Can two disparate investment markets – one old and one new – get along without driving each other crazy?

That is the key question for crowdfunding and the real estate market, and one being answered in positive ways, as the odd couple appears 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 a recent Innovations in Real Estate: Crowdfund Investing conference in New York City, Markley Roderick, a lawyer with Flaster/Greenberg PC and the conference moderator, addressed regulations linked to the Jumpstart Our Business Startups (JOBS) Act of 2012. The 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 MogulCrowdStreet, 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.

Crowdfunding

Crowdfunding and the real estate market are a natural fit. 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 to 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, 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, it comes down to risk for both sides; 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 in which real estate projects they want to invest their money.
  • Investors have access to myriad projects, so choice isn't a problem.

Cons . . .

  • The investment risks are the same as for any real estate investor. If the market goes south, an investor 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 access to selling opportunities 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 for real estate than for 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 that rests on 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 half a 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, while providing 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 you trust, and who you’re confident will look out for your best interests 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 for 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 had 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 latter with the U.S. Securities and Exchange Commission (SEC).

In the past, Regulation D, Rule 506 placed restrictions on fundraising efforts, specifically 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 on Sept. 23, 2013. The new federal legislation represents a huge change for sponsors raising funds for a real estate acquisition or development. Essentially, Title II gives crowdfunding firms the green light to direct-market to a large pool of potential investors via social media and the Internet. It has also created 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 which they can browse, research, and make well-informed investment decisions about online.

The Bottom Line

Crowdfunding in the real estate market promises to be a revolution. It is just now taking off, but already attracting impressive levels of interest from serious investors.

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