By Scott Lichtman
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.
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.