Crowdfunding may have a more significant impact on the commercial real estate industry than previously projected. Steve Renna, President and CEO of CRE Finance recently reported on the Commercial Real Estate Show™ that even traditional lenders are looking at crowdfunding. The CRE Finance Council is the trade association for the $3.2 trillion commercial real estate finance industry, so it’s time to take notice.
Follow the Crowd
In 2012 the JOBS Act (acronym for Jumpstart Our Business Startups) was signed into law, enabling public and online offering and sale of securities. It has spawned a rapidly growing crowdfunding community, showing every sign of making a significant impact on the commercial real estate marketplace.
Before the JOBS act, real estate developers and sponsors couldn’t advertise generally for investors. Per the US Securities Act of 1933, to solicit funds from public you had to register with the SEC, a fairly onerous process.
“But that didn’t mean we weren’t raising capital from pools of investors,” noted Douglas Ellenoff, of Ellenoff, Grossman & Schole, a leading law firm in the crowdfunding space. “Your listeners might be familiar with the ‘friends and family’ offering.”
This is also known as a Private Placement, used in syndications, and it made a limited form of marketing possible under Regulation D. This required existing relationships between sponsor and investors, and accredited investors.
“With 20 years’ experience in real estate and securities law, my firm was well positioned,” Ellenoff told me. “When the JOBS Act brought crowdfunding to the forefront, we were ready.
“Unlike other forms of businesses seeking capital, the real estate community already understands syndication. You are ahead of the curve when it comes to successfully deploying crowdfunding.”
The Key Provisions of the JOBS Act:
Title II - Access To Capital For Job Creators
This regulation, enabled 16 months ago, permits a real estate sponsor or developer to raise money through general solicitation and marketing, including online portals. Although Title II doesn’t require a technology platform, it does empower it. Title II requires verified accredited investors, those of greater means, defined as annual income greater than $200k or over $1 million in net worth. It puts more responsibility on the offeror to verify the investor’s status than past regulations.
Title II is more relevant for the CRE audience: it allows the raising of greater amounts, has simpler fees and fewer limitations. Its only drawback is the stipulation of verified accredited investors.
Title III - Crowdfunding
Still awaiting final approval from the SEC, Title III allows offering to the broadest group of potential investors. It requires a regulated online portal and permits non-accredited investors. The SEC plans to finalize the Title III Equity Crowdfunding rules later this year.
Title 3 defines limits on the amount and frequency of transactions that may limit its usefulness to the CRE community. Once it becomes available, a developer can raise up to $1 million dollars through an official funding platform. There are limits on the amount an individual investor can put into deals. The sponsor can only do one $1 million raise once per year, and may not to conduct multiple raises through multiple entities.
Title IV – Crowdfunding
Title IV was just approved be the SEC allowing non non-accrediting investors to get in the game limited to 10% of their income/net worth. This could be significant as it comes into play in about 60 days. Chance Barnett in his Forbes article shares the details and his view on the impact these changes will bring to the landscape of private investing and fundraising.
Working the Crowd
Investor appetite for crowdfunding is ramping up, with over 70 portal sites operating as of today, and the amount of funds raised is climbing. Just how much equity has been raised since this took off in 2013?
“We don’t have reliable numbers on this yet,” said Ellenoff, “but we’re hearing numbers between $500 million to $1 billion raised online. Offline, it’s multiples of that. Funds per deal are increasing as people get more comfortable. The real estate crowdfunding community is quite lively right now as more offerors and investors get involved.”
Ellenoff noted that the commercial real estate business is also benefiting from the infusion of social media connectivity.
“The connectivity of the portals inspires much wider communications. It facilitates relationships and sales opportunity, and it’s really broadening the reach of the CRE profession.”
The Three Distinct Portal Types:
Broker-Dealer: Transaction-based compensation. The site takes a commission, and has all the rights and responsibilities of a broker. The only site model to get paid commission.
Benefit to investor: the broker takes some responsibility.
SPV– Special Purpose Vehicle: Not a broker-dealer, but creators of a fund. Performance based compensation. This site type matches partners to money. The portal participates in the deal as a general partner. Fee paid for ongoing management.
Posting Site – Paid per listing, only paid to list the information, no claims or verification. The fee is all they get, typically $500-1,500.
While it’s true that a buyer definitely should be aware, the people who run the portals are earnest professionals and they are vetting these deals.
“There is no incentive to bring lousy deals,” explained Ellenoff. “The ‘crowd’ in crowdfunding has social media and the power of noise at their disposal. If you misrepresent the returns possible in a deal, you will not stay in business.”
Every type of portal does some level of due diligence. No funding platform will survive if they allow bad deals. But, the Broker-Dealer portal is regulated and licensed, and has the highest level of responsibility for due diligence of any portal type.
In the SPV model the portal functions as a General Partner, with fiscal responsibility for other peoples’ money. Typically they have skin in the game. A Posting portal site has no regulated responsibility, but they are certainly screening their projects.
CRE businesses can have multiple streams of income, broker fees, leasing fees, maintenance fees, management fees, commissions, and all these expenses must be disclosed to the investor. Basically, be crystal clear about where money is going.
A Growing Business
“It’s been exciting, the incredible ascent of the crowdfunding scene, as more people discover it as a viable source of capital,” said Jilliene Helman, Founder of Realty Mogul, one of the first and most successful crowdfunding portals.
“Originally we were focused on the high net worth individual who wanted access to real estate earnings. Now we’re getting more demand from institutional investors. They want to play online and tap into new sources of business.”
Also, Helman noted, we’re also getting an infusion of interest in debt products.
“Entrepreneurs and investors are fed up with banks and loan brokers, and they need bridge loans, construction loans, and more,” she explained. “We’re creating a better, less onerous way to get a real estate loan.”
Helman emphasized that when you choose a crowdfunding portal, it’s most important to make sure the company actually has a ‘crowd’ – that they have access to plenty of capital.
“We raised a $73 million commitment from a hedge fund to give us that ‘certainty of capital.’ When you’re ready to fund, you want to know that the money is there.”
Her site does extensive pre-vetting: underwriting, analysis, fact checking, background checks, criminal checks, and variance analyses. But every investor is different, so make sure the risk profile is comfortable for you.
“Even if you invest a dollar,” added Helman, “due diligence is core to real estate; you don’t want a whole lot of surprises.”
Liquidity in Commercial Real Estate?
Speaking of exits, what if you urgently need to get funds out of a deal? Until now, investors didn’t have many options. Kevin Guy, CEO of Real Liquidity called Studio One to talk about an exciting new solution.
“We’re developing a secondary market that provides liquidity for these markets,” Guy told me. “It’s not only for crowdfunded projects, but also for syndicates. If you need to get your funds out before the planned exit, we’re creating a market where you can sell your shares.
“Crowdfunding has pushed us to the forefront, and it’s growing so rapidly, some of these new investors will find themselves needing liquidity. This is one of the big reasons people hesitate to get involved in real estate deals, so we’re filling a need.”
The Real Liquidity site is in development, completing the build out of their platform, and they expecting to be up and running in the next 90 days.
In order for shares to be tradable, Real Liquidity needs to approve the project. A project’s founding documents must include correct language allowing a share to be sold. Sponsors should build this into their details to attract more retail investors.
“This concept is in its infancy;” Guy noted, thoughtfully. “So far there’s lots of curiosity, of watchers on the sidelines. As crowdfunding has experienced its successful beginning, great deals have happened, with great yields, typically 8-14%. So the retail investor is getting more willing to take risks.
“We’re here to help more people get in the game.”
7 Tips for Crowdfunding Investors:
Make sure you choose a reputable crowdfunding portal.
Don’t invest more than you can afford to lose.
Study the track record of the sponsors and project manager.
Take a good look at due diligence, ask tons of questions, and know what kind of performance you can expect from the property.
Also, vet the locale. Investing in an apartment building in Detroit is a very different story from investing in multifamily in San Francisco.
If you are putting a significant sum of money on the table, consider getting a third party expert to help you with your evaluation.
Most importantly, always use your common sense. To hear more on crowdfunding check out the podcast from the Commercial Real Estate Show on iTunes or the show web site.