This being baseball season, a baseball metaphor seems apt to describe the stunning year-long rise of real estate crowdfunding: dramatic growth aside, we are still in the bottom half of the first inning. Crowdfunding is much like old-style syndication, but with the turbo engine of the Internet behind it. Internet-based platforms — funding portals — for raising both equity and debt are enabling individual investors and real estate owners and developers to connect directly. And investors are doing just that, with minimum investments ranging from $100 to $1 million.
Industry denizens call it a quantum leap forward in improving the efficiency and transparency of conventional, often archaic, fundraising for commercial real estate. Crowdfunding platforms also are reaching out to individual investors as well as to developers and owners of smaller projects that typically do not get a second glance from institutional investors.
These platforms typically create a limited liability company as a “special purpose vehicle” for each project. They post all relevant information about the project on their website and handle all reporting to investors. Project sponsors cut one check to the LLC according to the terms of a deal, from which the platform pays out returns to investors. Everything related to a deal on a portal’s website may be transparent, but that doesn’t mean investors needn’t conduct their own due diligence before making an investment. As William Skelley, founder of iFunding, pointed out, “we don’t advise anyone on due diligence.”
Why and how has crowdfunding made the leap from “what’s that?” status in just a year? In September 2013, the Jumpstart Our Business Startups (JOBS) Act Title II eased up solicitation rules for private companies seeking investors. Those people must be accredited investors, able to prove that they either have an individual annual income of $200,000 or more or a net worth (excluding their primary residence) of $1 million or more. Rules for Title III of the Act, regarding nonaccredited investors, have yet to be promulgated. But that hasn’t stopped dozens of portals from entering the fray.
A Pioneer’s Perspective
If anyone knows how quickly the business has grown, it is Ben Miller, co-founder of Washington, D.C.-based Fundrise, a pioneer in the field. Miller and his brother Daniel started the company in 2012. Interviewed for an article that appeared in the fall 2013 issue of Development, Miller said that crowdfunding would “scale faster than anyone expects.” That included himself, as it turns out. Miller’s biggest surprise in the last year has been the growth of new portals, partially a result of the low barrier to entry, he said. Fundrise has grown substantially, too.
“We get calls from 10 developers a day,” he said. Consequently, Miller now spends more of his time on company management issues, building the company’s team, and with investors. (Before that, he spent more than 60 weeks visiting three cities a week to meet with real estate companies.) Last year, Miller expected to be working with 100 developers in a year’s time; that number now is closer to 300.
One sign of the changing times: three years ago, when Miller met with Larry Silverstein, chairman of Silverstein Properties Inc., developer of the World Trade Center in New York, to discuss the concept, Silverstein said, “Great. Let us know how it goes.” But relationship building pays off. Several months ago, Fundrise raised more than $31 million in its first round of funding from a group of prominent technology, real estate and other backers, including executives of Silverstein Properties as well as Renren, a large social networking company based in China, and individuals in several real estate firms.
“Our market will start looking like the public market, with $10 to $20 million a month raised, for iconic buildings,” Miller said.
Reaching Nonaccredited Investors
Not all portals are limited to soliciting from accredited investors; state law sometimes enables portals to market to and accept investments from nonaccredited investors. Grady Thrasher, co-founder and CEO of CrowdVested in Georgia, explained that its model is to give local people the opportunity to invest locally, with a $500 minimum. Among the benefits: property owners can show that there is community support for a development and, ultimately, the development returns funds to local pockets. Over the past year, Thrasher, an attorney who already had worked extensively with real estate developers, has spent a lot of time educating investors.
“Real estate is an ideal place for crowdfunding,” he said. “It’s tangible; you can touch it; it’s surrounded by metrics. Ultimately, it’s easier to explain than a software patent.”
Crowdfunding attorney (and blogger) Mark Roderick of Flaster/Greenberg PC in New Jersey got involved in the field, he explained, because when the JOBS act was being discussed, “I thought that this would be the most transformative legal change in my lifetime. So I decided I would make it my business to get involved and learn.”
How should developers and property owners approach crowdfunding as a new source of capital? Roderick recommended that developers could become portals themselves. “They have the deal flow and the investors,” he said. “Put the deals online. Create it from existing deal flow.” If they are looking for an existing crowdfunding site, he also advised them to look for those that have a lot of capital and the ability to close a deal. Pay close attention to how fees are structured and how the portals will split any promote that becomes part of the deal.
A Look Into the Future
What can we expect to see in the next several years? The business will continue to grow, but not all portals will gain traction and consolidation is inevitable, industry observers say. As Kevin Arrabaca, president of real estate investment at AssetAvenue, said: “A lot of groups are [run by] core real estate people but not technology people; or they’re technology people, with a service background, but without a lot of real estate expertise.” AssetAvenue itself first focused on debt investments, but now includes development, investment in cash-flowing properties and refinancing. It also works with what Arrabaca called a rotation of institutional investors.
The portals themselves may morph into forms that depart from their origins. Joey Jelinek, co-founder and CEO of GroundBreaker, for example, explained that, based on feedback the company had gotten from operators who wanted something unique to them, GroundBreaker has revamped its architecture so that each operator can have its own privately branded portal: “You get your own sandbox, with full control of your web-based portal.” Operators can make their own decisions about minimum investments, how they will vet investors and how they provide information to them. GroundBreaker will provide the software (for which it is compensated) and also will act as an investor lead generator through its own website, for which it expects to earn a fee as well.
Luan Cox, CEO of Crowdnetic (see “Crowdfunding Metrics” below), believes that one key challenge to the nascent industry’s growth is the risk that a bad actor (either at the issuer or the portal level) could tarnish the industry’s reputation. Both issuers and project sponsors must focus on public awareness, education, promotion and publicity, she said.
Along with growth, consolidation and change, bigger names, bigger projects and bigger investments seem inevitable. For example, the Carlton Group, an international real estate investment bank in business since 1991 that has been involved with numerous high-profile transactions, has created the Carlton Accredited Equity Crowdfunding portal. Unlike many of the sites that require minimum investments of $1,000 or $5,000, Carlton’s price of entry is $1 million.
Moreover, there will be more specialization, not only by property type or by equity or debt, but also by geographic area. CityShares LLC, for example, provides accredited investors the opportunity to invest in appreciating New York City neighborhoods (some of which may be just shy of the gentrifying stage). It launched its first Neighborhood Investment Fund (NIF) for Bedford-Stuyvesant in Brooklyn and will invest in a portfolio of residential and mixed-use properties there.
And here, perhaps, is the ultimate irony. An industry that arose to disrupt the status quo of raising capital through conventional means, particularly institutional capital, has caught the eye of major investors, such as venture capital funds, as well as lending institutions and investment banks.
Nor is it out of the realm of possibility that a few of these portals will become public companies themselves. But that’s for the industry’s later innings.
A Developer Takes the Plunge
For owners and developers contemplating dipping their toes into these new waters, the experience of David Pittman, principal of Acacia Real Estate Group, is noteworthy. Frustrated with the lack of institutional capital available for smaller industrial developments, Pittman attended a crowdfunding conference, read a lot about the subject and spent considerable time talking with people at GroundBreaker last summer. Acacia was looking for equity investment for smaller, for-sale industrial properties in the San Gabriel Valley of California, which has experienced low vacancy, high demand and antiquated supply.
So Pittman decided to take the leap, to raise up to $5 million in equity for the Los Angeles Flex Center, a 13-acre site for six buildings of 35,000 to 50,000 square feet each. The total project cost is expected to be $27.2 million, with the cost of closing on the land $12.88 million. Acacia offered investors a 10 percent preferred return and an estimated total return of 59 percent, with an estimated maturity of two years.
Pittman approached this process with skepticism, he said, because GroundBreaker was still in its infancy. “These things are structured for people with a long lead time. It’s hard to do if the window to close is short.” Fortunately, Acacia had some flexibility on timing. In January 2014 the project began raising money, with 65 individuals signing on to invest $500 to $50,000 a piece. Acacia is investing 10 percent of the equity and has additional equity investment from other sources. The crowdfunded portion, he said, is “gravy.”
The experience has been “interesting, but not something I’d be completely sold on yet,” he said. “Mostly what I’ve seen is for existing property, not for development. The key is to be able to raise money quickly. You have to have an extensive network of people to tap into.” But, he added, “there are always new opportunities out there. You have to embrace them. I don’t see this going away.”
Since the rules allowing for general solicitation went into effect, Crowdnetic, a provider of technology and market data solutions to the global crowdfinance marketplace, has aggregated data for 48 U.S. real estate “private issuers publicly raising (PIPRs).” From the end of the first month of data collection (October 31, 2013) through May 31, 2014, the number of total PIPRs in the industry grew by 336.4 percent.
Of those PIPRs, more than half were involved with residential real estate, while nearly one quarter were involved with two or more real estate categories. The percentage involved solely with nonresidential (office, industrial, retail and hotel) properties is in the single digits. The total amount of recorded capital commitments received by these 48 PIPRs since inclusion in Crowdnetic’s data is nearly $23 million. After services and technology, real estate is the third-largest crowdfunding business category. The states attracting the most crowdfunding capital are California, New York, Texas, Florida and Illinois.