Crowdfunding: How will New Regulations Impact Sponsors?
- Jun 05, 2015
By Joanna Schwartz, EarlyShares
Crowdfunding—the practice of raising funds from a group of people leveraging online tools—has evolved into the world of sophisticated equity and debt capital raising for multifamily real estate and a variety of other sectors. On platforms like EarlyShares, real estate developers and sponsors showcase investment opportunities to accredited investors.
The process—technically classified as “general solicitation”—can be mutually beneficial for both parties: capital raisers gain access to a platform’s nationwide investor base and broaden their marketing exposure; investors learn about deals they would otherwise be unable to access.
Crowdfunding is a major advancement for the technology-averse real estate industry and can be leveraged to more seamlessly raise capital for multifamily projects. Like any innovation, however, it faces early resistance in the market. Why? Because some stakeholders in the multifamily sector don’t realize that crowdfunding isn’t really a “revolution” to the capital raising landscape… it’s an evolution of existing processes.
Syndication: Smart multifamily financing
Commercial real estate is an extremely broad sector, encompassing both the development of trophy high-rise developments and the refinancing of modest neighborhood apartment buildings. Naturally, the larger the project the more likely that institutional players finance all or most of the capital stack.
In the multifamily market, however, deals have long been at least partially financed (or refinanced) through the precursor to crowdfunding: syndication.
Syndication is the process whereby a developer or sponsor divvies up a portion of the equity for a project—typically 80 to 90 percent—among a group of investors. In multifamily deals, these are often “private” syndications to high-net worth individuals. The investments are pooled into an LLC or LLP with the operator serving as general partner or manager; investors are limited partners or passive members.
Rights and protections are built into the syndication process to keep the best interests of each party in mind: Distributions, voting rights, and management fees are typically set forth in the Operating or Partnership Agreement. Both parties make money from property income and appreciation according to preset terms. From a regulatory perspective, syndications typically take the form of Regulation D securities offerings—aka “private placements.”
Syndication is nothing new to the multifamily sector, though it has grown in popularity in recent years. According to a report from the SEC, 5,617 separate Reg D offerings for real estate were conducted over the four-year period from 2009-2012. In 2012 alone, over 47,000 investors participated in syndicated real estate deals.
Private syndication is a smart way for sponsors to fill the capital stack while reducing their exposure to risk and lessening their reliance on institutional funding. The only problems? High costs, inefficient tools, and limited investor exposure.
Crowdfunding: Multifamily syndication simplified
In 2015, there’s likely no industry that remains as attached to phone calls, fax machines, and pen-and-ink signatures as real estate. That reliance on outmoded systems not only slows down the syndication process, it imposes unnecessary costs and limits the number of investors who can ultimately participate.
Syndication typically takes the “Country Club Model”: While making the financial arrangements for a multifamily property, the project sponsor solicits investments from members of his existing network. He keeps a spreadsheet tracking verbal commitments until he reaches his target amount; he circulates an offering memorandum and variety of other documents unsecurely—via mail, email, fax, or a combination of all four; he manually collects and tracks signatures and wire transfers until all funds are received. The administrative workload, transaction timeline, and associated expenses are staggering.
Many in the multifamily sector regard the country club approach as “the only way” to do things – and prior to September 2013, it was. Before the 506(c) General Solicitation exemption took effect 18 months ago, conducting a private placement raise required utilizing regulatory exemption 506(b), which limited capital raisers to acquiring investments from only those individuals with whom they had “pre-existing, substantive” connections. That has restricted each deal to a small number of investors and reinforced the reliance on outdated, paper-based processes.
Under the new General Solicitation regulations, however, 506(c) crowdfunding provides a better solution—enabling multifamily operators to raise investor capital more quickly from a broader investor audience than ever before. Thanks to the online nature of the process, it also involves far less administrative effort.
Consider the “Crowdfunding Model” of syndication: While making the financial arrangements for a multifamily property, the project sponsor posts his deal and associated documents on a secure funding platform. He invites his network to invest, monitoring a custom deal dashboard to track commitments, signatures, and transfers. Interested investors from the platform’s database contact the sponsor to request to access to view the full deal details and terms, and the sponsor communicates with them as needed to understand their interest in the deal before granting access and accepting their investments. With a lower administrative burden and broader investor pool, the transaction timeline is lessened significantly.
Keys to crowdfunding success
Broadly, crowdfunding itself is an old concept powered by online tools. Similarly, real estate crowdfunding is traditional syndication evolved to entail less effort and larger reach. As such, many of the “old rules” of capital formation still apply. Developers and sponsors need to conduct themselves with integrity, possess strong track records of success, and offer compelling opportunities to investors in order to reach their fundraising goals.
My platform, EarlyShares, has seen the best success in multifamily projects that feature strong return projections, high occupancy rates, and clear, concise business plans. Issuers who solicit investments from members of their own network (as well as “crowd” investors) also tend to close their deals sooner. One issuer, Insula Companies, raised $3.64 million from 24 investors in 54 days.
Crowdfunding may not be a revolution, but it’s a valuable new tool in the arsenal of any multifamily developer, operator, or sponsor. And as more investors look to capitalize on the resurgent real estate sector, crowdfunding is only going to grow—expected to top more than $2.5 billion this year.
Joanna Schwartz is CEO and co-founder of EarlyShares, the platform that gives accredited investors direct access to vetted, return-driven investment opportunities in commercial real estate. Follow Joanna on Twitter @EarlySharesCEO.