The Ultimate Guide to Crowdfunding Real Estate Development
For many investors, the rarefied world of real estate development is attractive and a bit daunting. Most of us have little experience in the real estate sphere outside of our home mortgages or dealings with landlords. There is also a widespread perception, right or wrong that the real estate industry is full of sharks, many of whom will do their utmost to separate a fool from their money. However, like many aspects of life and business, things are not always as they seem. A sea change in how real estate projects are financed has developed, in the form of crowdfunding real estate finance, is giving investors across the country the ability to participate in and benefit from the flourishing commercial real estate sector like never before.
What is Real Estate Crowdfunding, and How Does It Work?
Real estate crowdfunding is an investment avenue that uses crowdfunding or sourcing capital from a “crowd” of investors, to raise money for investments in real estate assets like multifamily apartment buildings, retail centers, office buildings, and other types of real estate.
Through crowdfunding, investors can deploy capital in a wide range of properties, without having to purchase or manage real estate directly themselves. They do this by investing in a real estate syndicate set up by a developer, sometimes also called a ‘sponsor’ or ‘operator,’ and it is the developer who takes on the day to day responsibilities for managing the property.
What is the history of crowdfunding real estate development?
Something big happened just a few years ago that changed everything for the commercial real estate industry. It is now legal to raise capital online for real estate projects.
But it wasn’t always that way.
In the wake of the Great Depression
The Great Depression transformed American capital markets. Before the crash that devastated the U.S. economy in the 1930s, American capital markets operated with few rules, and, in the worst cases, became a swamp of investor fraud and stock market manipulation.
Firms that wanted to raise capital operated with few or no disclosure requirements. Investment syndicates favored those with connections to a deal’s principals—with special treatment and preferential terms—at the expense of others.
After the Depression, President Franklin D. Roosevelt and U.S. Rep. Sam Rayburn, D-Texas, wrote the U.S. securities laws as we now know them today in direct response to the collapse of the capital markets. The Securities Act of 1933, the Exchange Act of 1934, and the Investment Company Act of 1940 strengthened securities laws, making them the most stringent and transparent laws in the world. The laws resulted in what we have now: the most efficient, most trusted and most valuable capital markets in the world.
Public Offerings vs. Private Offerings
One fundamental new rule governed the financing of the real estate development industry. It made a distinction between private offerings and the public offerings of securities. In a public offering, you were allowed to advertise for investors, but were subject to considerable time consuming and costly disclosure requirements.
Real estate developers buying apartment buildings, for example, were de facto prohibited from such advertising because the scale of their projects simply did not warrant the expense in time and money of ‘going public.’
Instead, real estate developers and others took advantage of an exemption under the 1933 Securities Act that said they were not required to make such disclosures provided they raise money only from people they knew or people who knew the people they knew. Technically they had to demonstrate they had a ‘preexisting relationship’ with a prospect before being permitted to invite them to invest.
That meant a real estate developer had to work through an inefficient series of barely connected private networks.
Everything changed in 2012.
The JOBS Act of 2012
President Barack Obama signed into law the JOBS Act of 2012 to provide financing for small and medium-sized companies. JOBS Act stands for “Jumpstart Our Business Startups Act.” There are a lot of complicated rules included in the Act but the one that matters most to real estate developers is the reversal of the 85-year-old rule against advertising.
That single change transformed the capital formation industry. Before the JOBS Act, you could not advertise; after the JOBS Act, you can advertise virtually any way you want including, importantly, on the Internet.
How things changed under the new law
The JOBS Act rendered moot clauses in sponsors’ contracts that warranted or represented that a sponsor had a pre-existing relationship with an investor. There’s no longer a requirement of a pre-existing relationship in the post-JOBS Act world. You can bring in any investor from anywhere and this means you can put up a website and distribute content related to your real estate projects on social media.
The official term for this is general solicitation. It means a private developer can go to the public to solicit investment in the same way a public company can go to the public for investors through an initial public offering.
This means that the Internet has come to capital formation in the real estate industry. In the past, when the Internet came to an industry, it always did the same thing in an industry-specific context: It always directly connected buyers and sellers and displaced the middleman.
The changes the JOBS Act brought creates a marketing opportunity for developers. It frees the commercial real estate entrepreneur to use digital marketing and social media services to reach a potentially unlimited audience of high net worth investors and to raise capital.
How does it work?
To Investors in a syndicated property receive rental income distributions from the deal sponsor on a monthly or quarterly basis, depending on the terms of the deal. As many real properties appreciate in value over time, investors are also entitled to a share of the growth in appreciation value upon the sale of the property.
Requirements to Become an Accredited Investor
To prevent novice investors from taking significant financial risks they may not truly understand, the US Securities and Exchange Commission (SEC), by the use of the accredited designation standard, has set up a firewall to prevent unsophisticated or investors without high enough capital resources from investing in “high risk” investments. This is primarily to ensure that investors who deploy capital in riskier investments have the financial wherewithal to weather declines in the investment and that the investor will be less likely to go bankrupt from excessive risk-taking with their portfolio.
The SEC guidelines for an accredited investor are as follows:
The investor has earned income more than $200,000 in each of the past two years, or $300,000 together with their partner- the investor must also expect to make the same amount of more in the upcoming year.
The investor has a net worth of 1 million dollars or more, either as a single individual or combined with their partner. The value of one’s primary residence does not count towards this requirement.
The investor is an executive officer, general partner, or director working in concert with the issuers of the offered security.
Accredited investor status is required to invest in many real estate crowdfunding platforms, but not all. Let’s take a look at some of the different types of crowdfunding options available to investors.
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Different Types of Real Estate Crowdfunding
As is the case with many other investment types, real estate crowdfunding deals can be divided into different subcategories, each of which offers different risk profiles, payment schedules, and return potential.
There is no “one size fits all” option, so before investing in a real estate crowdfunding deal, you must understand the differences between the three types of opportunities most common in the industry, like preferred equity, common equity, and debt crowdfunding.
Type #1: Equity Crowdfunding
Quick Takeaway: Equity crowdfunding investments generate regular returns via rental income from tenants, as well as appreciation gains upon sale of the subject property. Equity investors may also benefit from depreciation expense deductions.
Equity investing is the most common form of crowdfunded real estate deal. With this investment type, investors are shareholders in a specific property or property portfolio, with their stake in the project being proportional to the amount of capital they’ve invested in the crowdfunded property/portfolio. Returns come in the form of a regular share of rental income generated minus any expenses, fees, or other charges related to managing and running the property.
If the property is sold, investors may also receive a share of the appreciation value. For example, if a crowdfunded property is initially worth $100,000, but appreciates to $200,000 throughout the investment, stakeholders will be entitled to a percentage of that $100,000 increase in value, less any share of it owed to the sponsor.
Type #2: Preferred Equity Crowdfunding
Quick Takeaway: Preferred equity works like equity crowdfunding, with one key difference that preferred equity investors are first in line to be paid, which is ahead of common equity investors.
Through preferred equity crowdfunding, investors acquire an ownership stake in a property or property portfolio. However, the difference between equity and preferred equity crowdfunding comes down to the advantage that preferred equity has over common equity. Preferred equity entitles investors to more rights/benefits and preferential treatment in several critical aspects of a crowdfunding deal.
The term ‘preferred equity’ has taken on a second meaning in recent years. It can also be used as a form of debt to a project (even though it is called ‘equity’) where investors are paid an interest rate with no share of the profits, just as a regular bank loan might, but retain extensive control rights should the property fall into default on payments.
Preferential Liquidation Terms
Possibly the most valuable aspect of being a preferred equity investor is the preferential liquidation terms they receive. In the case of a business liquidation event, where for whatever reason the company and assets must be sold due to poor performance or mismanagement, preferred equity shareholders receive preference when the proceeds from the sale are distributed to investors.
Leaders of The Crowd
Conversations with Crowdfunding Visionaries and How Real Estate Stole the Show
Discover how laws that gave us crowdfunding were solely meant to finance small companies and yet inadvertently opened the doors to allow you to invest in real estate like never before.
Read the book and listen to the actual conversations.
Preferential Dividend Payout Terms
In a similar vein to liquidation terms, preferred equity holders are paid first when it comes time to pay dividends from profits from the crowdfunding deal. Once preferred equity holders are paid, the dividends to which they are entitled to will go to the common equity holders that will receive the remainder of the proceeds.
Favorable Tax Treatment
Real estate is considered to be among the most tax-advantaged classes of real estate for a good reason. There are several benefits offered to real estate investors by the IRS, and one that comes into play in a big way with equity crowdfunding is depreciation.
In most cases, investors can claim a portion of their investment on their taxes through the depreciation schedule set forth by the IRS. This holds true for both preferred equity and common equity holders, but not for debt crowdfunding holders, as they do not become “owners” of the property, but lenders to the sponsor.
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Type #3: Debt Crowdfunding
Get Paid First
Similar to preferred equity investors, debt investors get paid first if the loan should go into default. Your investment in the crowdfunding deal is secured either by the property itself or by a promissory note which is held by the entity that owns the property.
Shorter Hold Periods
When compared to equity investments, debt investments usually have shorter hold periods. They have pre-set payoff dates, which typically range anywhere from 6 to 24 months.
Set Payback Schedule
Since debt crowdfunding is essentially a loan, investors are entitled to payments on a regular payback schedule, in the same way, mortgage holders receive payments. These interest and principal payments usually come quarterly or monthly, and a set schedule allows investors to know when and how much they will be getting paid for their investment.
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Real Estate Crowdfunding Terms You Should Know
New investors often have trouble making sense of the jargon that comes along with discussions about crowdfunded real estate deals. Like many other avenues of finance, these terms can be daunting or confusing at first, but they represent simple concepts that you should have little to no trouble understanding. For now, let’s take a look at a few of the real estate crowdfunding terms you should know before getting involved in a crowdfunded deal.
The crowdfunding sponsor is the person or organization/company that finds, organizes, and manages the crowdfunding investment. The sponsor of the deal works to facilitate the acquisition of the asset or assets, works with contractors and builders, lines up financing, and is responsible for selling the property if and when the time comes.
In most cases, deal sponsors put up some of the initial funding for the project and are entitled to an agreed-upon share of any profits generated as a result of the deal. The term ‘sponsor,’ as mentioned earlier, is synonymously used with the word ‘developer’ and other terms like ‘operator’ or ‘manager.’
2. Crowdfunding Platform
A crowdfunding platform is a website or app where the sponsor connects with investors to raise capital for a real estate crowdfunding project. The platform exists as a digital exchange where sponsors can advertise to investors, and the platform managers work to confirm that any posted deals follow legal and financial regulations. They also act as a filter to ensure that any potential investors meet the requirements for the investment, and the platform is sometimes responsible for collecting any invested funds for the deal sponsor, depending on the platform’s business model.
3. Real Estate Developer
Real estate developers are people who develop and sell/lease properties for residential or commercial use. Their duties include coordinating the project and working with architects, builders, finance personnel, and others involved in the development process. Within the crowdfunded real estate space, this person is also known as the sponsor, as mentioned above.
4. Rental Income
Rental income is the income collected from tenants via rent payments from leases and is one of the two ways that investors generate returns from crowdfunded real estate. Rental income is either expressed as gross or net income, with gross rental income referring to the total amount of rents collected, while net income refers to the leftover profit after expenses have been paid.
5. Property Appreciation
Property appreciation is another way that returns are generated for real estate crowdfunding investors. As properties can and often do appreciate in value, shareholders in equity deals are entitled to a percentage of that appreciation value upon the sale of a property or properties.
6. IRR (Internal Rate of Return)
The IRR or Internal Rate of Return for a property or portfolio is an estimate of the appreciation in value that either will generate while owned by an investor or investors on an annualized basis over the lifetime of the project. In simple terms, the internal rate of return is the yearly return that investors earn on each dollar they’ve invested in a property/portfolio during the entire holding period, whether that be six months or six years.
Related: What's Happening Right Now
Benefits of Real Estate Crowdfunding
As an investment avenue, real estate crowdfunding offers benefits not available with traditional real estate, stocks, bonds, and other asset classes, and in essence, combines many of the best qualities of these investments. Some specific advantages include:
Low Investment Requirements
Traditional property investments carry high acquisition costs, often in the hundreds of thousands, millions, or even tens or hundreds of millions of dollars. Even if you finance a property through a lender, you are looking at putting a minimum of 20% down payment to receive an acceptable interest rate on borrowed capital. The fractional ownership model of crowdfunded deals allows investors to invest as little as $500, which is substantially less than almost all other forms of property investment.
Ease of Access/Research
In a similar vein to the information mentioned above, low minimum investment requirements, crowdfunding platforms are much more accessible than direct investments in real estate. Crowdfunding platforms are just a click or tap away via PC or mobile device and sign up shouldn’t take more than a few minutes.
Once you’re on the platform, searching for potential opportunities is as easy as a Google search, and the platform itself will provide a fair amount of research and information that you can use to perform the due diligence required of any investment.
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Many proponents of real estate refer to the sector as one where you can deploy capital and “make your money work for you while you sleep.”
This is true for some real estate investments, but it is not a universal truth. For instance, when you own a multifamily building, you are either handing over a significant percentage to a manager, or spending your own sweat equity to make sure tenant issues are solved, repairs and maintenance are taken care of, taxes and insurance are paid, and the day to day duties you need to focus on to keep your asset generating returns.
With crowdfunded real estate, your sponsor takes on most or all of those duties, while you can sit back and collect rent and appreciation payments.
For more information and to gain access to:
- Guided tour of 8 real estate crowdfunding websites
- FREE: Complete list of every real estate syndication website
- FREE: 10 things to look for in real estate contracts
- Access to advanced real estate investment training
Real Estate Offers Higher Returns than the Stock Market
Comparing two asset classes that encompass so many subcategories of investments, like stocks and real estate, is an inexact science. With that being said, we can look at common performance metrics, like market tracking funds or stock indexes to see how asset classes perform over long periods of time.
While stocks have performed admirably over the past few decades, when you compare the S&P 500 Total Return to the Vanguard Real Estate ETF Total Return over the past 25 years, you will see that returns in commercial real estate outperformed the S&P 500 by more than 200%, with Vanguard’s real estate ETF coming in at 865.3%, while the same number for the S&P 500 is 621.8%.
Now, this does not mean that real estate assets will always outperform stocks, but it shows that as an asset class, commercial real estate is no slouch.
Plentiful Diversification Options
The most significant issues faced by new real estate investors is the lack of portfolio diversity that comes with the purchase of a commercial property. While some of us are lucky enough to have portfolios where a few million dollars represents a small allocation, the rest of us would be treading in dangerous territory by putting such a large amount of capital into a single investment.
Real estate crowdfunding allows for fractional ownership in properties, which gives you the ability to benefit from phenomenal growth in the commercial real estate markets while maintaining a sound long-term investment or retirement strategy.
Risks of Real Estate Crowdfunding
If you’ve made it to this point, and you weren’t born yesterday, you’ve probably had one nagging thought in your head – what’s the catch?
As with any investment opportunity, real estate crowdfunding has its share of drawbacks. As an investor, you need to weigh these risks with the potential rewards, all the while keeping in mind your personal tolerance for risk and your desired return on investment.
Let’s take a quick look at some of the risks inherent to real estate crowdfunding investments.
More Risk than Other Investment Avenues
As many of us remember from the dark days following the housing crash in 2008 and the turmoil surrounding the Coronavirus pandemic, investing in real estate is not currently, and never was a way to generate returns without risk. Like any investment not guaranteed by the federal government, such as bonds, there is always the chance that things could go sour on a macro or micro level, and you could be left holding the bag, and taking substantial or even total losses on your invested capital.
Keep in mind that you can reduce your risk in crowdfunded investments by employing tried and true strategies, like creating a diverse portfolio and performing rigorous due diligence on any potential investment.
Crowdfunded Real Estate is an Unsecured Investment, and May Suffer from Platform Failure
In the United States, the Securities Investors Protection Corporation, or SIPC, protects investors from the failure of a bank or brokerage, as explained on the FDIC website:
“The Securities Investors Protection Corporation (SIPC), a nongovernment entity, replaces missing stocks and other securities in customer accounts held by its members up to $500,000, including up to $250,000 in cash, if a member brokerage or bank brokerage subsidiary fails.”
Crowdfunding investments are not protected under the same terms, and this exposes investors to risks from the platform closing, or the crowdfunding sponsor mismanaging investor funds. Of course, similar risks are also present with securities – just ask Enron or WorldCom investors.
Like many of the other risks listed here, you can take steps to protect yourself from failure, including properly vetting your sponsor and doing business on an established, well-respected crowdfunding platform.
New Real Estate Investors May Have Trouble With Crowdfunding Investments
Crowdfunding is a relatively new way to invest in real estate, but the old fundamentals of the real estate business still hold true. The ease of access and digital nature of crowdfunded real estate may draw in investors who are unfamiliar with tried and true strategies for building wealth with real estate. Unfortunately, there is not much you can do to prevent this; it happens with any type of investment that gains widespread popularity, including stocks, tech startups, precious metals, and other commodities.
You can protect yourself from risk by being deliberate with your investments and putting in the sweat equity and research to ensure that you know how and why that investment is going to generate returns for your portfolio.
Related: About Gower Crowd
Some Aspects of Due Diligence May be Challenging/Lack of Analyst Reports
Digital platforms make it easier than ever to research a potential investment, and to connect with crowdfunding sponsors. Unfortunately, the financial research and analysis industry has not yet caught up to this new way of funding development projects. Resources for vetting potential projects are limited, especially when compared to the countless reports and analysis pieces crafted for equity and commodity investments. This is a blessing and a curse.
For those of us that are reluctant to trust someone else’s opinion or analysis, it gives us the chance to delve deeper and research a project on our own. However, this kind of deep-dive is not ideal for every investor, some of us simply do not have the time or desire to dig into financials, market reports, and other data points that would provide us insights on making an informed decision.
Real Estate Crowdfunding is Treading New Regulatory Ground
Anytime you have a radical paradigm shift in finance, tech, and many other sectors of the economy, it always seems like regulators and authorities are rushing to catch up. While the lack of clearly defined rules and regulations can be a boon to growth and creative thinking, it can also lead to many of the problems we’ve discussed above.
Additionally, when the government eventually does step up to the plate, it can present significant problems for existing players, who have to adapt to new rules or ways of doing things. This may also introduce risks into the crowdfunding space, which savvy investors, like you, should be aware of.
How Much Should You Invest in Real Estate Crowdfunding?
At this point, you may be wondering how much of an investment you should make in real estate crowdfunding deals?
The answer is simple: as much as you can comfortably invest while still falling in line with the same principles you use to balance risk and reward with traditional assets like stocks and bonds. In most cases, this means a higher risk tolerance for younger workers and less tolerance for those edging closer to retirement.
The beauty of the crowdfunded real estate is that you can alter your risk level by picking and choosing individual projects and real estate types to match your personal needs and goals.
Keep in mind that investing in real estate crowdfunded syndications means that your investment will likely be tied up for some years before you will get the principal returned, although there may be distributions along the way depending on how the deal is structured.
The golden rule for any real estate investment is not to invest anything you may need for other purposes during the lifecycle of the deal, and certainly, no more than you can comfortably afford to lose completely.
For more information and to gain access to:
- Guided tour of 8 real estate crowdfunding websites
- FREE: Complete list of every real estate syndication website
- FREE: 10 things to look for in real estate contracts
- Access to advanced real estate investment training
Best Real Estate Crowdfunding Platforms
Once you’ve decided to invest, you’ll need to find a platform. As we mentioned earlier, this is a mission-critical step in reducing risk and finding the right investment opportunity.
Listed below are 11 of the most popular crowdfunding options, most of which we’ve worked with here at GowerCrowd:
- Zeus Crowdfunding
- Patch of Land
- Small Change
- Fund That Flip
Real Estate Crowdfunding Trends in 2020
Real estate crowdfunding has piqued the interest of investors of all kinds. Even those with nominal sums of money to invest can now invest in institutional-caliber real estate projects that were once reserved for only the upper echelons. Real estate crowdfunding is particularly intriguing to those who want to diversify their portfolios, but who may be hesitant to dive head-first into the commercial real estate waters.
One of the reasons commercial real estate is so attractive – via online crowdfunding or otherwise – is that it tends to weather economic storms relatively well. We’re seeing that today. Unlike the wild swings in stocks or bond prices, commercial real estate values have held steady despite the economic turmoil brought on by the COVID-19 crisis. To be sure, this isn’t to say that commercial real estate will escape unscathed. However, in general, investors remain optimistic about the long-term prospects of commercial real estate. And as such, those with capital to invest are starting to look at how they may do so via crowdfunding platforms.
Real Estate Crowdfunding Trends
Commercial real estate prices have been on the rise for years, and as a result, many would-be investors have been priced out of some of the most attractive deals and opportunities. Bidding wars have become commonplace, particularly as more international investors look to park their capital in what’s considered a relatively “safe” asset class. Unable to invest independently, many are opting to co-invest alongside many others, in smaller increments, through real estate crowdfunding platforms and directly with real estate sponsors who utilize crowdfunding to capitalize their projects.
Real estate crowdfunding has been around for years, but only recently has it gained widespread acceptance among investors. Any early hesitation surrounding these online platforms has since been replaced with a recognition that online crowdfunding can be a powerful tool for those seeking to raise capital for commercial real estate deals.
We expect real estate crowdfunding to continue to evolve in the years to come. Here are a few of the top trends we’re monitoring in 2020.
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Trend #1: Institutional Capital
One of the reasons people are drawn to real estate crowdfunding is that, depending on the structure of the platform and deal, an individual can invest with as little as $100. This can be a great way for people to learn about commercial real estate, but such small investments present a challenge for those looking to raise more significant capital for larger projects.
This led to the emergence of crowdfunding platforms, or funds, that only accept accredited investors. Sponsors will often set a minimum threshold, say $50,000 or $100,000, as they crowdfund for their deals.
Institutional investors, such as pension funds and life insurance companies, are now starting to enter the fold, too. While crowdfunding was initially utilized for sponsor seeking smaller amounts of capital, sponsors are now finding that the same tool can be used to lure institutional investment in larger projects. Rather than seeking out hundreds of $50,000 investments, sponsors can now use these platforms to raise millions of dollars at once by pitching to institutional investors, who rarely invest less than $10 million at a time.
In 2020, expect to see more sponsors utilize crowdfunding to attract a blend of investors – accredited, non-accredited, and institutional investors alike. When raising capital, many sponsors will start by landing a major institutional commitment, say $20 million of the $25 million in equity needed to finance a project. The sponsor may then tout this substantial commitment when pitching to other investors, who would then contribute smaller amounts to fulfill that remaining $5 million needed. This approach may become more commonplace given that smaller-scale investors often take comfort in knowing a larger investor has committed to and believes in the project.
Trend #2: More Sponsors Will Independently Crowdfund Their Deals
As the popularity and success of crowdfunding through online platforms becomes more visible, so will the desire by sponsors to establish their own, independent crowdfunding capabilities. Having been prohibited by law from soliciting investors outside of their immediate circle of acquaintances and business contacts, real estate sponsors are increasingly realizing the power of extending their networks to create a virtually unlimited pipeline of equity capital.
To date, most sponsors who realize how effective marketing their projects online can be have deferred to listing their projects on crowdfunding platforms as the means by which they leverage the opportunity. Increasingly, however, more sponsors will realize that by elevating their own visibility online they accomplish two goals in one; one, that their efforts raising money on crowdfunding platforms is facilitated and two, that the more they become known in the investment community, the more they can raise via their own websites directly.
Very few sponsors have realized yet the significance of being an early adopter of digital marketing to raise capital but for those who do, the opportunity before them is truly blue ocean. We expect the number of sponsors to increase exponentially as they begin to realize that without an effective online presence, their ability to raise capital begins to be eroded by those who have.
Trend #3: Rise of Specialized eREITs
Fundrise and other real estate crowdfunding platforms have begun to offer online “eREITs” – or online, non-trade real estate investment trusts. These eREITs function similarly to publicly-traded REITs. Those looking to buy shares of real estate, which provides greater liquidity than investing in a property directly, will want to consider the eREIT model.
In 2020, we’re monitoring not only eREIT activity, but specifically, the growth of specialized eREITs. For example, Fundrise offers five eREITs characterized by region (West, East, Heartland) and investment style (Growth, Income). We expect this specialization to increase, particularly among younger investors who want to have more of a role in determining how their investment is made. For example, in the wake of the COVID-19 crisis, we may see investors steer away from certain asset classes, such as assisted living or hospitality. Investing in a specialized eREIT is one way for someone to have more control over the assets in which they invest.
Trend #4: Further Consolidation
Since the JOBS Act was passed in 2012, which allowed non-accredited investors to participate in real estate crowdfunding, and sponsors to raise money from the general public, there has been an explosion in the number of platforms that have come to market. There are dozens of online portals for people to consider investing through. Not all platforms will survive. Some will also not be equipped to go the distance and scale into a sustainable business. We’ve already seen several companies go under. The sudden shutdown of RealtyShares in late 2018 is one prominent example that took the industry by surprise.
RealtyShares collapse had nothing, however, to do with the CRE crowdfunding per se; it was a failure brought about by the way the company was capitalized and not because crowdfunding real estate syndications is a flawed thesis. The biggest challenge facing the industry is, and always has been, the impact of a real estate downturn – such as the one triggered by the Coronavirus crisis. Nothing tests a real estate investment hypothesis better than the forces of the economic cycle, no matter what the cause of the downturn, and it is likely that some platforms and sponsors will have a hard time riding the out the storm.
More than flawed economic models led to the demise of RealtyShares, but we expect consolidation of real estate crowdfunding platforms will be primarily as a result of the impact of an economic slowdown in 2020.
Trend #5: More Accessibility to All
Initially, deals funded via real estate crowdfunding platforms were only available to accredited investors (i.e., those who have $200,000+ in income or $1+ million in net worth, excluding their primary residence). In 2014, laws were promulgated allowing Regulations CF and A+ of the JOBS Act to take effect opening the doors to non-accredited investors. Under Reg A+, sponsors were permitted to raise up to $50 million per year through securities offerings in what are sometimes referred to as ‘mini-IPOs.’ This also brought about the emergence of eREITs, which tend to provide lower thresholds for initial investments.
Non-accredited investors can commit up to $2,000 per year to equity crowdfunded projects if the person’s income is less than $100,000 per year, and up to $10,000 per year if their income is greater than $100,000.
Regulation CF, the classic form of crowdfunding, initially permitted sponsors to raise up to $1 million per year from anyone, accredited or non-accredited, provided the raise was conducted through a regulated funding portal. Those that have taken the lead in this industry, such as the SmallChange website, have had a measure of success hampered by excessive bureaucracy making it difficult for them to reach their true potential.
As regulations loosen and as more companies realize they can raise money from non-accredited investors also, we expect to see sponsors to use Regulations A+ and CF to appeal to a wider range of investors for their deals – particularly small and mid-size deals that need to raise $10 million or less.
How to Get Started with Real Estate Crowdfunding in 2020
It is important to understand that each online crowdfunding platform operates a bit differently. Some, like Patch of Land, raise debt for real estate projects. Others, like ArborCrowd, raise equity. Then there are platforms like Fundrise, which operate eREITs. Some platforms are only open to accredited investors, whereas other will allow someone to invest with as little as $100.
With relatively low barriers to entry, it is tempting for the first-time investor to pull the trigger on a nominal investment just for the sake of getting started. But rather than invest haphazardly, investors are urged to do their homework on these crowdfunding operators before investing a penny.
As we mentioned above, we expect there to be a consolidation of platforms – and of sponsors – in the coming months, particularly as a result of the slump brought about by Covid, and in the longer term as the real estate cycle follows its natural course. Any investor will want to be sure they’re investing with someone who’s credible and can withstand changing market conditions.
What to Look for in a Real Estate Crowdfunding Platform
There are many real estate crowdfunding platforms to choose from these days though only a handful really dominate the field. The biggest challenge is as much with deciding which platform to go with as it is with the array of investment opportunities the platforms offer, from different asset classes, sponsors, locations, types of investment. It can be difficult for any investor to navigate, but even more so for first-time investors or those who have little experience with commercial real estate.
An investor will want to start by considering his or her own financial situation and investing objectives. Are you an accredited investor? Many platforms are only open to accredited investors, so if you are not, then you can immediately cross these platforms off your list (for now!). What’s your desired time horizon? Some platforms specialize in real estate deals that have a short lifecycle; others are long-term investments in which it may be years before an investor gets their money back. How much do you want to invest? Minimum investments can range from $100 to $50,000 or more, so depending on how much you want to invest, this can be another easy way to filter through various platforms.
Now, once you’ve narrowed the options a bit, here are a few other factors to look at when considering otherwise seemingly similar real estate crowdfunding platforms.
One of the most important things to look for in a real estate crowdfunding platform is who’s behind the company. In truth, many early real estate crowdfunding platformers were simply tech-enabled websites that allowed anyone to post their real estate deals. The people behind the websites may or may not have had any commercial real estate experience at all.
As the industry is an intersection of technology and real estate, so the most successful companies have been a marriage of tech entrepreneurs and commercial real estate professionals.
Yet, while tech is important and not to take away from the herculean effort involved in building a successful real estate crowdfunding platform, it is (dare I say it) a commodity. The differentiating factor that investors must keep a keen eye out for is the platform’s commercial real estate capabilities, for it is in that, and not the technology, that they are investing.
The most prominent platforms typically have a team of seasoned real estate professionals who vet real estate deals prior to allowing them to raise funds online. Any prospective investor will want to evaluate these teams, including their level of experience and underwriting capabilities.
Perhaps the most important aspect to research before investing is the sponsor behind the real estate deal. The sponsors are who you are entrusting your hard-earned capital with when investing. They are the people who will be overseeing the day-to-day activities of the transaction, from acquisition through construction, and eventually through stabilization and refinance or disposition.
There are a few ways to differentiate a good sponsor from one who’s great – indeed you would be better off investing in a mediocre deal with a first-rate sponsor than a first-rate deal with a mediocre sponsor. Start by looking at the track-record of the principals. What level of experience do they bring to the table? Do they have specific experience managing projects in this same asset class (e.g., multifamily, office or retail) and in this geography?
A great office sponsor may not be equipped to spearhead a multifamily transaction, for example. And someone who has specialized in South Florida properties may not be as capable of overseeing a deal in New England, where the market dynamics are much different. Be sure the sponsor has time on their side, as well. Look for a sponsor that has successfully navigated multiple real estate cycles, as markets will inevitably ebb and flow.
Related: Aspects for Evaluating a Sponsor.
When considering various real estate funding platforms, look at the volume of transactions hosted by each site. You’ll typically want to find a platform that balances transaction volume with quality of transactions. For example, it could be a red flag if a platform offers up hundreds of deals at once – they’re essentially farming commercial real estate deals from the masses, leaving the quality of these deals in question.
Conversely, a platform that only has completed a few transactions (or worse, zero transactions!) to date may also be of concern. Unless the platform is in its nascent stages, it leaves one to wonder how capable the sponsor is of raising the funds needed to move a deal forward.
It’s important to find a platform that strikes a balance between volume and quality. One way to gut-check volume is to ensure the platform has sufficient underwriting staff to adequately evaluate the number of deals featured on its site.
Another thing to look at is how the deals on any given platform are performing during the COVID-19 crisis. How a platform is communicating with sponsors and investors may be indicative of their sophistication in weathering the storm.
Transactional volume of sponsors also is of importance. Investors want to know if sponsors have sufficient track record that speaks to their capabilities and, as importantly, to their ability to raise debt finance. Particularly during downturns when debt dries up as banks become reticent in their lending, sponsors who can tap into debt markets will be better positioned to take advantage of opportunities that may arise out of other, less well positioned sponsors’ misfortunes.
The Financial Projection
Here’s a dirty little secret: some sponsors will use a crowdfunding platform as a financial vehicle of last resort. They may have tried, unsuccessfully, to raise the debt and equity needed for the project through more traditional means and have come up short. This is why it is so critically important to carefully vet the financial underwriting proposed by the sponsor. Be sure there’s nothing you’re missing.
What sort of details should you look for? Start by looking at the pro forma. Are the rent projections in line with market averages? Do expenses seem reasonable? What has the sponsor baked in for vacancy and other contingencies? What is the sponsor using as the going-in and exit cap rates? Any qualified sponsor will be happy to review their underwriting assumptions in detail with prospective investors (and you should run away from anyone who won’t!).
The Customer Service
A platform or sponsor’s customer service – or investor relations – should never be overlooked. This is what separates the technology-oriented platforms from those that are more investor-oriented (in other words, there’s more than just technology connecting sponsors and investors).
A good customer service team will offer best-in-class investor relations to help prospective investors navigate the marketplace, including the nuances of each transaction and the finer-point details that some may not understand. A great customer service team will also provide robust informational materials to educate investors—not only about deals, but about crowdfunding (e.g. eREITs vs. specific deals) and commercial real estate trends more broadly. It should not matter whether you are a first-time investor or have decades of experience; the platform should offer the same quality customer service to investors of all kinds.
And as with all things crowdfunding, the same is true not just of the platforms, but of the sponsors operating their own independent crowdfunding efforts. As an investor, you want to be sure that the sponsors you invest with are responsive to your inquiries, deliver reports and necessary documentation on time, and are forthright when challenges emerge. The last thing you want is for a sponsor to go silent during tough times so be sure to stay in touch every so often so you can recognize when their responses are not quite the same as normal and may indicate something is amiss.
Crowdfunding for commercial real estate projects is growing in popularity. While it is still a relatively niche market, it is certainly becoming a more mainstream way for sponsors to line up both equity and debt for their projects.
Those of us in the industry are watching the COVID-19 crisis closely, keeping an eye out for how the pandemic may impact commercial real estate crowdfunding moving forward. If there’s a slowdown in traditional debt and equity markets, this could spark additional activity in the crowdfunding space.
That said, we must also recognize that crowdfunding is a capital raising tool largely came about during an upcycle, with many platforms identifying as tech companies instead of true real estate companies. If and when the economy contracts (as a result of COVID or otherwise), we expect to see further consolidation of these platforms, with those founded by true real estate professionals to emerge as the industry leaders.
And we expect that, particularly as the world becomes accustomed to working remotely and sponsors realize that they don’t need to rely on the old fashioned in-person meetings to raise money (because they cannot), crowdfunding will become increasingly the only option worth considering when a real estate company needs to raise equity capital.
Conclusion/Go Forth and Conquer
After completing this brief crash course, you will have all the tools you need to get started with crowdfunded real estate. Your mission, should you choose to accept it, is to take this knowledge, add some hard work and due diligence, and take advantage of the immense possibilities provided by real estate crowdfunding investments, while also remaining cognizant of the pitfalls and risks that come with this unique form of investing.
You won’t get anywhere by sitting on the sidelines, so get out there, go forth and conquer.
Related: Leader of the Crowd.
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