your time and your investment capital are too valuable to risk on a do-it-yourself investment spreadsheet. For more than 30 years, RealData has provided the best and most reliable real estate investment software to help you make intelligent investment decisions and to create presentations you can confidently show to lenders, clients, and equity partners. Learn more at www.realdata.com.
Copyright 2014, Frank Gallinelli and RealData® Inc. All Rights Reserved