Crowdfunding changing real estate financing for operators and investors

By Scott Lichtman
iFunding

Two years ago, U.S. Congress passed the JOBS (Jumpstart our Businesses) Act, which empowered smaller companies to raise financing more easily.

The law also opened the gates for long-term expansion in the real estate investor base, through crowdfunding.

Crowdfunding uses secure websites to list a variety of real estate projects seeking financing, to match those needs with investors individually contributing thousands to hundreds of thousands of dollars, and to manage the legal setup, promotion, transactions and reporting.

Assuming real estate crowdfunding follows the path of ‘crowd’, or peer-to-peer, consumer lending — where companies such as Lending Club and Prosper have facilitated over $4 billion in debt financing, and hedge funds are putting money to work on these platforms — then crowdfunding will transform our industry as well. Let’s examine why investors see crowdfunding as a unique way to participate in real estate; how developers, operators and financiers can get involved; and what the future may bring.

Compared with other types of real estate investing, crowdfunding can be easier for the average investor to become comfortable.

In contrast, publicly traded REITs may be more liquid, but the portfolio holdings are not very transparent. REIT market valuations can fluctuate rapidly according to changes in the economic environment, which many investors find hard to understand.

By contrast, the same investors feel they can estimate the fundamentals of a property’s value, especially residences with comps, when it comes to investing in a specific property, as one does through crowdfunding.

SCOTT LICHTMAN

SCOTT LICHTMAN

Next, when considering being a limited partner on a closely held project, investors with discretionary wealth often respond that they neither have the funds necessary to become a sought-after deal participant to project sponsors, nor do they have a means of screening promoters.

Contrast this to crowdfunding, where investments in a project can be as little as $5,000 or lower, every listed deal is accessible to all registered website users (some sites only work with accredited investors), and promoters are pre-screened.

Crowdfunding is most similar to traditional syndications, but with a scalable technology element. Deals are more transparent, because all the information is online.
Publishing responses to all questions about a deal makes for better investment education. And, an investor can compare many investment opportunities at the same time across crowdfunding sites.

There are approaching 50 platforms participating in real estate crowdfunding.

Carlton plans to focus on very high net-worths investing $1 million or more per deal. Groundfloor is supporting individual investments under $1,000 for projects in particular states. Others, like Lymo in France, focus on a particular country.

Our firm, iFunding, takes a broad project scope — funding residential and commercial projects with equity or debt in the US and soon in Asia — while opting for a conservative entity structure, serving only accredited investors under the established framework of Reg.D, rule 506(b).

Based on recent announcements of the leading crowdfund sites, we estimate that in 2014, $100 million or more of real estate projects will be financed across platforms.

This is a modest figure versus the overall real estate industry, though it’s displaying exponential growth that is comparable to other hot startup markets over the years, such as e-commerce. The crowdfunding deal landscape runs the gamut from equity to debt financing; refurbishment-to-sell to buy-and-hold; existing properties to new construction. The property types have included single families, multi-family, retail, mixed use, industrial and storage facilities and a number of projects at prominent addresses in major cities.

In iFunding’s experience, investments subscribe most quickly when the crowdfunded dollar-raise ranges from just under $100,000 to roughly $500,000. Crowdfunding strategies that are proving most effective for operators right now include:
• Single-Family Home Refurbishments. Crowdfunding is being used to finance 100 percent of the equity or debt on single-family home flips and 1-4 unit refurbishments. Operators appreciate the ability to close quickly on properties under contract. These operators report that, while they may be able to finance some projects at slightly better terms, they look to crowdfunding to scale the number of projects they can take on at once. We have found that some investments of this type fund within days if not hours.
• New Residential Construction. Operators are using crowdfunding to finance new residential construction, including higher-end homes and condos. Investors may be slightly more cautious evaluating these projects because of the longer project durations versus flips. However, a developer with repeated success building and selling a particular type of residence, in a market they know well, will be able to make a solid case to the investors.
• Tranches of Larger Commercial Deals. Other operators are using crowdfunding to finance a tranche of a larger commercial deal, including retail or mixed-use.

Developers are using who are experimenting with crowdfunding for larger projects are interested in expanding their investor base locally. This might be because community buy-in plays a role in project approvals, or because the developer is looking for an inexpensive ways to be introduced to accredited investors.

What to expect, when expecting to crowdfund? Many crowdfunding services evaluate 20 or more proposals for each deal they choose to list.

The mutual evaluation process can be quick: a few days for straightforward projects with iFunding, and up to a few weeks to complete terms for more sophisticated projects. It’s best to propose a project within your proven area of expertise. For example, a developer who has built or operated 20 or more units of the same property type, in the same region/city as the new project, is more likely to gain the crowdfund services’ and investors’ confidence. After a successful raise and progress on the first project, subsequent projects tend to fund faster.

Because investors don’t have face-to-face introductions to the developers or properties, the operators’ on-paper backgrounds become even more important.

Using crowdfunding doesn’t guarantee that a project’s financing target will be fully subscribed. Somewhat counterintuitively, it can help to seed a project’s progress by introducing some of your existing investors to the crowdfund platform to achieve initial momentum.

Going further, if an operator liked how the crowdfunding service took care of the legal, financial and administrative aspects of a deal – allowing the operator to focus on the on-site project activities – then the operator may pursue with some of the crowdfund sites, including iFunding, whether they could bring many or all of their investors to the table, at a discounted administration fee.

Crowdfunding has the flexibility to address a number of strategies, including the enhancement of affordable housing initiatives with community investments online. We believe the future may involve a blend of institutional and individual investors acting in parallel online, possibly on different equity and debt tranches in a deal.

Overall, the time seems ripe for operators and investors to begin piloting crowdfunding on a selection of projects.

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  • William Kline

    Been studying crowdfunding for over a year now, figuring out how companies work with investors over these portals. I agree with the article; It seems like the typical investor would need to feel comfortable with more than just the deal but the sponsor and the crowdfunding company underwriting the asset. But how involved is the sponsor in rallying investors around his projects? Is that up to the sponsor, the crowdfunding company, or a non-partisan registered investment advisor. It’s worth mentioning that the guys over at http://groundbreaker.co/ are doing a great job at answering questions. Would be great to hear your take, Scott.

  • William Kline

    Been studying crowdfunding for over a year now, figuring out how companies work with investors over these portals. I agree with the article; It seems like the typical investor would need to feel comfortable with more than just the deal but the sponsor and the crowdfunding company underwriting the asset. But how involved is the sponsor in rallying investors around his projects? Is that up to the sponsor, the crowdfunding company, or a non-partisan registered investment advisor. It’s worth mentioning that the guys over at http://groundbreaker.co/ are doing a great job at answering questions. Would be great to hear your take, Scott.

    • Terra Funda

      We have just listed our first projects on the new groundbreaker.co platform, so you can follow that to get an idea of how this is developing at our link:
      projects.terrafunda.com

    • Hi William, we find all sponsors are closely involved in answering
      questions about their projects. Some however have a larger existing
      social (real estate) network and experience with outreach. Leveraging
      this can dramatically increase the speed of funding. So as in all
      industries, building your network is a key advantage. At iFunding, we spread the word for the sponsor and the project through webinars,
      blog posts, site photos & video. We’re quite interested in
      investment advisors communicating to clients about crowdfunding,
      though it seems to be outside their focus for many right now. If you
      know of some that would like to discuss direct real estate investments
      online for their clients, do let me know via ifunding.co 🙂 And you’re right, our team also finds that answering questions ASAP is a big driver of returning investors. – Best wishes, Scott

  • Snowy

    It will surely give a new dimension to the investors as well as to the operator for their upcoming business.
    http://www.lefrois.com/

  • Joseph Hogue

    Crowdfunding is the practice of funding a project or venture by raising monetary
    contributions from a large number of people, typically via the internet. We fund people as well as companies. Grab this golden opportunity and fulfill your ambitions.

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