UNDERSTANDING NEW CAPITAL FORMATION OPTIONS
Written by: Joanna Schwartz, CEO & Co-Founder, Early Shares
Through new capital raising regulations implemented in September 2013 under the JOBS Act, “real estate crowdfunding” has become a highly active sector of the private finance market. According to a recent report from Massolution, a research and advisory firm serving the crowdfunding industry, over $1 billion of capital was infused into the real estate space through various crowdfunding platforms in 2014.
Crowdfunding – the practice of raising funds from a group of people, leveraging online tools – has evolved beyond its origins in donation-based fundraising into the world of sophisticated equity and debt capital raising. Through so-called “equity crowdfunding,” business owners can raise investment capital online from individual investors who pool their funds with others to buy shares in private ventures.
Real estate is the fastest growing sector of the emerging equity crowdfunding market, and its attractiveness to “crowd” investors is unsurprising. Though the JOBS Act – short for “Jumpstart Our Business Startups” – was originally designed to increase capital allocation from individual investors into early-stage companies, the high level of risk inherent in startup investing has made investors hesitant to participate in growth opportunities under the new regulations. Real estate, on the other hand, is a more tangible and familiar asset for investors to understand.
“When investors are presented with different opportunities on a crowdfunding platform, I believe the majority prefer to co-invest with a sponsor who has been in business for a long time, rather than in a start-up business,” Jack Glottman, President of Saglo Development Corporation, told CRE Finance World. Saglo is a Miami-based retail shopping center investment and management company that owns, leases and manages 800,000 SF of shopping centers and provides third party management and leasing for an additional 230,000 SF of commercial property in Florida. Saglo conducted two successful $3+ million capital raises on EarlyShares, a private investing platform that specializes in real estate crowdfunding.
“They’re not without risk, but real estate investment opportunities come with firm time horizons and yield projections,” Glottman continued. “When investors can get 7-9% returns on a project that they can invest in online, that’s a pretty appealing prospect for them.”
Crowdfunding’s appeal for investors is matched by its appeal for capital raisers. Most real estate developers, project sponsors, and operators are already well-acquainted with deal syndication – the process of pooling investments from a group of investors to finance a portion of the equity for a project. Today’s crowdfunding (or “private investing”) platforms provide tools, resources, and services designed to make the syndication process more efficient.
It’s crucial, however, to understand the background and nuances of the new real estate crowdfunding market before utilizing it as a tool for real estate capital formation or investing. This includes gaining familiarity with the current regulatory environment, the types of platforms in the market, and sponsors’ options for raising capital – all of which are highlighted below.
#1: Regulations: Making the Private Market Public
The real estate crowdfunding industry has arisen thanks to the enactment of Title II, which is one of the seven titles of the JOBS Act. Enacted in September 2013, Title II lifted the ban on the public advertising or “general solicitation” of private investment opportunities.
The regulatory exemption for general solicitation is Regulation D Rule 506(c). Prior to the rule’s implementation, all real estate syndications were traditional private placements under the longstanding Rule 506(b) securities exemption. 506(b) stipulated that capital raisers (“issuers”) could only raise funds from those investors with whom they had “substantive, pre-existing” relationships.
As such, the pool of investors for a given real estate deal was largely limited to the sponsor or developer’s network. With general solicitation, however, dealmakers can now solicit investments from any accredited investor. The key stipulation is that the issuer is required to verify that all investors qualify as accredited according to the SEC’s income or net worth criteria – $200,000 in annual individual income ($300,000 joint) or $1 million in net worth, not counting the value of primary residence.
By moving the capital raising process online and broadening issuers’ access to potential investors, 506(c) “crowdfunding” is helping facilitate an evolution for the real estate industry. Bringing dealmaking out of the country club and into the 21st century is a significant change for the industry – one that may have the potential transform the real estate finance landscape.
#2 Platforms: Powering Real Estate Through Technology
Despite the relative newness of the real estate crowdfunding market, investors and sponsors can already choose from a multitude of platforms to fit their needs.
At their core, most platforms offer largely the same tech-driven features and benefits. For deal sponsors (“issuers”), platforms help streamline capital formation through deal monitoring tools, transaction management functionality, privacy controls, and access to a database of registered investor users. For investors, they provide transparent access to all of the tools and the information needed to review, evaluate, and invest in a variety of opportunities.
Yet that doesn’t mean all platforms are created equal. Beyond the technology benefits, platforms vary across seven key variables:
Focus: Does the portal concentrate on a specific type of real estate asset or a particular geographic region?
- Due Diligence: Does the platform vet its deals? If so, how? What are its investment selection criteria?
- Products: Does the platform offer debt or equity investment opportunities?
- Regulatory Profile: Does the platform operate as a registered broker-dealer or just an intermediary?
- Service Range: Does the platform help issuers craft their investment offerings or is it self-service?
- Deal Structure: Do investors receive notes or make direct investments into the deals on the platform? Or, are investments pooled into a special purpose fund?
- Portal Compensation: Is the platform paid via profit participation, points, or a flat fee?
Issuers and investors should research a platform to understand its niche in the overall market before investing or pursuing a capital raise. The most reputable platforms – among them EarlyShares, RealCrowd, Fundrise, and several others – offer a wealth of educational materials and resources to help you make the most of their products and services.
#3 Capital Raises: Options for Streamlined Syndication
Given the vast number of real estate crowdfunding platforms on the web – now estimated at over 100 – there are variety of fundraising vehicles available to developers and sponsors to help them capitalize on the crowdfunding trend. Investors and issuers alike should understand the different options, since they can impact the structure of the investment offerings.
Private Raise-506(b): Leverage technology to conduct a tech-powered private placement
Many platforms offer issuers the option to utilize their transaction management and deal tracking tools without making the deal public (and thus incurring the legal requirements that come with initiating a 506(c) raise). With a private raise, sponsors can leverage the benefits of technology without having to go through the investor verification process. Issuers simply invite members of their existing networks to view and invest in their deal(s). The drawbacks: no marketing exposure beyond their existing network, and no investments from new audiences.
Direct Crowdfunding: Raise funds publicly and directly from accredited investors
In this model, an issuer posts a deal to a platform – triggering 506(c) – and accepts investments from members of his or her network and new investors who contact the issuer through the platform. The sponsor publicly syndicates a portion of the debt or equity (usually between $1 and $5 million) and accepts 5-40 new investors into the deal (on average, depending on offering size and minimum investment). Typically, the platform takes care of investor verification and furnishes the sponsor with documentation for his or her records.
‘Fund’ Crowdfunding: Raise capital into a fund and share profits with your platform
This option is largely the same as the one above, but involves slightly different structure. The platform will pool all investor commitments into an LP or LLC and then use the fund to invest directly in the issuer’s deal. As such, the sponsor only has one new investor in the offering: the fund. Some platforms pre-fund the deal by underwriting it up front and syndicating it to investors after the fact. Others open the fund directly to investors and close the offering once the target goal is reached. The platform typically acts as the fund manager and shares a percentage of the profits after investors receive their take.
No matter which approach appeals to you, it’s a smart move for all constituents in the real estate market to familiarize themselves with the concept of crowdfunding, given its growing popularity and its potential to fundamentally change the way real estate dealmakers do business. Now is the time to act, because the real estate crowdfunding industry is expected to grow to more than $2.5 billion in 2015.