Would you like the opportunity to own a piece of residential or commercial real estate or make an investment in a mortgage loan? Today, investors around the country are receiving e-mails and other solicitations, as well as hearing from the media, about the opportunities to invest in the booming real estate market.
Online, it appears as if hundreds of companies are interested in offering qualified investors with the opportunity to invest in commercial and residential real estate. It is as easy as searching for “crowd funding for real estate” and hundreds of companies names will be listed offering investors “the once in a lifetime chance to invest in real estate”. Recent changes in securities laws have allowed more individuals the opportunity to invest in commercial real estate.
Each and every day, more people are hearing the term crowdfunding, especially for real estate investments. The April 13th, 2014 edition of the Wall Street Journal profiled the use of crowdfunding for the sale of shares in a variety of real estate ventures with investments as low as $100 to several millions.
In April 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law. The JOBS Act requires the SEC to write rules and issues studies on capital formation, disclosure and registration requirements. The act has allowed entrepreneurs, including real estate developers from certain restrictions, to solicit and raise capital in small amounts from a broad number of individuals. The Act was designed to streamline the process through which startups and business could raise funds by selling equity capital and soliciting small investments over the Internet.
The Act enables average investors to access more complicated investment opportunities that were previously available to “accredited investors” who earned more than $200,000 a year, or who have a net worth exceeding $1 million. The new law creates an entirely new exemption from registration under the Securities Act, which will permit companies to publicly offer and sell up to $1 million in securities over a 12 month period without needing to register.
These sales, known as crowd funding transactions, are facilitated over the Internet and are subject to several restrictions, including the following:
- If an individual investors’ annual income or net worth is less than $100,000, he or she may invest no more than the greater of $2,000 or 5% of his or her annual income or net worth.
- If his or her income or net worth is higher than $100,000, then he or she may invest no more than 10% of annual income or net worth and never more than $100,000.
A new type of broker known as a “funding portal” must be used to facilitate the sale. Last year, crowdfunding organizations created a number of websites devoted to the promotion of the new vehicle, which offer portfolio diversification and access to commercial real estate deals for individual investors as well as project financing for real estate developers.
The funding portal will be required to register with the SEC and other organizations (such as state regulatory authorities), and to confirm that the investors satisfy the investment requirements and can bear the risk of the investment.
Companies that use the crowdfunding process will have to file with the SEC and disclose certain information to the parties involved, such as their business plan, a description of the company’s capital structure, and the intended use of the proceeds. Audited financial statements will be required for offering of more than $500,000. After the offering, the company will need to file ongoing reports with the SEC, based on rules to be determined by the SEC.
Perhaps the major difficulty for an investor in the world of crowdfunding is to determine the entity where they are comfortable to invest and understand the ramifications of this process. Nevertheless, here are some thoughts on the benefits and disadvantages of crowdfunding.
Main advantages of real estate crowdfunding for investors are:
- There is a minimum investment of $1,000-$10,000
- Individual investors employ an expertise of a portals’ executive team to vet lucrative investments and to project future returns
- The portals offer new level of transparency and real time information about the properties
- Unlike in public and private real estate investment trusts (REITs), an investor can choose specific properties, he/she want to participate in funding of
- An investor can choose between debt and equity deals
- A passive investment (no responsibility for the property management of the asset)
- An investor is not limited in geography an asset class for the investments
- An individual can mitigate risks by co-investment alongside hundreds of other stakeholders, sometimes including large investment funds.
Main advantages of real estate crowdfunding for developer are:
- Access to funds from a large pool of geographically diverse investors
- Access to marketing and legal expertise provided by a crowdfunding platform
- Big potential for community oriented projects
While new real estate crowdfunding portals emerge every month, there are many skeptics and opponents of the idea in general.
Here is a list of the most common concerns:
- Portal investors do not have voting rights and will not be able to influence decisions of a property management
- If crowdfunding is the last resort for the project, maybe it’s not a sound investment
- Here’s the most important thing to remember: Good developers and investors with proven track records will propose quality development or acquisition projects and can get cheap financing from banks that compete vigorously for such deals. That’s doing to vie the investors the most profit, and maximizing profits is there goal.
So what type of developer or investor would chase crowdfunded capital from the general public? These are typically inexperienced developers and investors, or ones with limited financing options due to pitching low quality, high-risk deals. Some may have even lost prior investors’ money.
- The risk of dilution for a project investors if future capital is needed is too high leaving the initial investors unprotected
- If invested in equity, an individual would have to hold the shares for indefinite period of time because there is no secondary market for this type of securities
- For a developer it would be very consuming to deal with hundreds of inexperience shareholders as well as risky in terms of potential lawsuits.
Even if the crowdfunded deal you are considering is via an experienced developer or investor, there’s still a chance that the deal will go sour. In some cases, the developer will take large fees out of your ‘investment” or your money could be stuck in a deal for years, if not a decade or longer.
Zillow suggests that if you are going to invest in any private real estate deal, you should require the “sponsor” who is pitching the deal to provide you with the following:
- An offering showing how much equity the sponsor has at risk in the deal.
- An analysis of how this deal will make money and how the project fits in to the area.
- Extensive documentation and proof of the sponsor’s past history doing deals, including bank and past investor references. It would be smart to review a copy of the sponsor’s credit report to verify past borrowing and repayment history, and even requesting tax returns, would not be out of bounds.
We are in the early days of crowdfunding for real estate. It will take a number of years before this industry will mature and go through a recession and additional legislation. Currently, it is a maze to understand all of the players in the market.
Since there are not guarantees that your investment in real estate will appreciate, you must be willing to sustain a loss of principal before investing.