Crowdfunding for real estate is gaining momentum. The basics of real-estate crowdfunding are the same as various other crowdfunding formats. In this method of property financing, the real estate developer approaches a large number of investors to fund his project via the internet, rather than going in person to a single company or a high-net-worth individual.
Real-estate crowdfunding is mostly equity- or debt-based, and hardly ever reward-based. It is an opportunity for investors to invest money in quality institutional properties. The fundraising is done through popular online platforms like RealtyShares, RealCrowd, FundRise, EquityNet, Realty Mogul, Patch of Land and others. Real-estate crowdfunding platforms showcase both projects under development and completed projects. The projects can range from office/retail spaces and apartments to skyscrapers.
Crowdfunding platforms that cater to the real-estate industry are steadily increasing. Despite this, these sites account for only a fraction of the capital that is raised for real-estate funding. This shows the huge potential that real-estate crowdfunding holds.
The real-estate crowdfunding industry is likely to gain more traction when investors across the globe perceive it as a simple and safe way to invest. Previously, a real-estate developer could approach only accredited investors for real-estate crowdfunding. Now, with new legislation in place, even non-accredited investors can be solicited.
One such example is Pure Capital Funding, a Birmingham-based crowdfunding platform that allows non-accredited investors to invest in Michigan-based real-estate projects. Another platform, Fundrise, also allows non-accredited investors to invest in real estate. Realty Mogul lets a number of investors to pool their money and invest as little as USD $5000.
Further, Fundrise allows investors in the U.K., Canada, and Australia to invest, while RealtyWealth is exploring options in China, South Africa, Latin America, and Canada. Others, like SeedFeed, aggregate deals from multiple platforms, while iFunding offers a mobile app to connect to investors.
Cheaper capital for the developer & access to investments for the investor…
From the developer’s point of view
- New form – Crowdfunding is a boon for real estate developers. They now can raise funds at a much lower cost base. Normally, banks come with a lot of overhead costs in the form of infrastructure, labour etc. However, with crowdfunding, the cost of capital for the developer is much lower than with banks, private equity funds and moneylenders.
- More efficient – Crowdfunding platforms are faster and more efficient than the traditional methods of finding investors. This is due to the global reach of these platforms. Some realty projects have been crowdfunded in just four days. This is much faster compared to the months of waiting for clearance typical in the traditional set-up.
- Higher returns – Crowdfunding involves technology and can hence eliminate middlemen. This helps companies earn higher profits, which the developer can share directly with the investors. According to industry experts, the average return-on-investment exceeds those of traditional investment alternatives.
From the investor’s point of view
- Choice of projects – Individual investors with no prior experience in real-estate investing have access to a myriad of projects. They can now weigh various options and make measured decisions on their real-estate investments. Investors can access billion-dollar projects that were otherwise available only to institutional investors or high-net-worth individuals. They need not invest in REITs (real estate investment trusts) that invest on their behalf.
- Small investments – A minimum of USD $50,000-100,000 is required to participate in the traditional method of real-estate investing. On a crowdfunding platform, individual investors can invest very small amounts. These highly transparent platforms charge a much smaller fee compared to private equity funds and REITs.
- Diversification – Investors can allocate small amounts across multiple projects in different geographical locations. This enables them to diversify their investment, and lower their risk. The investors don’t get directly involved with any issues related to the property. This makes it relatively safe for the investor to put his money in.
How to crowdfund real estate…
Since the industry is still evolving, the approach to raising funds is distinct on different platforms. Here’s a broad outline of how real-estate crowdfunding works:
- The funding platforms verify the track record, structure and quality of the property. These platforms try to do due diligence on the developer to ensure investor protection. According to Nav Athwal of Realty Shares, “Realty Shares receives almost 1,000 applications a month, but puts only 5 percent onto its platforms.”
- Once the real-estate developers finish the due diligence process, they launch their campaign on an appropriate platform. These developers have a funding goal. When the funding goal is reached, the developers execute the project.
- Typically, the performance of the property, along with the deal documents, photographs of the property, offer agreements and a confirmation of issuance of membership units must be communicated to the investors on a regular basis. Tax and other required documents also need to be provided on an annual basis.
Broadly, the investments can be solicited in two different ways. One is the Equity mode, where investors are given shares in the property. The other is through loans, which pay monthly interest and the investment is secured by the property. The former falls in the high-risk, high-return category, while the latter provides steady income to the investor.
Challenges & Risk of Real Estate Crowdfunding…
Traditional real estate investment happens within a well-established regulatory framework. The evolution of real-estate crowdfunding will depend on how efficient and streamlined these regulations become in the future. The credibility and long-term viability of crowdfunding platforms will play a key role in determining this future.
Legislation will continue to evolve with amendments and thresholds, according to the needs of the market. The legal requirements are much more relaxed for accredited investors (i.e., individuals with a net worth of USD $1 million or an annual income of more than USD $200,000).
Easing of the regulations for non-accredited investors will address a whole new unmet market. At the same time, it’s better for non-accredited investors to remain in the protective arms of the government until they learn the rules of the game.
Further, investors stand to lose money if the market goes on a downward spiral. There are higher chances of a default compared to the traditional method of real-estate investing. Since there is no secondary market, there is also a lack of liquidity for the investor.
Raising funds from accredited investors differs from raising money from non-accredited ones. Currently, three kinds of crowdfunding options fall under various SEC rules. The table below should help you understand them:
|Heading||SEC Rule 506(b)||SEC Rule 506(c)||SEC Regulation A|
Raise unlimited amount of money from an unlimited number of investors
|Raise unlimited amount of money from an unlimited number of investors||Raise up to USD 50 million per year from an unlimited number of investors|
|From Whom||Accredited investors and up to 35 non-accredited investors||Accredited investors||Accredited investors and non-accredited investors|
|Advertising||Only existing customers allowed to see the deal on the internet. Need to register and wait for a cooling period of 30 days to view and invest in a particular project||Anywhere - Newspapers, radio or the Internet||Anywhere - Newspapers, radio or the Internet|
|Other Details||All necessary disclosures like financial statements and opinion of counsel required if even one non-accredited investor participates||Responsibility of the developer to check investor’s tax returns and/or financial statements.||Mini IPO, filing of a lengthy registration statement with the SEC, time consuming and significant legal fees.|
The Bottom Line
The number of deals, the volume of deals and the speed at which deals occur suggest that real estate crowdfunding is maturing. Mergers, consolidations and substantial partnerships are also anticipated within the crowdfunding platforms.
The marriage between two unlikely partners – real estate and crowdfunding – seems to be turning out quite well. A few years down the lane, when banks may sit on the sidelines, real estate crowdfunding could become mainstream and see participation from both accredited and non-accredited investors.