Crowd Pleasers

By Mike Ratliff, Senior Associate Editor

By now you’ve heard that multifamily is turning to crowdfunding to raise smaller portions of a project’s capital stack, typically in the $1 million to $3 million range. While the debate is out on how big a deal the growing crowd will be able to cough up, top-tier companies are testing the waters in case this turns out to be the next big thing.

But just what is crowdfunding? And why now? First off, the label crowdfunding is a bit inaccurate, largely a result of the Internet lexicon and popularity of sites like Kickstarter and Indigogo.

“Crowdfunding is really a misnomer,” says Lewis Feldman, partner in Goodwin Procter’s real estate capital markets group and co-chair of the firm’s crowdfunding practice. “This is really accredited investor private placement syndication.”

An accredited investor must either have a net worth of $1 million, or earn at least $200,000 a year to qualify. This definition hasn’t changed. What has is how companies are allowed to solicit. In July 2013, the SEC adopted a new rule that lifted a ban on general solicitation for certain private offerings in preparation for Title II of the Jumpstart Our Business Startups Act (JOBS Act), which was enacted in September 2013. (A guide published by Goodwin Proctor this past fall gets into the legal details.)

“The confluence of technology and real estate coming together to get rid of middle men and women is what is motivating people to go online,” Feldman adds. “The cost of raising equity goes from seven to 15 points—which is what a non-traded REIT charges someone to invest a small increment—down to somewhere around three to four points, all in. As Warren Buffet would say, economic friction is eliminated.”

Today there are nearly a dozen platforms offering different ranges of services, all competing for the same pool of 9 million accredited investors. These sites range from basic exchanges where properties are posted in an MLS-style format, to full “concierge” services like Realty Mogul and FundRise that underwrite and package projects. FundRise even pre-funds all projects—well, the 5 percent of projects that make it through their screening and due diligence process.

How to tap into the crowd

With so many options out there, how do you decide where and when to tap into the crowd? Access to capital is obviously at the top of the list. Picking a crowdfunding platform with a solid investment network and track record is crucial.

“You also want to make sure that the platform you are working with has a solution and strategy around regulation,” says Jillienne Hellman, CEO of Realty Mogul, a firm that has put out close to $50 million in capital across 175 properties since its formation in 2013.

Being comfortable with having all of your cards on the table is also important.

“You need to be sure you are comfortable with transparency,” says Sohin Shah, co-founder of iFunding. “The biggest benefit for an investor is that everything is transparent—we provide weekly updates and videos for every asset we raise money for.”

Feldman reiterates that transparency isn’t just SEC mandated, but a major aspect that attracts investors to crowdfunding rather than a private REIT.
“You may know a REIT has great properties, but there is no way to access—like you can in a crowdfunding context—a drop down menu to a title report, current rent rolls, previous property operators or whether or not there is a hazardous waste report.”

Sounds like a win-win for all parties involved. Should traditional lenders be nervous? According to Feldman, some larger institutions feel they can turn a switch and become more involved in online private placements once they figure out where they fit in. Banks, being subject to the Volcker Rule, are concerned.

Jake Kelly, senior vice president of real estate investment banking at JLL, believes there is potential for intermediary types to get involved in crowdfunding.

“If it’s going to remain small potatoes, where you can only raise $1 million to $2 million from the crowd, I think it’s going to be tough for firms like ours to have a serious enough interest to get into the business. What hasn’t been determined yet is whether there is really the potential to raise $25 million from the crowd on a single deal.”

We might find out soon. FundRise, which closed the first real estate crowd funded deal in the country with a $325,000 offering, is working to close a $10.5 million position by pairing the crowd up with family real estate offices and institutions—so an investor could be investing on the same terms as a company like Guggenheim Partners.

The platform has also taken advantage of the intrastate crowdfunding exemptions currently in place in 14 states to raise money from any individual, whether they are accredited or not. Commitments start at $100. The non-accredited crowdfunding component of the JOBS Act (Title III) is expected to go into effect in 2016, making investing much more democratic at the federal level. With investment caps based on income and a $1 million cap per project, the changes won’t be groundbreaking for real estate. However, future renters could be investing in your future developments.

“You would have to assume that your apartment building is going to lease up faster if you have 1,000 investors who are telling friends about it,” says Daniel Miller, president and co-founder of FundRise. “That is what we see over time: activating users not just as an investment, but as a base of people who can support the deal.”

Also on the horizon, perhaps three to five years out, is a marketplace model where investors are able to buy a piece of a deal even after closing. Couple this with an app that sends a push notification when a user is within 100 feet of a building and you have impulse buying.
Miller compares the shift to what the Internet did to retail and publishing. Twitter changed the economics of content distribution with free global messages. Crowdfunding distributes an equity investment in real estate to thousands of people instantaneously. As with many new technologies, it pays to be an early adopter.

“Sponsors may do $250,000 the first deal, $500,000 the next, then $1 million. Ten deals in they might have raised $5 million and we are a real source of capital. It is sort of like making an investment in a longer term platform, somewhat like Twitter. You don’t have many followers day one, but with continued interactions you build a following that becomes a powerful distribution network.”