Crowd funding is at a very crucial point in its industrial history. The Jumpstart Our Business Startups (JOBS) Act, and in particular Title 2 and 3, will bring about many changes in the industry and already have since the introduction in 2012. Having said that, it is important to distinguish the different types of crowd funding. The most commonly associated with crowd funding is a simple gift system. An entity offers a tangible object in return for money. This is often done in tiers with the more money donated the more that is received. This type of crowd funding is often called donation based crowd funding and is what one would see on sites such as Kickstarter. The other type is equity based crowd funding where the money invested is actually used to purchase securities within the entity itself. It is in this second type that equity and debt real estate crowd investing is focused with the entity being interested in actual real estate and the laws that govern the transactions are the security laws set forth by FINRA and the SEC2,5.
These laws have brought multiple pros and cons for the process of real estate crowd funding. Some of the pros is that investors can gain access to real estate much easier than before and hopefully realize gains from exposure to the industry. Another pro is that investors can choose the project and the location they want to invest in which is something they do not have control over if they had of invested in a REIT. Investing in a REIT is very similar to buying stock in a company and although the investor holds interest in the company as a whole, it is not tied to any single asset. This amount of control has made crowd funding very appealing amongst accredited investors. No investment is risk free however and there are several cons as well2.
One of the biggest cons for investors is that there is very little liquidity in the deals. There is no secondary market so after the funding process the investor is locked in for the entire run. The next con has to do with default risk. Even the best due diligence can be undone if the market is predicted poorly and without a secondary market investors will lose money. The risk of default through a lack of due diligence is what has led so much resistance.
The laws of investing and more importantly the laws defining the marketing to investors have been significantly changed due to Title 3 of the JOBS Act. It loosens the definition of an accredited investor and with the equity/debt crowd funding industry being fairly new, the industry has been described as the wild west. I believe that this sentiment is true to a certain degree. Laws such as the Blue Sky laws and other security regulations are in place to make sure that investors are given the entire picture when contemplating whether an investment is sound or not. The main opponents to Title 3 state that it has no way to protect unaccredited investors who can’t tell even with the information if the deal is sound and that they may be subject to fraud1,3,5.
Even with all of the pros and cons, I believe that crowd funding is beneficial to the real estate industry because it opens up possible opportunities within the real estate market that would of otherwise been inaccessible to any but high wealth individuals. In the end, even if people don’t like it or do like it, the real estate industry is going to need to adapt to it.
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1. Small Biz Jobs Act Is a Bipartisan Bridge Too Far. Bloomberg. October 27, 2014.
2. SEC Proposes Crowdfunding Rules. CFO.com. Retrieved 24 October 2014.
3. Comments on SEC Regulatory Initiatives Under the JOBS Act: Title III — Crowdfunding. N.p., n.d. Web. 25 Oct. 2014.
4. Comments on SEC Regulatory Initiatives Under the JOBS Act: Title II — Access to Capital for Job Creators . N.p., n.d. Web. 28 Oct. 2014.
5. Jumpstart Our Business Startups Act.
About the author:
Jared Rodio is studying at the University of San Diego, working towards a Master in Real Estate.
Top image via Thampapon