Crowdfunding has swept through large verticals of consumer finance, including student loans and credit card debt. And so, naturally, in a market of rising property values, the real estate market is the latest frontier for crowd-based financing.
Seemingly overnight, the funding solution appears to have gone from crickets to crammed, with everyone claiming to be the first to hit the innovation trigger. But the question of who came first is irrelevant compared to whether or not crowdfunding will ultimately work as an answer to financing a more vibrant real estate market in America.
At this point, several peer-origination platforms that HousingWire spoke to have evolved to generate up to two-thirds of their capital from institutional investors and are actually becoming even more institutional based, according to one market analyst.
Luckily, there’s still room for the little guy. That’s because although platforms are increasingly tapping into high-net-worth investments, some still find value in keeping the small-dollar investor around.
For investors, the allure of crowdfunding is the opportunity to tap an asset class they may not otherwise have been able to access, or to access better yields. For the borrowers, crowdfunding cuts out the middlemen and cheapens fundraising. In some cases, it’s as easy as going to a website and clicking through the prompts and putting down a couple hundred bucks.
WHAT STARTED THE HYPE?
The buzz around crowdfunding for real estate investments kicked into a new gear back in May, when the subject became the topic of a closed session, held in the halls of the Boca Raton Resort & Club, during the IMN REO-to-rental forum.
What was most interesting about this development is that the REO-to-rental emerging asset class is often charged with the disproportionate presence of investment speculators. However, there is now plenty of money talking about large amounts of property volume.
And some of the attendees were successfully pushing their latest platforms. Tieback completed a few rounds of testing and successfully deployed $65 million to borrowers in one fiscal year to “prove business concept,” according to its crowdfunding site. Tieback is currently raising Tieback Realty Services Fund II to deploy even more capital.
“We’re looking at crowdfunding our REO-to-rental holdings,” said Richard Neil McCay, president of Tieback Holdings. “It democratizes the funding process. You start with your circle of friends and eventually the opportunity expands to everyone.”
Most capital in real estate consists of managed funds on behalf of somebody else, like private equity companies for example, which are ultimately funded by high-net-worth individuals or institutional investors.
But what’s really attractive about crowdfunding, proponents say, is that it’s a cheaper product to bring to market.
“If those investors can invest directly into deals, they are cutting out a whole layer of fees,” said Daniel Miller, co-founder of Fundrise.
Fundrise was started four years ago to do creative retail developments in Washington, D.C. The company’s new focus on institutional money is indicative of a larger shift in the crowdfunding industry.
Miller said that starting next month, Fundrise will allow an institutional investor to invest between $10 million and $20 million in a portfolio of buildings through its platform. So far, its investors can only buy into individual buildings.
On May 28, the company announced that it raised more than $31 million in financing from a consortium of real estate, technology and financial institutions.
Miller said the recent capital raising will help the company target bigger projects by tapping into institutional money and rich individuals.
The company is looking at several ground-up developments in Manhattan and Brooklyn with a cost of more than $100 million each, for which it would seek to raise $15 million to $40 million each through crowdfunding.
However, Miller said that while the company is “growing-up” to court big institutional money, the small cash investors are still integral to its platform. “The formula makes sense because these local investors know the asset, know the neighborhood and are connected to it,” said Miller.
The idea of local, community investment is ideal for projects like the one that Fundrise set up in the city of Detroit. The city declared bankruptcy in mid-July 2013. Via a partnership with The Kresge Foundation, Fundrise plans to get the local community to invest in the revival of the city.
Miller said that the small $100 investor is still very important to the Fundrise platform. “We started this to give everyone the opportunity to invest in projects, to allow them to connect to projects that matter to them,” said Miller.
According to Miller, it took the company two years of regulatory filings and nearly $1 million in legal fees for its first project to launch in August 2012. Anyone in the D.C. area could have invested in that deal for as little as $100.
Sharestates, another crowdfunding platform, which set up in 2013, also stresses the importance of tapping the small-money investor base. “It’s important to us because we grew up on the other side of the tracks,” said co-founder Allen Shayanfekr. “We’ve all worked very hard to get to where we are, but we always wished we had these opportunities when we were just starting out.”
The popularity of crowdfunding can also be attributed to the simple fact that the unaccredited user base is huge, since 98% of Americans don’t qualify as accredited.
REACHING TO THE CROWD
If the street of crowdfunding appears paved with gold, it’s important to remember someone still needs to set down the asphalt. In other words, crowdfunding takes sweat and labor to get up and running. For one, courting the small-dollar investor doesn’t come cheaply. Fundrise said that each deal it does with $100 minimums still requires review by the SEC — a process that can take six to nine months.
Shayanfekr said that the Sharestates platform handles all the reporting, tax and distribution requirements. “We have brought everything in-house, allowing us to operate more efficiently. For instance, our public offerings cost one-tenth what our competition has paid and we have also completed the filings in one-third the time.”
At Fundrise, Miller said that the platform employs a template of documents for different types of securities that include mezzanine, senior debt and preferred equity. “We close the deal, manage the investor reporting and we then service the loan on a monthly basis,” said Miller.
Even private equity companies are tapping into the notion that crowdfunding can both access a new investor base.
The Carlton Group, which has structured and invested in high-yield real estate investment opportunities since 1991, recently launched a crowdfunding platform for high-net-worth individuals that want to test out real estate investments.
Investments are limited to accredited investors with a minimum investment requirement of $1 million and up to a maximum of $50 million per investment, with transaction sizes ranging from $20 to $200 million.
One of the main advantages for accredited investors in partnering with Carlton is the high quality, multibillion-dollar pipeline which Carlton has as a result of property owners and financial institutions who utilize Carlton to access capital for their transactions. All of the deals that are currently on the platform are Carlton’s. The private equity group also intends to invest its own capital into each crowdfunding investment.
CROWDFUNDING SINGLE-FAMILY RENTAL
Nearly all of the sites focus on a gamut of commercial real estate assets that include multifamily properties, retail and office properties.
Miller believes that there remains an enormous application for the broader idea of crowdfunding within real estate because these platforms create “more efficient supply and use technology to connect it and it’s a more efficient delivery vehicle.”
“What is happening is that alternative platforms using technology are starting to take off slices of the [single-family home] market,” he said.
At Sharestates, the goal is to offer a diverse set of options such as the geographic location of the project, the project’s type and its financial structure. “We offer everything from residential to commercial to ground-up development to loans,” said Shayanfekr.
“We will offer equity and loan positions in residential properties primarily for fix and flip purposes, but also for short-term purchase/rental scenarios in the case of a loan,” he added. “Our goal is to always be as conservative as possible in order to protect our investors. That being said, only 2% to 3% of the deals we review actually make it onto the site.”
The problem, said one market pundit, stems back to the subprime residential mortgage-backed woes of 2008. Investors today are more skittish when it comes to the notion of pooling residential mortgages and need more transparency on the risk they are taking.
“But how do you certify that all of the investors are OK with the fact that an asset may lose its value a lot quicker than expected, as can be the case for some of these loans where the valuation may not be stabilized?” asked one market source. “And investments in the asset class are also more heavily regulated so it’s a lot more of a headache to do anything with single-family investments.”
CROWDFUNDING LAW
In April 2012, President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. Also known as “the crowdfunding bill,” the JOBS Act aims to lessen regulation burdens on small businesses and legalized equity crowdfunding.
The law permits a private company to sell to investors in any state in the U.S., securities which are financial instruments that often represent an ownership interest in the company, in smaller amounts such as $2,000 to a large number of unaccredited (not wealthy or accredited investors and more specifically defined in the federal securities regulations) investors, without registering the securities with the Securities and Exchange Commission or state regulators.
This included removing the ban on general solicitation that prevented entrepreneurs from publicizing that they’re raising money.
New proposed rules on crowdfunding under the JOBS Act would raise crowdfunding limits from $1 million to up to $5 million.
The new law also allows for self-certified financials for raises under $500,000 — and independently reviewed financial statements for raises between $500,000 and $3 million. The law leaves the more onerous audited financials for raises above $3 million.
It would also eliminate the requirement that the SEC promulgate rules requiring detailed, registration statement-like non-financial disclosure resembling a public company report.
Shayanfekr said that while current crowdfunding platforms are operating within existing laws, the first set of proposed rules made crowdfunding largely “unworkable.”
“We are hopeful the new rules will address some of those issues,” he said. “If the new rules raise the $1 million minimum and the audit thresholds, then involving the public will become that much easier.”
