Real Estate And Crowdfunding: A New Path For Investors
Can two disparate investment markets – one old and one new – get along without driving each other crazy?
That’s the key question for crowdfunding and the real estate market. It’s a question being answered in positive ways in 2014, as the two “odd couples” appear to be pairing up quite nicely and giving investors a new way to leverage profits from the burgeoning U.S. real estate market.
The real estate crowdfunding site iFunding estimates the size of the combined market at $11 trillion.
At the “Innovations in Real Estate: Crowdfund Investing” conference in April 2014 in New York City, Markley Roderick, a lawyer with Flaster/Greenberg PC and the conference moderator, pointed out that new regulations are linked to the Jumpstart Our Business Startups (JOBS) Act of 2012. The new rules allow mostly affluent investors (with a net worth of $1 million or more) to gain direct access to the real estate market through crowdfunding, or peer-to-peer lending (among other investment markets).
While the U.S. Securities and Exchange Commission explores ways to allow investors of all income levels to access the real estate market online, Roderick says that wealthier investors are already investing on crowdfunding sites like iFunding, Realty Mogul, CrowdStreet and Fundrise.
“If only a small percentage of them invest only a small amount of their assets in real estate, the market will be trillions of dollars,” explains Roderick.
By definition, crowdfunding should be a natural for the real estate market. In a word, crowdfunding makes use of the easy accessibility of vast networks of friends, family and colleagues through social media websites like Facebook, Twitter and LinkedIn to get the word out about a new business and attract investors. Crowdfunding has the potential to increase entrepreneurship by expanding the pool of investors from whom funds can be raised beyond the traditional circle of owners, relatives and venture capitalists.
Real estate industry groups are already climbing aboard the crowdfunding bandwagon and are touting the relatively low-risk access to the U.S. real estate market to, for now, wealthier Americans.
“Crowdfunding for real estate is not an entirely new phenomenon,” said the Commercial Real Estate Development Association in a recent statement. “Numerous players have entered the field. Although each of these platforms has its own niche and strategy, with different levels of minimum investment, all are geared toward accredited investors who meet specific requirements for net worth and/or annual income. By contrast, crowdfunding under the JOBS Act will open the field to many more smaller investors.”
What are the pros and cons of crowdfunding for investors? In a word, both sides come down to risk; specifically, how much investors want to absorb online.
According to the report, both real estate developers and investors can reap significant financial returns through crowdfunding, and both are able to spread their risks.
Pros . . .
- Investors get access to the real estate market with small amounts of money.
- Investors get to work directly with real estate developers and have a voice in the process.
- Investors can choose which real estate projects in which they want to invest their money.
- Investors have access to myriad projects, so choice and options aren’t a problem.
Cons . . .
- Investors have the same issues as every real estate investor. If the market goes south, they will likely lose money.
- The risk of investment default (from real estate developers) is higher for crowdfunding compared to peer-to-peer and direct real estate investment funding.
- A lack of liquidity, as the absence of a secondary market restricts easy selling access for investors.
To get started with crowdfunding in real estate, Jillienne Helman, chief executive officer at Realty Mogul, advises going with a firm that’s going to be around for a while.
“First, work with a crowdfunding company that will survive,” she says. “That means well-capitalized. What scares me is the number of crowdfunding companies out there that are headed up by two students who just graduated from college, and who aren’t capitalized themselves.”
Darren Powderly, co-founder of CrowdStreet.com, says doing your due diligence is more important in real estate than other investments, as far as working with a crowdfunding company goes.
“From the investor's perspective, one should take care to research the platforms on which they are searching for investment opportunities,” says Powderly. “Not all platforms are created equal, and multiple business plans are being tested in order to capitalize on this emerging trend.”
Powderly specifically advises investors to investigate the founders and senior management of the crowdfunding platform or firm to make sure they have a sterling reputation built upon their previous business experience.
“Key industry expertise in finance, real estate and technology is essential to operate a trusted and reliable platform,” he adds. “Investors should gravitate toward platforms that deliver excellent customer service not only during the fundraising process, but also after the deal is fully funded and closed. Despite the fact that there are 50-plus platforms in some mode of operation, there are only a half dozen or so that are emerging as leaders in the space. Investors should research multiple platforms and select their top three based on their investment goals and preferred user experience.”
Transparency is Critical
Powderly advises looking for crowdfunding platforms and sponsors that acknowledge the risks and provide an education-based approach to risk management. “Most real estate crowdfunding platforms today only permit accredited investors, as defined by the SEC, to invest,” he says. “Accredited investors are advised to invest amounts that they are comfortable with given their overall investment portfolio.”
Another tip - only invest in offerings from sponsors that you trust and that you’re confident will look out for your best interest in good times and bad.
“If an investor does not understand how their money is being used, the risk factors of the investment and what factors influence their return on investment, then they should seek the advice of their trusted investment adviser or pass on the investment,” adds Powderly. “There will be plenty of other investment opportunities to choose from, so don't get rushed into making an uninformed investment decision.”
A professional real estate crowdfunding platform should provide investors with ample opportunities to communicate about the offering, including making introductions directly to the sponsor of the particular property listing.
Is This Doable, and How?
The catalyst to launching crowdfunding for real estate investments, along with other types of business ventures, was the passage of the JOBS Act in 2012. Until recently, the ability to advertise and solicit investors for real estate investments has been restricted. The JOBS Act (Title II) dramatically changed the way investment capital can be raised by modifying existing Regulation D rules, specifically those rules pertaining to how companies can offer and sell their securities without having to register the securities with the U.S. Securities and Exchange Commission (SEC).
In the past, Regulation D, Rule 506 placed restrictions on fundraising efforts – namely, limiting fundraising to only pre-existing relationships and preventing a sponsor or other party from openly soliciting or advertising those private investment opportunities. The new Rule 506(c) allows issuers, sponsors, syndicators and others who are raising capital from private investors to advertise those private-investment opportunities to accredited investors under certain conditions. That rule became effective Sept. 23, 2013. The new federal legislation represents a huge change for sponsors that are raising funds for a real estate acquisition or development. Essentially, Title II gives crowdfunding firms the green light to a direct market to a large pool of potential investors via social media and the Internet. It also has opened up a new vehicle for investors to more easily access direct real estate investment opportunities.
As Powderly notes, for the first time ever, investors have direct access to a selection of private real estate offerings where they can browse, research and make well-informed investment decisions online.
The Bottom Line
Crowdfunding in the real estate market promises to be a revolution that’s just now taking off, and it's attracting serious interest from serious investors these days.