Crowdfunding, or the use of raising equity or debt through online portals and social network contacts instead of through the regular medium of investment banks, partnerships and financial institutions, has grown much more significantly in 2014 than even its early supporters would have expected. Crowdfunding got its start on sites such as Kickstarter, which allowed inventors and artists to post an idea or project and allowed benefactors to fund them. No promises were made yet often the “investors or benefactors” received a product or service once available. This lack of a promised return opened up a sliver of a door crack in the highly regulated securities world.
The concept has now carried over to real estate, where the loosening of the laws defining how funds and private companies solicit investors in 2013 through changes to the US based Jumpstart Our Businesses (JOBS Act) has allowed crowdfunding to soar as a viable alternative to banks, traditional partnerships and institutional cash. New portals emerge monthly seeking some of the market share for serving this new way of funding enterprises. The websites allow potential investors can learn about and invest in a any scale real estate project from micro deals to the revitalization of a whole neighborhood. See for example, CityShares LLC’s Neighborhood Investment Fund which will invest in a basket of residential and mixed use properties in Brooklyn’s up and coming Bedford-Stuyvesant neighborhood. Although the portion of the JOBS act defining how funds can be raised through “nonaccredited investors,” or those incomes less than $200k per year or net worth less than $1MM have yet to be set, dozens of portals have already launched crowdfunding opportunities with as low as a $100 minimum investment.
Crowdnetic, a provider of technology and market data solutions to the global crowdfunding marketplace, found that from October 31, 2013 to May 31, 2014, the number of total crowdfunding portals or funds grew by 336.4% (Rand, 32). According to Nav Athwal, cofounder and CEO of RealtyShares, “Over the last year, crowdfunding for real estate platforms has been responsible for raising over $100 million for hundreds of real estate properties across the U.S.”
The funds work by creating a limited liability company for each property or project, through which investors can commit to funding a project once they have researched and completed internal due diligence. When sufficient commitments are reached the funding is required. Investors receive returns but with few promises, aside from revealing track records of prior investment returns from the same sponsor. Thus, the track record is key and it takes time to be able to pull down a larger funding, but some funds expect to soon approach $100 million via crowdfunding.
In addition to allowing those without significant means to become investors in a project, crowdfunding can also be used as a metric to show that there is community support for a specific project which may be valuable to getting regulatory approvals and permits, and arguing that any profits from a project will go to local pockets. The nature of real estate: tangible, regulated, and well defined by data, make it more compatible with crowdfunding than other type of venture or investments such as software development.
Currently, most portals are independent of specific properties or projects; that is, a developer would come to a portal and sign their project up funding through that specific portal. Fees tend to run 5% to 10% of funds raised plus legal costs for documentation, but this is rather modest compared to typical investment banking costs for start ups and smaller funds. Portals which opened just 2 years ago expecting to be working with 100 developers in a year have far surpassed their goals.
In the future some investment sponsors, developers and building owners may try and become portals themselves to gain direct funding for their projects. We will see a shake out in this industry in terms of portals and probably a few that will be more successful for real estate, but for now it is the wild west and every portal is out to be the last one standing. Industry insiders see the key challenge to crowdfunding’s growth as being the potential for a “bad apple” to tarnish the industry’s reputation. They believe this can be minimized through utilizing education, promotion, and public awareness. Transparency seems to be key to credibility and delivering on what is promised. Specialization by size and geography and property type will surely follow if crowdfunding continues to become a new favored form of capital raising.
Co-written by Brian Sanger, MSRE University of San Diego and Dr. Norm Miller, University of San Diego
- -How real estate crowdfunding is changing the rules?
- -How crowdfunding could reshape and will affect the future of real estate investing ?
- -Process, risk and regulation: how does it work?
- -Crowdfunding vs traditional funding?
Check out the exclusive session on crowdfunding at MIPIM 2015
References
http://www.forbes.com/sites/vanessagrout/2014/09/10/move-over-kickstarter-real-estate-equity-crowdfunding-is-catching-on-with-investors/
Rand, Ellen. “Crowdfunding Scales Up.” Development. Fall 2014 issue. Simon, Ruth and Brown, Eliot(11 June 2014). “Real-Estate Sector Moves Crowdfunding Beyond the Trinkets”. Wall Street Journal. Retrieved 26 June 2014(subscription required).
