“Copyright” By Jonathan B. Wilson CrowdFund Beat Sr. Guest Editor, Partner, Taylor English Duma LLP
The impact of crowdfunding on real estate finance and deal-making has been one of the hottest topics of the past year. With the advent of crowdfunding, real estate developers and investors have multiple pathways to finance their projects and even to plot their exits. But in many ways the impact of crowdfunding has not yet arrived. Crowdfunding for real estate is still in the early stages and may take several detours along the way to its final destination.
What is Crowdfunding?
The idea of “crowdfunding” has been in the news a great deal but investors have only just begun to realize its potential for the industry. Crowdfunding is the idea that a large number of people, with no particular expertise, can accurately predict the likely success or failure of a venture by combining their own observations and communicating with each other. James Surowiecki, in his book, The Wisdom of Crowds, recounts dozens of examples where a large group of people who were able to collect and share information were able to make more accurate guesses about the success of a project than the best guess of any individual expert in the topic. The Internet, with its ability to collect a large number of people quickly and easily, makes it possible to collect a “crowd” to evaluate an idea better than was ever possible before.
Crowdfunding applies this idea to the process of evaluating investment opportunities, allowing members of the crowd to put money behind their predictions and preferences. Proponents believe that by allowing a crowd of potential investors to share their opinions about the investment and the information they collect that crowd will be better able to predict the success of the investment than individual investment experts. Sydney Armani, the publisher of CrowdFundBeat, says, “People get excited when they engage with a new product that arouses their passions. Those passions take on even greater intensity when they can invest in that new product.” 
Crowdfunding can take several forms. Popular crowdfunding sites like Kickstarter and Indiegogo let project sponsors describe their projects to the public and ask for donations. In an “affinity” campaign, supports of a project pledge funds for a project because they like it and support it. Their affinity for the project is their only reward. In a “rewards-based” campaign, project sponsors offer rewards for cash contributions. Rewards may range from recognition on a website or on a wall, to t-shirts, products samples and more.
Securities-based crowdfunding is possible through several recent changes in U.S. securities laws, most of which are derived from the 2012 Jumpstart Our Business Startups Act (or “JOBS Act”). In particular, the JOBS Act created three types of crowdfunding: (a) crowdfunding to “accredited investors” under Rule 506(c), (b) crowdfunding for up to $50 million each year under new Regulation A+ and (c) crowdfunding to both accredited and non-accredited investors in small offerings under Title III.
Investing Under Rule 506(c)
First, a sponsor could offer debt or equity securities to “accredited investors” under Rule 506(c). The JOBS Act changed some of the rules affecting private offerings under Rule 506 so that sponsors could publicly-advertise their offerings. Before this change in the law, public solicitations of private offerings were strictly prohibited. Under new Rule 506(c) however a promoter that wants to advertise publicly must take various steps to ensure that every investor who participates in the offering is “accredited”, which is defined as having a net worth of over $1 million (excluding the investor’s principal residence) or having an income of more than $200,000 for two consecutive years ($300,000 is the investor is married and files tax returns jointly with a spouse).
Crowdfunding under Rule 506(c) has been feasible for more than a year and several websites, have had some success hosting real estate crowdfunding campaigns that have included securities under Rule 506(c). Most of the popular real estate crowdfunding sites included in our survey, however, require accredited investors to create a membership on the site before they can view any live offerings. As a result, the offerings made available to members are intended as a private offering, and not a general solicitation. Because there is no general solicitation, those websites take the position that their offerings are private offerings under Rule 506(b) rather than publicized general solicitations under Rule 506(c).
Investing Under Regulation A
Another legal change that came from the JOBS Act was a change to Regulation A, an SEC rule that allows a private company to qualify its securities (which may be equity or debt) through filing a formal prospectus with the SEC. The SEC reviews the prospectus to ensure that it adequately describes all of the risks of the business and the risks to investors. Once the issuer’s prospectus is approved by the SEC (at which point it is said to be “effective”) the sponsor may sell the securities to both accredited and non-accredited investors.
Before the JOBS Act, offerings under Regulation A were limited to not more than $5 million. Under the new provisions of Regulation A (sometimes called “Regulation A+”) an issuer of securities may raise up to $50 million in any 12-month period.
One of the advantages of a Regulation A offering is that the company will be able to solicit investments from both accredited and non-accredited investors, thereby widening the scope of interest in the project. The SEC’s rules, implementing these changes to Regulation A, however, have only been effective since October 2015. As a result, there have been relatively few offerings that have completed the new process and it is harder to tell how these new offerings will be accepted by investors.
The third possible route for crowdfunding is often called “Title III” because it arises under Title III of the JOBS Act. Although the JOBS Act became law in 2012, the SEC only released its rules implementing this new law in October 2015 and those rules didn’t take effect until May 2016. Under those roles, a promoter may issue securities, in an amount up to $1 million in any 12-month period, to both accredited and non-accredited investors. But, soliciting for investors may only take place through licensed crowdfunding portals that have received a license from the Financial Institutions Regulation Authority (“FINRA”).
Under Regulation CF (the name used for the SEC’s Title III regulations), issuers do not file a prospectus with the SEC but do need to include certain disclosures about the company in their offering memorandum. The funding portal will also be liable for making sure that all of the prospective investors receive certain notices about the process and for ensuring that each investor does not invest more than a certain maximum that is derived from the investor’s taxable income. While a Regulation CF offering can “go national” by accepting investments from people across the country (whether they are accredited or not) the $1 million limit and the requirement that all solicitations take place online through the licensed portal make this approach a challenge for many new ventures.
Because of the $1 million annual cap on fundraising under Regulation CF, however, this approach is usually not a good fit for real estate projects that often require more than this maximum amount.
Surveying the Landscape
The following websites have used one or more of these regulatory pathways to create a marketplace for crowdfunding real estate projects. By surveying some of the more popular websites I have tried to provide an overview for how industry players are using these now crowdfunding regulations to make deal flow and investment opportunities possible. This list is not an endorsement of any of these sites and a site’s omission from this list is not intended as a criticism or a suggestion that the site is not worthwhile or valuable.
PeerStreet specializes mostly in residential debt investments (with a smattering of multifamily and commercial). PeerStreet utilizes Rule 506(b) to solicit accredited investors to participate in loans that are secured by real estate. They have one of the lowest minimums in the top 10 ($1K versus $10K average), and a healthy volume of new transactions.
Virtually every site in the industry claims that they have superior due diligence. PeerStreet, however, supports its claim with concrete proof. PeerStreet allows investors to review the performance of every past investment. PeerStreet’s site claims that, since 2014, the site has offered more than 200 notes but without any foreclosures or unremedied defaults.
Unlike many other real estate crowdfunding sites, however, PeerStreet does not originate its loans. Rather, project sponsors introduce opportunities to the site and then earn a fee based on successfully closing the investments. As a consequence, investors that participate in deals on PeerStreet pay slightly higher total fees than some other sites. Because of the relatively high performance that PeerStreet’s deals have produced, however, these fees so far have not kept investors away.
Real Crowd acts as a syndication platform for real estate development companies and real estate funds. The development companies and funds pay a fee to Real Crowd to have their offerings listed on the site. Viewing the offerings is possible only for accredited investors who have created a free membership account on the site. Most of the opportunities on Real Crowd involve commercial real properties or multi-family properties. Some of the investments are funds in which the fund manager will be investing in the proceeds in a targeted type of property while others are syndicating take-out financing for existing properties.
From the investor’s point of view, Real Crowd has successfully recruited a large number of property developers and fund managers, so there are many investment opportunities to consider. Most investments, however, require a minimum investment of at least $25 to $50,000, so the platform is not friendly to small retail investors who want to dip their toes in the water. In addition, most of the investment opportunities are equity securities, so there is a higher risk of principal loss than is generally the case with debt-oriented platforms.
Realty Mogul is one of the largest real estate crowdfunding sites and it uses several different approaches based upon the needs of the project sponsor and the class of investor involved. Accredited investors may invest in either debt or equity securities. Accredited equity investors invest in syndicated private placements of special purpose limited liability companies that exist to finance equity investments in particular properties. The equity investment has the higher potential return associated with equity as well as the potential downside risk of loss.
Accredited investors may also invest in debt securities called “Platform Notes”. Each Platform Note is a debt security issued by a Realty Mogul special purpose vehicle which uses the proceeds of the Platform Notes to make a loan to particular sponsored investment. By issuing the note from its special purpose vehicle, Realty Mogul is able to take on the management function of managing the underlying loan (reviewing financials, monitoring loan covenants, working out any defaults, and so on) without involving the passive investors who have purchased the Platform Notes.
For non-accredited investors, Realty Mogul has sponsored its own non-traded real estate investment trust. Although the REIT (called Mogul REIT I) is not traded on any stock exchanges, its shares were qualified with the SEC through a Regulation A prospectus. According to the prospectus (which went effective in August, 2016) the REIT plans to hold:
“(1) at least 55% of the total value of our assets in commercial mortgage-related instruments that are closely tied to one or more underlying commercial real estate projects, such as mortgage loans, subordinated mortgage loans, mezzanine debt and participations (also referred to as B-Notes) that meet certain criteria set by the staff of the SEC; and (2) at least 80% of the total value of our assets in the types of assets described above plus in “real estate-related assets” that are related to one or more underlying commercial real estate projects, these “real estate-related assets” may include assets such as equity or preferred equity interests in companies whose primary business is to own and operate one or more specified commercial real estate projects, debt securities whose payments are tied to a pool of commercial real estate projects (such as commercial mortgage-backed securities, or CMBS, and collateralized debt obligations, or CDOs), or interests in publicly traded REITs. We intend to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes beginning with our taxable year ending December 31, 2016.”
Because Realty Mogul facilitates both equity and debt investments for accredited investors as well as equity investments for non-accredited investors through MogulREIT I, Realty Mogul is ideally-situated to generate substantial deal flow and relatively rapid underwriting for projects that apply for funding. As a platform for providing funding for sponsored-projects as well as a platform for creating investment opportunities, Realty Mogul has one of the best head starts of all the available real estate websites.
Those advantages, however, come at a cost. Realty Mogul has a large staff operation (which is required for its extensive underwriting duties) and that cost is borne by investors through the 1-2% fees they pay to participate in investments on the site. While the site has tremendous deal flow, however, a student of the industry might ask, “is this really crowdfunding?” Because Realty Mogul takes such an active role in performing due diligence on its projects and in structuring the investment opportunities on its site, the overall experience is more structured than most crowdfunding sites and there is less opportunity for the collectively give-and-take than crowdfunding was originally thought to represent.
Realty Shares facilitates both debt and equity investments into both commercial and residential real estate. The site claims that it has funded over $300 million to 550 projects that have returned more than $59 million to the site’s more than 92,000 registered accredited investors. Project sponsors must submit to underwriting through Realty Shares and only projects that have exceeded the site’s standards can be offered to the site’s members. Fees range from 1 to 2% of the investment amount, but investment minimums are as low as $5,000.
As with most of the other real estate crowdfunding sites, investments are made through private placements under rule 506(b).
Residential Real Property Sites
There are several websites that focus primarily on residential real estate. Because of the similarity of their focus and approach, they can be surveyed as a group:
Lending Home describes itself as the “largest hard money lender” [providing] “fix and flip loans up to 90% LTC and 80% LTV.” Unlike many of the other sites that aim their value proposition at investors, Lending Home addresses itself primarily to homeowners how are looking for loans and are willing to pay “hard money” rates of interest to get cash. Accredited investors can participate in Lending Home in increments as low as $5,000.
Roofstock’s tagline is “Property Investing Like the Pros.” Like Lending Home, Roofstock focuses only on single family residential properties. Differently, however, Roofstock allows accredited investors to invest directly through loan participations as well as through small funds that focus on particular regions or particular rates of return. Roofstock also emphasizes, through its underwriting and its messaging, the underlying quality of the properties and their surrounding communities, school systems and the like. Browsing through loan opportunities on Roofstock feels more like browsing through listings on Zillow than looking for investments.
Patch of Land
Patch of Land is one of the largest and most heavily-trafficked real estate crowdfunding sites. The site claims to have originated more than 400 loans for over $245 million in loans, returning over $61 million to investors. Although Patch of Land has made investments in multi-family and commercial real estate, more than 70% by value of its investments have been made in single family real estate.
Fund That Flip
Fund that Flip is a site that proudly advertises its role in financing single family residential rehab and resale projects. The site claims that the sponsors underwrite individual deals, requiring borrowers to put at least ten percent in the property’s value in equity. The site also tries to entice investors, claiming average returns between 10 and 14%.
The Future of Real Estate Crowdfunding
Real estate crowdfunding has definitely arrived. Through the dozens of existing sites claiming to offer some kind of real estate crowdfunding, investors have invested more than a billion dollars through thousands of investments in just a few short years. While this method of investing is still very small (in contrast to retail investments in mutual funds and the stock market) it fills a market need that shows no sign of disappearing.
For real estate crowdfunding to achieve a wider degree of acceptance, platform owners will need to continue to facilitate high quality investment opportunities while improving transparency. Wider acceptance will require a level of information sharing that does not yet exist in the industry. Even the most popular sites today have varying levels of information available to potential investors. These inconsistent levels of disclosure can undermine the trust that is necessary to grow crowdfunding as a method of investing. Real estate crowdfunding sites that facilitate exempt transactions under Rule 506(b) are not regulated, and that is probably a good thing. But the lack of regulation also permits a wide diversity in style and approach that can make comparing the platforms difficult.
If the leading crowdfunding platforms could collaborate on a standardized “scorecard” that pulled together standard metrics on transactions, investment amounts and rates of return, the result would make it possible for both investors and project sponsors to compare platforms on a level playing field. The investor confidence that might come from such a development would encourage new investors to come into the market. Platforms that did not adopt the scorecard at first would experience market pressure to begin reporting results in the scorecard format. Adopting a standardized scorecard for recording would, in a sense, demonstrate the power that crowdfunding was supposed to represent, by making it possible for the market to adjust itself to the information needs of the investing community.
 Surowiecki, James, The Wisdom of Crowds, Anchor Books (2005).
 Wilson, Jonathan B., Follow the Crowd: What the Future of Crowdfunding Holds for Startup Restaurant Owners, Restaurant Owner Startup & Growth Magazine, 18 (Feb. 2016).
 PeerStreet claims that its loans have generally yielded between 6 and 12%. See PeerStreet FAQs, available at https://info.peerstreet.com/faqs/how-do-peerstreet-returns-compare-to-other-debt-investments/ (last visited January 29, 2017).
 MogulREIT I, LLC SEC File, available at https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0001669664&owner=exclude&count=40&hidefilings=0 (last visited January 29, 2017).
 Realty Shares website available at https://www.realtyshares.com/ (last visited January 29, 2017)
 Lending Home website available at www.lendinghome.com (last visited January 29, 2017).
 Roofstock website available at www.roofstock.com (last visited January 29, 2017).
 Path of Land website available at https://patchofland.com/statistics/ (last visited January 29, 2017).
 Fund that Flip website available at www.fundthatflip.com (last visited January 29, 2017).
 Fund that Flip website available at https://www.fundthatflip.com/lender (last visited January 29, 2017).