Jessica Reeves | BizJournal | Aug 25, 2014 – During the past few months, the internet has been buzzing with articles and discussions about real estate crowdfunding. The topic even received its own panel discussion at a real estate conference that I attended at Yale this past spring. As the buzz grows louder, the benefits and risks of real estate crowdfunding are worth considering as we experience continued grow in the real estate market.
What is Real Estate Crowdfunding?
Crowdfunding is a term used to describe mass financing by numerous individuals and companies. The term has typically referred to online financing platforms for emerging businesses, but there has been an emergence in companies and developers that are using crowdfunding to raise capital for real estate projects. Before this emergence of real estate crowdfunding, traditional real estate investing was reserved for high net-worth individuals and private equity.
The main reason is that the costs of registering securities has typically been too costly for individual real estate projects. However, the current and anticipated exemptions that the Jumpstart Our Business Startups Act will provide has opened the door for growth in real estate crowdfunding. The JOBS Act was signed into federal law in 2012 and requires the Securities and Exchange Commission to write and/or modify rules regarding securities registration and disclosure requirements, with the goal of facilitating access to cost-effective capital for businesses.
Crowdfunding platforms allow investors to participate in individual deals involving the financing of apartments, hotels, office buildings and other commercial real estate projects. Through these models, investors purchase shares in individual buildings and share in their portion of the operating profits (and losses) associated with the building. Investors will typically receive a share in the rental income and the earnings from the sale of the building.
Though most investors can currently invest in real estate by purchasing shares in publicly traded Real Estate Investment Trusts (REITs), crowdfunding offers investors alternative opportunities to invest in particular buildings rather than a portfolio of buildings. Crowdfunding models are attractive because of the control that they provide investors to concentrate on particular projects and for their potential to produce higher returns for investors than REITs, which typically have more overhead cost due to the management of multiple buildings and registration requirements.
Real estate crowdfunding is a relatively new model for financing real estate acquisitions and investments, which means that we have not seen a full recession cycle to experience the potential fallouts regarding crowd-funded real estate deals gone bad. Additionally, real estate crowdfunding investments are highly illiquid. In addition to the underlying real estate being illiquid, many registration exemptions restrict the re-sale of the crowdfunded securities for a set period of time.
Therefore, investors should not expect to receive short-term returns when investing in real estate through crowdfunding. The public should also be aware that exemption from registration requirements does not exempt issuers from SEC anti-fraud rules or Tennessee Securities Division regulation. Investors should insist on adequate disclosures from issuers of crowdfunded real estate projects.