In September, I wrote an article about the latest crowdfunding trend: real estate. At the time, the Hard Rock Hotel in Palm Springs was receiving attention for crowdfunding a 15% equity stake for $1.5 million. While this was great press for the hotel, it also advanced the public perception of an investment strategy that appears to be real and lasting.
A recent study from Massolution reports that crowdfunding investors injected $1 billion into the U.S. real estate market last year. By the end of 2015, that number should climb to $2.5 billion. Advances like $100 investments, debt participation and availability to foreigners are contributing to this projected surge.
“It’s growing beyond expectations,” says Richard Swart, Massolution’s research adviser on the report. “When the JOBS Act passed we didn’t think real estate would be a part of it, but it turns out to be a more efficient way for investors to find good deals across the spectrum.”
Now is it time for you to jump in?
For accredited investors who like the idea of pooling small sums to purchase large properties, crowdfunding is an excellent way to get into the game. “The excitement for us is giving everyone access to investing in commercial real estate,” says Dan Miller, co-founder and president of Fundrise, one of the original real estate crowdfunding platforms, which now has 41,000 users.
The crowdfunding concept is not exactly new. REITs — formed decades ago — allow investors to combine resources to access a large and diversified portfolio of properties. Today, technology fast-tracks this process with engaging and highly supportive websites to help investors evaluate the merits of each offering.
If you’ve never looked into real estate crowdfunding, here’s how it works: Once you’re confirmed as an accredited investor (with a net worth of at least $1 million, excluding your home, and an income of $200,000 for each of the last two years), you can browse open investments on the platform of your choice. Some of the biggest players in the game are Prodigy Network, RealCrowd and Fundrise.
Crowdfunders are classified as limited investors, grouped together and managed by the platform. The minimum investment required is often $10,000.
Some platforms have begun allowing nonaccredited investors to participate. Using the little-known Regulation A portion of the JOBS Act, nonaccredited investors can take part in deals of under $5 million. “The whole industry is changing by allowing nonaccredited investors to participate for as little as $100,” says Miller. These deals take a bit more work — the platform has to register them in each individual state — but Miller says it’s worth the effort to include more investors.
Despite promotion for the Hard Rock Hotel, and lately the new World Trade Center towers in New York, the opportunities are mostly smaller cash-flowing properties. Recently investment in new construction has become popular — a riskier proposition, but with potentially more upside.
The search for the right crowdfunder may be daunting. According to the Massolution report, there are now 85 active real estate crowdfunding platforms in the U.S. and more on the way. Massolution expects there to be 100 platforms globally by midyear, and a legislative change could make the market grow even faster.
When perusing crowdfunding platforms, look for one that is well capitalized. “Most consumers will probably feel more comfortable with teams that have deep benches in the industry,” says Swart. Fundrise recently raised $35 million to fund deals on its balance sheet. This means the platform has so much confidence in their selection, they commit before the crowd.
Be aware that crowdfunding platforms earn most of their money up front by charging the sponsor a flat diligence fee plus a percentage of funds raised (typically 2%) at closing. Then they collect a lesser annual servicing fee from the investor (around 0.50%).
Look for sites with good content. The ability to originate profitable deals is the lifeblood of any crowdfunding platform. Without the deal, there would be no reason to use the service. A good crowdfunder will present only 3-5% of the deals they see. “Origination is probably the most difficult aspect as we’re scaling,” says Dan Miller. “Online origination doesn’t work. We need someone on the ground who knows the market to bring in local deal flow.
Through SEC Regulation S, foreign investors may soon be able to participate in U.S. deals. Platforms like Fundrise expect to have their first deal available to foreigners by June 2015. This could have a huge impact in cities like my hometown of Miami, which is expanding rapidly with the inflow of foreign investment.
Another industry break is the emergence of debt deals. According to the Massolution report, 75.7% of 2014 funding volume came from debt deals — whereas equity-linked securities accounted for 18.5% of the volume.
For those seeking less risk, debt is a good play. For starters, debt holders are repaid before equity investors. There is also a more dependable rate of return and maturation period. But providing debt may also mean that when the property is sold, there's no participation in the profits.
When measuring your appetite for risk, consider that of the more than 500 deals crowdfunded in 2014, 2% became problematic, according to the report. That doesn’t mean everyone is getting rich, but this failure rate is pretty low. Presumably the results from this nascent industry are skewed for lack of data. Massolution estimates that so far less than 4% of capital has been returned to investors. With the three-to-five-year hold times of deals, we may not know the true success of the industry for some time.
