THINKING OF CROWDFUNDING YOUR DEAL?

The Basics You Need to Know

For any number of reasons, a property or project may not be feasible for traditional lending. Crowdfunding real estate is increasingly becoming the tool of choice to fill the financial gap for the project’s principals and developers.

Crowdfunding has exploded since the JOBS (Jumpstart Our Business Startups) Act of 2012 opened the door for accredited and now, finally, nonaccredited investors alike to participate. Initially, only high net worth “accredited” individuals could participate in crowdfunding, which effectively shut out the average investor. Regulations opened the door for nearly anyone to get involved, and today you see more crowdfunded properties available for investment opportunities than ever before. All of these changes create an environment where online crowdfunding platforms can serve as a solid solution for the future of real estate investing and redevelopment.

The Basic Model

The basic crowdfunding model includes three primary entities:

1.The Project (the Investment Sponsors/Developers). People and organizations propose the projects to be funded. They are seeking funding from the next entity.

2.The People (the Investors). They are, in essence, “the crowd” who collectively support the proposals/projects of the sponsors/developers by investing in the project.

3.The Platform (the Entity). The project/proposal is supported by an organization that brings together the project and the people through an online platform.

The Project

Properties such as shopping centers, office or industrial business parks, or mixed-use sites that can benefit from financial-only methods to add value are prime candidates for crowdfunding. “Financial only” methods to add value have nothing to do with renovations or upgrading infrastructure. Financial-only methods focus on restructuring the terms and financing to boost the financial performance of the property. Crowdfunding smaller-scale projects like single-family or smaller multi-unit residential properties has yet to fully emerge. Given the demand for capital for small site projects, it’s likely to only be a matter of time before some enterprising companies will meet that demand.

The People

The “crowd” is now made up of both accredited and nonaccredited investors. (Prior to the Title IV rulings of the JOBS Act, only accredited investors could invest.) Accredited investors are individuals who earn more than $200,000 per year or have a net worth of over $1 million or entities with over $5 million in assets. The new rules broaden the definition of “qualified investors” to include nonaccredited investors, but caps are placed on how much they can invest. Nonaccredited investors can invest a maximum 10 percent of their income/net worth per year. The intent is to protect less experienced investors and ensure they don’t “sell the farm” with a single crowdfunded investment.

The Platform

For those looking for out-of-the-box financing, the crowdfunded, layered funding model can be a viable option. To make it happen, you need the platform. Any quick web search will turn up dozens of sites that can facilitate funding from the crowd using their platform. But not all crowdfunding sites are created equal. Some offer investments only to accredited investors. Some support only specific types of properties and projects in specific geographic areas. Some offer only debt or equity funding, not both. Due diligence is in order before choosing.

When Does It Make Sense to Crowdfund a Deal?

With banking being what it is today, obtaining funding for ambitious projects can be a laborious drain on time and resources. Crowdfunding is a viable alternative for properties that need increased leverage at a lower cost than banks or traditional equity partners offer, and because the process of crowdfunding deals is streamlined, it can often be done in a fraction of the time of the traditional bank/partners route.

A crowdfunding platform also helps you source intelligent funding: Investors are vetted and verified, making for a reliable, one-stop shop for attracting multiple sources of capital. The platform manages all investor relationships for you and pools all accredited investors into a single entity that is a limited liability company (LLC). The investor management and communications, reporting, updates, and education is left to the crowdfunding platform’s team, including attorneys, accounting and financial professionals, and support staff.

What About Debt vs. Equity?

Real estate crowdfunding has two subgroups: debt and equity.

Debt Investment

The participating investor acts as a lender, not an owner of the property. The investor is entitled to monthly interest and return of any unpaid principal at maturity. But debt investors do not receive the benefit of property appreciation. The investment is secured by the property, and if the borrower fails to perform, the investors have recourse and can recover their investment through foreclosure.

Equity Investment

In this case, the investor is an indirect owner of the property. The investor is not secured by the real property and has little recourse if the property doesn’t perform. The added risk means the investor is entitled to a greater return, which is generally achieved through property appreciation and then realized when the property is sold.

When considering crowdfunding your deal, the structuring of debt and equity is critical and depends on a wide range of factors, including project type, timing, and market conditions.

The Cost to Raise Capital Through a Crowdfunding Platform

Beyond the returns paid to the crowd, this funding model has expenses related to the facilitation of the funding. Costs will vary depending on the platform, but in general expect fees for establishing and managing the fund that invests in your project.

There will be legal, accounting, compliance, and administrative costs. The platform will put together a marketing package with profiles of the developer and the investment to showcase investment experience, credentials, credibility, past projects, successful turnarounds, rebranding, or leasing results, all in an effort to generate a strong response by investors for your project.

Crowdfunding is still in its infancy but stands to become a standard for funding, and as such, it promises to disrupt the entrepreneurial capital market in a more fundamental way, bringing change to the previously elite world of investment fundraising and investing that used to be the exclusive domain of only the wealthy.

TAKEAWAYS

What is the difference between a debt investment and an equity investment?