A primer (rhymes with swimmer) is a position paper that covers the elementary principles of a subject. That is exactly what I’m attempting to do in this article because I’m only a few steps ahead of you on understanding the impact of crowdfunding on commercial real estate.
And make no mistake about it crowdfunding it is here to stay and it could have enormous influence on how real estate gets funded in the future. Some pundits are even predicting that crowdfunding has the potential to be a disruptive technology, i.e., a new technology that helps create a new market that eventually disrupts the traditional way of doing business. But before I go any further let’s start with the basics:
What is crowdfunding? Crowdfunding, as defined by the Massolution 2015CR-RE Crowdfunding for Real Estate Report (http:/www.crowdsourcing.org/research) is, “an Internet-facilitated means for sponsors, businesses, or other entities to raise funds from a multitude of individual investors or patrons, even institutions, for a particular project or initiative. For securities-based transactions the outreach, or open call, is typically limited to accredited investors.”
The crowdfunding concept of raising funds from a multitude of individual investors or patrons for a particular project has been around for a long time. For example over 100 years ago the base for the Statue of Liberty was financed by Americans donating small sums of money to the cause.
What makes crowdfunding unique? What makes real estate crowdfunding unique from other forms of real estate investments is their use of the internet and other technology to raise the needed funds.
Who is allowed to invest? In the United States only accredited investors are allowed to invest in crowdfunding. An accredited investor is someone who has a net worth of at least $1 million, not including the value of their primary residence, or has income of at least $200,000 annually for the last two years (or if married $300,000 together with their spouse).
How many crowdfunding models are there? There are four financial crowdfunding models. They are:
- Lending – crowdfunders lend money to a sponsor, typically secured by real estate, in exchange they receive interest payments and a return of their original capital.
- Equity – crowdfunders invest their funds in a sponsor’s property and in return they receive on-going cash flow and capital appreciation when the property is sold.
- Royalty – crowdfunders invest their funds and receive a usage-based payment from another party for the other parties’ right to ongoing use of an asset, e.g., a percentage of rent from a commercial lease.
- Hybrid – a combination of two of the other three models.
Which crowdfunding model is most popular? By far lender-based real estate crowdfunding is the most popular crowdfunding model. In 2014, 75.7% of all crowdfunding volume worldwide was lender-based and another 18.5% was equity based.
How much growth has there been in crowdfunding volume over the years? Worldwide crowdfunding volume increased from $396.4 million in 2013 to $1.014 billion in 2014. It is projected to grow to $2.57 billion this year.
How many crowdfunding platforms are there? There are currently 85 crowdfunding platforms globally with more than 100 anticipated by the end of the year.
What are the initial results of these 2014 real estate crowdfunding campaigns? Over 500 real estate crowdfunding campaigns were conducted by 85 CFPs in 2014. Commercial real estate being what it is, it’s too early to tell how well these campaigns met their projections. That question will certainly be answered in the years ahead, but for now it’s too early in the process to know.
So these are some of the basic facts about real estate crowdfunding. I believe it is here to stay, that it is not a fad and that it truly has the opportunity to be a disruptive force in commercial real estate. If true, then how do we take advantage of this new technology and at the same time avoid being a lemming running with the pack head long into the ocean? Here are my thoughts:
How to avoid being a lemming? Do your homework.
- Choose your crowdfunding platform wisely. Not all platforms are equally good. Find out if they are they well capitalized. Do they have qualified people at the top? Or are they two recent college graduates with no real estate experience?
- Choose the crowdfunding model that works best for you. For me personally, I plan to invest in a lender-based crowdfunding model. I think there is substantially less risk with this model (and likely a whole lot less reward) than the equity-based crowdfunding model.
- Qualify your sponsor. What is their track record? How much real estate experience do they have in senior management? Can you meet them?
- What is the collateral of your investment? Is it the real estate or is it in an investment product structured by the crowdfunding company?
- How leveraged is the investment? Would it be overleveraged if there were a downturn in the market?
- How long is the proposed holding period? Is that an acceptable time period? There is currently no secondary market for crowdfunding investments, which means that the project will have to come to a completion before the investor can liquidate.
It is very possible that in the years ahead real estate crowdfunding will expose its Achilles heel. But for now I see it as a legitimate model for funding commercial real estate. Proceed with caution. Do your homework. Start with modest investments until you get a feel for what you’re doing. Good luck and let me know how it works out for you.
Source: The source for all of the facts in this article, except for a few definitions from Wikipedia, came from the Massolution 2015CR-RE Crowdfunding for Real Estate Report, http://www.crowdsourcing.org/research