Real Estate and Crowdfunding: A New Path For Investors

Can two investment mind-sets – one old and one new – get along with each other without driving each other crazy? That is the key question that is posed by crowdfunding in the real estate market, and one being answered in mostly positive ways. This odd couple of crowdfunding meets real estate appears to be pairing up quite nicely and giving investors a new way to leverage investments in the global real estate market.

Mostly for Wealthier Investors (For Now)

Indeed, the real estate crowdfunding site iFunding estimates the size of the combined market at more than $11 trillion! At a recent industry conference in New York City, Markley Roderick, a lawyer with Flaster/Greenberg PC and the conference moderator, addressed new regulations linked to the Jumpstart Our Business Startups (JOBS) Act of 2012. These rules allow mostly affluent investors (with a net worth of $1 million or more) to gain direct access to the real estate market through crowdfunding, or peer-to-peer lending (among other investment markets).

While the U.S. Securities and Exchange Commission explores ways to allow investors of all income levels to access the real estate market online, Roderick says that wealthier investors are already investing on crowdfunding sites like iFunding, Realty Mogul, CrowdStreet, and Fundrise. “If only a small percentage of them invest only a small amount of their assets in real estate, the market will be trillions of dollars,” explains Roderick.

Real Estate Crowdfunding

Crowdfunding makes use of social networks such as friends, family, and colleagues linked through social media websites like Facebook, Twitter, and LinkedIn to get the word out about a new business and to attract a wide array of individual investors. Crowdfunding has the potential to greatly expand the pool of potential investors from whom funds can be raised beyond the traditional circle of insiders, owners, relatives, and venture capitalists. Recent modifications to laws around who can invest in real estate in this way and how have opened the door to more crowdfunding.

Real estate industry groups are already climbing on board the crowdfunding bandwagon, touting relatively low-risk access to the U.S. real estate market. “Crowdfunding for real estate is not an entirely new phenomenon,” the Commercial Real Estate Development Association reminds us in a statement made in the fall of 201; “Numerous players have entered the field. Although each of these platforms has its own niche and strategy, with different levels of minimum investment, all are geared toward accredited investors who meet specific requirements for net worth and/or annual income. By contrast, crowdfunding under the JOBS Act will open the field to many more smaller investors.”

What are the pros and cons of crowdfunding for investors? In a word, it comes down to risk for both sides; specifically, how much information investors want to absorb online. According to the report, both real estate developers and investors can reap significant financial returns through crowdfunding, and both are able to spread their risks.

Pros & Cons of Real Estate Crowdfunding

How to Get Started

To get started with crowdfunding in real estate, Jillienne Helman, chief executive officer at Realty Mogul, advises going with a firm that’s going to be around for a while.

“First, work with a crowdfunding company that will survive,” she says. “That means well-capitalized. What scares me is the number of crowdfunding companies out there that are headed up by two students who just graduated from college, and who aren’t capitalized themselves.”

Darren Powderly, the co-founder of CrowdStreet.com, says doing your due diligence is more important for real estate than for other investments, as far as working with a crowdfunding company goes. “From the investor’s perspective, one should take care to research the platforms on which they are searching for investment opportunities,” says Powderly. “Not all platforms are created equal, and multiple business plans are being tested in order to capitalize on this emerging trend.”

Powderly specifically advises investors to investigate the founders and senior management of the crowdfunding platform or firm to make sure they have a sterling reputation that rests on previous business experience. “Key industry expertise in finance, real estate, and technology is essential to operate a trusted and reliable platform,” he adds. “Investors should gravitate toward platforms that deliver excellent customer service – not only during the fundraising process but also after the deal is fully funded and closed. Despite the fact that there are 50-plus platforms in some mode of operation, there are only half a dozen or so that are emerging as leaders in the space. Investors should research multiple platforms and select their Top Three based on their investment goals and preferred user experience.”

Once you’ve decided to invest in real estate this way, one of the main advantages is that you can allocate a lower amount of capital for each of your crowdfunded investments. You can find a number of different projects that may only require as little as $500 or $1,000, making diversification easy. Another benefit of going through this route is that there are generally no investment fees, unlike the additional costs you would be expected to pay with traditional real estate investments such as closing costs or realtor commissions.

Transparency is Critical

Powderly advises looking for crowdfunding platforms and sponsors that acknowledge the risks while providing an education-based approach to risk management. “Most real estate crowdfunding platforms today only permit accredited investors, as defined by the SEC, to invest,” he says. “Accredited investors are advised to invest amounts that they are comfortable with, given their overall investment portfolio.”

Another tip: only invest in offerings from sponsors you trust, and who you’re confident will look out for your best interests in good times and bad.

“If an investor does not understand how their money is being used, the risk factors of the investment, and what factors influence their return on investment, then they should seek the advice of their trusted investment adviser, or pass on the investment,” adds Powderly. “There will be plenty of other investment opportunities to choose from, so don’t get rushed into making an uninformed investment decision.”

A professional real estate crowdfunding platform should provide investors with ample opportunities to communicate about the offering, including making introductions directly to the sponsor of the particular property listing.

A New Regulatory Environment

The catalyst for launching crowdfunding for real estate investments, along with other types of business ventures, was the passage of the JOBS Act in 2012. Until recently, the ability to advertise and solicit investors for real estate investments had been restricted. The JOBS Act (Title II) dramatically changed the way investment capital can be raised by modifying existing Regulation D rules, specifically those rules pertaining to how companies can offer and sell their securities without having to register the latter with the U.S. Securities and Exchange Commission (SEC).

In the past, Regulation D, Rule 506 placed restrictions on fundraising efforts, specifically limiting fundraising to only pre-existing relationships and preventing a sponsor or other party from openly soliciting or advertising those private investment opportunities. The new Rule 506(c) allows issuers, sponsors, syndicators, and others who are raising capital from private investors to advertise those private-investment opportunities to accredited investors under certain conditions. That rule became effective on Sept. 23, 2013. The new federal legislation represents a huge change for sponsors raising funds for a real estate acquisition or development. Essentially, Title II gives crowdfunding firms the green light to direct-market to a large pool of potential investors via social media and the Internet. It has also created a new vehicle for investors to more easily access direct real estate investment opportunities.

As Powderly notes, for the first time ever, investors have direct access to a selection of private real estate offerings which they can browse, research, and make well-informed investment decisions about online.

The Bottom Line

Crowdfunding in the real estate market promises to be a revolution. It is just now taking off, but already attracting impressive levels of interest from serious investors. While real estate crowdfunding is inherently risky, real estate investments can help diversify your portfolio and provide competitive returns. Remember, for the time being you still need to be an accredited investor in the U.S., but as this market gets more popular, hopes are that it also becomes more accessible to average Americans.