June 20, 2014 MeissnerJacquet

Crowdfunding – the practice of selling shares in an enterprise to multiple individual investors – is rapidly gaining momentum in the real-estate industry.

When the Jumpstart Our Business Startups (JOBS) Act was passed in 2012, it eased off the crowdfunding controls that kept individuals from directly investing in companies. (The JOBS Act is the first securities law to change in 80 years.) But, while the Act is a huge factor in the surge of real estate crowdfunding, Sebastian Gomez Abero, Chief of the Office of Small Business Policy of the Division of Corporation Finance of the SEC, cautions that, “The crowdfunding proposals are not yet final.”

Still, for investors, the opportunity to invest relatively small amounts of money into a variety of  real estate ventures peaks their interest – especially as it has fewer risks than other types of investing. NAIOP, the Commercial Real Estate Development Association, has this to say – “Crowdfunding for real estate is not an entirely new phenomenon. 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.”

At the present time, the majority of crowdfunding deals are limited to accredited investors, those with an annual income higher than $200,000 or a net worth (excluding a primary residence) over $1 million. But the Securities and Exchange Commission is working on new rules that will  open crowdfunding to non-accredited investors too.

So the excitement surrounding crowdfunding in the commercial real estate industry is indisputable.

Websites for successful real estate equity raises are cropping up every day. Owned by developers, these platforms offer individuals a stake in a wide range of real estate  properties. Two of the more established developers in this field are Realty Mogul (“Real Estate Investment – Simplified”) and Fundrise (“Real Estate Investing for Everyone”).  Both companies open investing to local residents, real estate developers and financial investors. The Realty Mogul website encourages visitors to “check current investments and invest as small as $5000”. The Fundrise site states the same, but highlights the fact that their potential local investors don’t have to wait for the dust surrounding the JOBS Act to settle because Fundrise, “filed local public offerings with the SEC and state regulators to allow all local residents—not just accredited investors—to invest for as little as $100.”

An UK global property crowdfunding website launched in May of this year, allows investors a chance to fund property projects around the world called Launchpad. The company states that  it, “has become the first Public Limited Company to list its shares on the Crowdfund site and aims to raise £160,000 for 10% equity within 40 days.”

What are the benefits and risks around commercial real estate crowdfunding?  The International Organization of Securities Commissions (IOSCO) shares their research on the topic in a recent report.

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.

In addition, for investors, clear benefits include the opportunity to invest smaller amounts of money, work directly with the developers, get direct answers to any questions they have, access to many different deals and to personally choose the buildings in which they want to invest. Plus investors can help economic recovery by financing entrepreneurs and smaller businesses.

For the developer, key advantages are the ability to gauge customer response to the property and raise capital without giving up all equity interest. They also have easier inventory management and more operational flexibility, especially once the property is up and running.

But the report also lists some risks that come along with financial return crowdfunding. For investors these may be for both developers and investors. They include:

  • “A high risk of default and investment failure, estimated to be around 50% for equity crowdfunding. For peer-to-peer lending, the estimated high was 30% in 2009.”
  • “Risk of illiquidity. The lack of a secondary market prevents investors from selling their participations.”
  • “Lack of transparency and disclosure of risks. Risks may not be disclosed until a lender or investor becomes a member of the platform.”

Another expert, Sherwood Neiss, co-founder of consulting firm Crowdfund Capital Advisors, states, “By nature, [real-estate] crowdfunding is a high-risk asset class.” He recommends that investors start out small, and take a close look at the developers running the projects.

For developers the risks can be more subtle, but more immediate. Ethan Mollick with the University of Pennsylvania – Wharton School, has done an exploratory study on the dynamics of crowdfunding.  He states that, “The most difficult aspect now [of real estate crowdfunding] is regulations around offering [opportunities] to small-dollar investors.”

Mollick adds that safeguards are essential. “You need a mix of government safeguards, legal and enforceable contracts, and some of the value that a crowd can bring into a situation.”

As with any new trend, Tim Meissner, a Principal of Meissner Jacquét Commercial Real Estate Services, says that even though crowdfunding is appealing due to the physical means of the collateral, the ability to more easily project cash flow, return and exit time, investors must perform their due diligence as data on crowdfunding is limited due to its newness.”

Given the pros and cons, could real estate crowdfunding one day rival publicly traded real estate investment trusts?

 

SOURCES:

Journal of Accountancy

Fox Business

The Wall Street Journal

Forbes

NAIOP