Nov 25, 2013
Sometimes, when you cover your ears to escape all the chatter about real estate crowdfunding, you may ask yourself, “What is the big deal?”
After all, crowdfunding is not new. Indeed, it’s ancient.
“At the end of the sermon, they’re passing the plate,” crowdfunding expert Sydney Armani said at a recent crowdfunding conference hosted by The Soho Loft, a financial adviser for crowdfunders.
Real estate finance is also no stranger to crowdfunding. For decades, intermediaries have aggregated and funneled money from investors to real estate companies that use the money to purchase or develop property.
But the fact is, the technology-fueled method of pooling money for real estate investments that has come to hog the label of “crowdfunding” iterates on its predecessors in a fashion that could transform real estate finance in a big way, particularly once the Securities and Exchange Commission (SEC) fully implements new regulatory changes.
As a result, the differences between crowdfunding and its ancestral forms may be worth exploring. If you’re interested, they boil down to two words: access and transparency.
Accredited investors, all aboard!
Have you ever heard of an investment when you know who else you’re investing with?”
Real estate crowdfunding — pooling money online to purchase individual properties — opens up real estate investments to many more people than traditional “real estate syndication,” crowdfunding’s offline predecessor.
That’s partly because crowdfunders power portals that anyone can visit to glean at least some information about potential real estate investments, whereas in the past, investors could only sniff out syndication deals by tapping existing relationships with syndicators or making direct offline contact with them.
“Almost every investor in our transactions wouldn’t have known about the transactions without us,” said Jilliene Helman, CEO of real estate crowdfunder Realty Mogul, in a crowdfunding panel discussion at The Soho Loft.
Realty Mogul, which crowdfunds both residential and commercial properties, has raised about $8 million for 23 deals since its founding in 2012, according to Helman.
Still, it’s not as if anyone can join the party. Generally, real estate crowdfunders let only “accredited investors” — investors who are worth at least $1 million or have made at least $200,000 a year for the last two years — participate in their deals. In fact, most of them won’t even show their investments on their websites to people who don’t represent themselves to be accredited investors.
That’s because, traditionally, the SEC has allowed companies to raise money from investors without filing for a public offering (a move that is cost-prohibitive for many small companies) only if the companies use a securities exemption, and most securities exemptions don’t permit companies to publicly solicit funds.
According to the exemption that Realty Mogul and others use (Rule 506(b) of Regulation D), maintaining a website that publicly displays deals counts as “general solicitation.”
Ready, set, solicit
But to much fanfare, the SEC recently changed course. In implementing Title II of the Jumpstart Our Business Startups (JOBS) Act, it lifted the ban on general solicitation for private offerings.
Still, many crowdfunders don’t publicly display their investments because, as part of the new regulation implemented by Title II (Rule 506(c) of Regulation D), doing so also requires them to verify that investors are accredited.
Most real estate crowdfunders prefer to let investors self-certify their qualifications — which they can still do if they follow the rule that they have been following (Rule 506(b) of Regulation D) and don’t publicly display their deals.
If crowdfunders advertise their investments, “it now is the issuer’s burden and liability to prove net worth or salary,” said David Drake, chairman of The Soho Loft and a founder of Crowdfund Intermediary Regulatory Advocates (CFIRA). Real estate crowdfunders “don’t want that liability and rightfully so for now.”
Nonetheless, experts say the lifting of the ban on general solicitation is likely to fertilize crowdfunding as companies grow more comfortable with 506(c) and ultimately take advantage of it.
At least one real estate crowdfunder has already decided to test the waters.
Democratizing real estate investment
Fundrise pounced on the opportunity to publicly display a private investment opportunity the very day Title II went into effect in September, posting a $500,000 private offering for a Washington, D.C., commercial property currently occupied by a grocery store, according to CEO Ben Miller.
Fundrise’s trailblazing doesn’t end there. The startup, which Miller said has raised $7.75 million for deals so far, also demonstrates crowdfunders’ potential to drastically increase accessibility to investments by virtually extinguishing the entry threshold for people who want to invest in individual properties.
In addition to doing private offerings with accredited investors, the startup also conducts bona fide crowdfunding: fundraising that draws on the crowd — not just people who make more than $200,000 or have a high net worth. Shares of its “local public offerings” cost only $100 a pop.
Fundrise pulls this off by using a different securities exemption than most other real estate crowdfunders. The exemption (Regulation A) lets small companies raise up to $5 million from the public in a sort of miniature public offering that costs less than a full-blown initial public offering (IPO). Regulation A allows companies to advertise their investments, so Fundrise openly displays all its Regulation A offerings, and, depending on its investors’ preferences, some of its private offerings (Regulation D).