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Will ‘Wisdom of the Crowd’ Become a Major Financing Source for CRE Deals?

While Viewed as Good Fit for Small Businesses, New Crowdfunding Proposals May Have Limited Impact for Larger CRE Projects
October 30, 2013
With a unanimous vote, the U.S. Securities and Exchange Commission last week agreed to propose news rules permitting companies to offer and sell securities through what has recently come to be known as crowdfunding.

The proposed rules could impact the real estate investment market in a big way if crowdfunding catches on and large numbers of 'unaccredited' investors pool their money to invest in new construction, community landmarks, etc.

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Crowdfunding describes an evolving method of raising capital that has been used outside the securities arena to raise funds through the Internet for a variety of projects ranging from new products and services to artistic endeavors such as movies or music. It has also been used with some success to fund real estate investments.

Title III of the Jumpstart Our Business Startups (JOBS) Act created an exemption under the securities laws making it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. All investors - not just the so-called “accredited investors” - now have the opportunity to invest in entrepreneurs and projects at an earlier stage than ever before.

"The basic concept is simple: it allows the wisdom of the crowd to identify, and reward with capital, good ideas," said SEC Commissioner Kara Stein. "Different methods of crowdfunding have expanded rapidly over the last few years with the help of the Internet and social sites that bring together individuals and the projects in need of financing.”

Key rules from SEC proposal include:
  • Issuers can raise $1 million per year from unaccredited investors; and for campaigns seeking more than $500,000, independently audited financial statement are required.

  • Investors are permitted to invest up to $2,000 or 5% of their annual income or net worth if less than $100,000 and up to 10% if more than $100,000.

"It's great to see this new development from the SEC. These proposed rules could prove to be a significant step toward changing the way that equity investments are made," said Jilliene Helman, founder and CEO of Realty Mogul. "Now that the rules are one step closer to being finalized, we're in a position to evaluate how they might affect our industry generally and the real estate finance sector in particular."

Realty Mogul is a real estate crowdfunding company that has thus far limited participation in its platform to accredited investors, those who earn $200,000 or more annually or have a net worth more than $1 million.

"While we have concerns with the potentially burdensome audited financial requirements and want to be sure that fundraisers will be able to combine unaccredited and accredited raises for maximum impact in the real estate sector, we hope that the increased use of online crowdfunding can help promising companies raise the capital they need to grow and expand,” Helman noted.

The $1 million cap included in the proposed rules could be a limiting factor for real estate owners and developers, said Harold Hofer, founding member of Nexregen, a proprietary web-based system through which investors can purchase small-dollar interests in commercial real estate properties in the real estate investment trust or "REIT" format.

Hofer said Nexregen will not be availing itself of the new JOBS Act nuance because it already has an existing offering, Nexregen Real Estate Investment Trust I, available to non-millionaires, Hofer said. That offering relies on an existing exemption from SEC registration requirements called the "intra-state" offering exemption. If money is raised solely in one state, all of it deployed in the same state, it does not register with the SEC.

“We are thus not limited by the $1 million cap, but can accept non-accredited (non-millionaire) investors into our offering,” Hofer explained.

Better Fit for Small Deals?

While the $1 million limit may just be too small for largescale commercial development, many see the opportunity for the single family residential property fix-and-flip business and may also open doors for prospective small business owners for raising capital to expand their operations.

“Crowdfunding seems like it would be a great way for a retailer or restaurateur to raise money from enthusiastic customers,” Armond Spikell, a founding partner of Roadside Development, a Washington DC-based real estate firm. “The $1 million limit means that that a real estate project can’t be larger than about $4 million or $5 million total, assuming 25% equity and 75% debt.

“Crowdfunding could save 17% of a $1 million profit on a small deal or about $170,000,” Spikell said, but asked, “Is the a lower cost of capital, say 8% for crowdfunding versus 25% for a typical equity partner worth it if you have to deal with 10 to 50 partners on a small deal?”

David Dobson, a business park developer with International Development of Virginia LLC said another component of the SEC proposal could also limit its application for real estate use. Because audited financial statements will be required for $500,000 or larger requests, it will be time-consuming and more expensive for the fundraiser.

"Also, it is not clear yet whether receipt and review of tax returns will be required of larger investors. If so, that would chill participation," Dobson added.

The SEC is seeking public comments for the next 90 days on the -proposal before it will issue a final rule.

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