Tuesday, January 13, 2015

Crowdfunding: The Wave of the Future Is Now, Part 2 of 3

Illustration by Alis Atwell for Bloomberg Businessweek, Source: Getty Images (9)
by Matt Reynolds and Spencer Marona

In part 1 of this 3 part series we covered: what is crowdfunding and the impact we are beginning to see on investment real estate. Part two discusses the process involved for accredited investors.

Crowdfunding, Part 2

If KickStarter and traditional brokerage for investment real estate had a baby, the child would be crowdfunding. The name of this child would also be the industry leader for  US real estate crowdfunding:  Fundrise, based in Washington D.C.

In attempting to push the possibilities of real estate capital raising they have brought into the limelight many key issues surrounding real estate investment. Prior to the passing of the JOBS Act in 2012 investing in real estate required investors to be officially accredited. To become an accredited investor required that you be an extremely wealthy individual; earning more than $200K per year or having a net worth of more than $1million. Fundrise Co-founder Ben Miller, points out that this makes it nearly impossible for anybody but institutional investors to invest in Real Estate. Miller claims this has caused a divide between investors and locals. Fundrise’s marketing campaigns aim to put the power on investing in property back into the hands of the people that the property will impact.

For many crowdfunding sites, minimum required investment amounts are still relatively large for people of average income. CrowdStreet, the most prominent Portland based company, requires a minimum investment of $10,000. By comparison Fundrise has offered deals that allow for investors in specific states to invest as little as $100 dollars, an exciting glimpse at what the future might hold. Crowdfunding sites find and investigate potential deals and then market deals that meet their standards to investors, usefully through their website. This places responsibility for finding good investments almost entirely on the shoulders on the crowdfunding company. Crowdfunding is new so naturally many investors are nervous, and traditional financial advisors—potentially worried about future threats to their own positions—are skeptical. For the moment crowdfunding companies appear to be choosing the investments they offer with great care.

Many real estate crowdfunding companies essentially act as a marketplace connecting investors to developers or other real estate companies. If you think about each real estate deal then this process is not incredibly dissimilar from the way stock markets operate. Individuals invest money into the real estate deal. When the deal becoming profitable they receive a proportionate amount of return. Finally, when the property is sold they receive their share of the sale revenue. Each investor also jointly assumes the traditional risks associated with real estate investments. For example if the building fails to sell, loses value, or become unprofitable then it is possible that individuals will see their investments evaporate.

Crowdfunding can also be used to supplement capital for institutional investors. For example, CrowdStreet recently raised $2.7 million to help Portland based Windmill investments purchase an $18.4 million apartment complex in Dallas. Windmill helped sponsor the deal by putting $300,000 of its own money on the line. Collectively, CrowdStreet and Windmill were then able to take out loans to cover the additional cost of the property.

The advantage to this type of investing is that it opens up new sources of capital previously unavailable to real estate investments. The biggest hurdle to overcome will be for crowdfunding companies to manage the risk of handling money from thousands of investors and limiting their liability to developers and investors if a deal goes south.

Part three of this series will cover the current debate and potential implications for crowdfunding and investment real estate in the future.

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