Crowdfunding for Real Estate

Home , Crowdfunding, General Catalyst, Indiegogo, Kickstarter, Patch of Land

John H. Vogel Jr. and Benjamin S. Moll*

The purpose of this article is to describe how crowdfunding works, the dierent approaches that crowdfunding Web sites have taken, some of the early real estate deals that have been funded through crowdfunding, the advantages and disadvantages of raising equity through the crowd, and potential implications for the real estate industry if crowdfunding becomes a signicant source of capital.

An old adage about real estate partner- Internet like clothing or shoes. Today it is ships goes something like this: “at the begin- hard to think of an item that we would hesi- ning of an investment, the general partner tate to buy online. Even when it comes to brings experience and the limited partners spending signicant sums or renting out our bring money. At the end, the roles are some- personal property, we trust Web sites like times reversed.” The history of real estate is Trip Advisor and Airbnb to provide reliable lled with scandals from sales of Florida advice and connect us with trustworthy swamp land to con men selling properties individuals. they do not own. Thus, our rst reaction on learning about sponsors using crowdfunding Two recent developments have elevated to nance real estate investment was one of the prole and potential for raising money for deep skepticism. Crowdfunding seemed private, real estate investments through custom made for sleazy promoters to take crowdfunding. The rst is the Jumpstart Our advantage of naïve investors. Why would Business Startup Act or JOBS Act which reputable real estate rms with dependable President Barack Obama signed into law on nancial backers go through the headaches April 5, 2012. This bill changes key provi- of bringing the general public into their deals? sions in securities law to allow sponsors to raise capital from the general public utilizing The counter argument is that crowdfund- broad based advertising (what the SEC calls ing is a disruptive technology. Raising equity “general solicitation”). The second develop- for real estate investments is inecient, lacks ment has been the injection of over $50 mil- transparency and tends to be time consum- lion from venture capitalists and strategic ing and expensive. Technology and the partners into the leading real estate Web Internet thrive in markets with these sites that facilitate crowdfunding. characteristics. Ten years ago, many of us were dubious about buying items on the Will crowdfunding become a signicant

*John H. Vogel Jr. is an adjunct professor at the Tuck School of Business at Dartmouth where he teaches courses in real estate and entrepreneurship in the social sector. He also is associate faculty director for the Center for Business and Society. Benjamin S. Moll graduated from the Tuck School of Business in 2014. He is the founder and managing partner of Arx Urban Capital, a commercial real estate investment rm that currently is raising capital through the crowd.

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 5 The Real Estate Finance Journal factor in the real estate industry? Will it lead tech products. Kickstarter and IndieGoGo to greater uniformity in the way fees are as- have funded more than 200,000 projects with sessed and deals are structured? Or will nearly $1 billion in capital. crowdfunding become discredited by a series Today there are about 500 crowdfunding of scandals? All three scenarios are possible. Web sites2 which rely broadly on one of two The purpose of this article is to describe how models to raise capital: donation/reward- crowdfunding works, some of the dierent based or investment-based funding. Political approaches that crowdfunding Web sites campaigns, charitable organizations and have taken, some of the early deals that have some entrepreneurs have relied on the dona- been funded through crowdfunding, the ad- tion and reward-based crowdfunding model vantages and disadvantages of raising equity to raise capital to fund projects or run this way and some potential implications for campaigns. Under this model, backers either the real estate industry if crowdfunding donate money to support a cause or receive becomes a signicant source of capital. a pre-determined reward for their capital. The General Crowdfunding Background donation and reward-based crowdfunding model is the platform used by Kickstarter The Oxford Dictionary denes crowdfund- and IndieGogo and many of the more estab- ing as, “the practice of funding a project or lished crowdfunding Web sites. venture by raising many small amounts of money from a large number of people, typi- The second model is investment-based cally via the Internet.”1 The Internet can where the Web site creates a marketplace greatly decrease the cost of pooling small where investors can choose from a variety of investments and allowing individuals to target potential investments. Under this model, specic opportunities. KIVA, for example, al- investors expect to receive a market rate of lows investors to loan money to small entre- return on the capital they invest. Before the preneurs in Africa and around the world in JOBS Act, it was very dicult to raise private increments as small as $25. In eight years, it equity using crowdfunding because of the has raised and made loans totaling $574 Security and Exchange rules about general million. solicitation. As Jonathan Axelrad, a partner at the Goodwin Procter law rm explained: In 2008, the use of crowdfunding expanded For many decades, emerging companies and from primarily funding nonprot ventures to private investment funds generally had only funding small, for prot ventures. IndieGoGo two choices when seeking to issue securities: a fully registered public oering, or a private and Kickstarter began raising money for new oering ‘not involving any public oering.’ ventures to develop things like high tech The Jumpstart Our Business Startups Act (JOBS Act) created a third path. It directs the products or new music albums. Since securi- U.S. Securities and Exchange Commission ties law, at that time, made it dicult for (SEC) to adopt new rules. Under Rule 506(c), individuals backing these projects to receive the prohibition against general solicitation is eliminated . . . so long as securities are is- a nancial return, backers of the projects sued only to accredited investors.3 typically receive an advanced copy of the product or a t-shirt. Typical projects spon- Real Estate Crowdfunding 101 sored by Kickstarter and IndieGoGo include Much of the early success in real estate lms, books, music, art, services and high crowdfunding focused on making loans on

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 6 Crowdfunding for Real Estate small residential properties. Accredited we learned that the leading Web sites have individuals would fund a Limited Liability developed their own underwriting models, do Corporation (LLC) which would then make a nancial stress testing and have set up loan to an individual or small real estate investment committees to approve the company to x up and sell a residential investments. Only investments that survive property. These loans are typically rst mort- this vetting process are listed on the Web gages, which are backed by a personal site. guarantee from the developer, and matured Each investment that is listed generally in six months to 18 months. There are sev- contains the information one would expect in eral real estate crowdfunding sites that cur- an institutional investment committee memo. rently oer their investors this type of invest- The memo and other attachments discuss: ment including: Realty Mogul, Realty Shares, the location, the market, historical nancials, iFunding, and Patch of Land. In our examina- underwriting assumptions, sponsor track rec- tion of several of these deals, investors ord, risks and exit strategy. For some deals, expect an annual interest rate between 7% the crowdfunding sites hold webinars or and 10% and return of capital upon maturity. conference calls to introduce the sponsor As crowdfunding for real estate has gained and the deal to investors who are registered greater acceptance, the emphasis has shifted on the Web site and are interested in the from this kind of niche lending to raising property. equity, mezzanine nancing and debt for In most of the deals that we reviewed, the larger commercial properties and multifamily sponsor allocated only a portion of the limited investments. There are at least 10 crowd- partnership equity to the crowdfunding funding sites that have successfully raised platform. For example if a sponsor needs to equity capital for real estate sponsors from raise $3 million in capital to fund an acquisi- accredited investors. To date, most of the tion, it may raise $2 million from its own real estate Web sites have followed a two- network of investors and allocate the remain- step approach which begins with nding ing $1 million to be raised by the crowdfund- credible real estate sponsors. Crowdfunding ing site. platforms like Realty Mogul, Fundrise, Real Crowd, iFunding, and Realty Shares look for When a potential investor, who is regis- real estate sponsors that have previously tered on one of the crowdfunding Web sites, raised capital through private syndications. decides to participate in a particular deal, These crowdfunding Web sites emphasize they can download and sign the legal paper- their ability to nd outstanding sponsors and work and then send their payment to an perform careful due diligence on these escrow account through an online portal. The sponsors. typical investment listed on a crowdfunding platform has a “reserve” or minimum amount If a sponsor makes it through this screen- of capital that it must raise. If the reserve ing process, they are allowed to present amount is not raised, the money held in the deals for potential investment. The second escrow account is refunded to the investors. step is that some crowdfunding sites use their internal sta to do property level due If sucient capital is raised, the crowdfund- diligence. In our discussions with sponsors, ing sites invest the money in one of two

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 7 The Real Estate Finance Journal ways. Some sites, including Realty Mogul, iFunding, and Realty Shares, set up a special E The most favorable promote to inves- purpose entity, which then invests in the tors was 80%/20% (80% to the inves- partnership or whatever legal entity owns the tors, 20% to the sponsor) while the least property. Essentially all the crowdfund inves- favorable was 50%/50%. The average tors act as a single limited partner. Nav promote across all the transactions was Athwal, the founder and CEO of RealtyShare, 72%/28%. commented that pooling investor capital this way, “greatly reduces the burden to the E Three fourths of the transactions sur- sponsor because the sponsor doesn't have veyed were structured with an acquisi- to manage many small investors and leaves tion fee. The acquisition fee ranged from that to us.”4 Other sites, including Real 0.59% to 5% and averaged 1.73%. Crowd, Prodigy Network, and Fundrise simply E Asset management fees ranged from allow investors to invest directly in the 0.5% to 5% and averaged 1.88%. Prop- partnership or Limited Liability Corporation erty management fees ranged from that holds title to the property as if each in- 1.25% to 8.5% with an average slightly vestor were like any other limited partner. below 4%. Advantages of Using Crowdfunding to The success of a real estate investment Invest in Commercial Real Estate depends on lots of things like the skill of the 1. Greater Transparency sponsor and the quality and location of the property. However, creating transparency so Perhaps the greatest benet of crowdfund- that investors can compare investments and ing for real estate investments is in creating compare deal structures is a great boon and greater transparency for both the investors a healthy step forward for the historically and sponsors. By screening and presenting opaque real estate industry. Over time, we multiple potential investments, investors hope that crowdfunding Web sites will force receive better information about what kinds sponsors to report fee structures and invest- of investments are available and can compare ment results in a standardized way so that the fee structures in each partnership. Most investors can make apples-to-apples equity real estate private placements are structured with a preferred return, which is comparisons. the amount that investors are entitled to 2. More Investors and Smaller before the sponsor begins to share in the Minimums cash ow and appreciation. According to RealtyMogul in its survey of $1 billion of Most private real estate partnerships private placements, the preferred returns purchase a single property. According to ranged from 7% to 12% with an average of RealtyMogul the median real estate, private 8.35%. In the past, most investors only saw a equity deal size in 2012 was $2.3 million.6 limited number of private, real estate oer- Finding and explaining these oerings to ings and therefore had a hard time guring potential investors is time consuming. So out if they are getting an appropriate pre- most sponsors set relatively large minimum ferred return. Similarly in its survey,5 Realty- investments. The average, private real estate Mogul found the following data about fees: partnership had seven investors.7 By present-

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 8 Crowdfunding for Real Estate ing the materials online rather than in person in rallying local support and appearing at means that these oerings can be viewed by community meetings. Once the project is thousands of potential investors. Sponsors operational, they serve as an extra set of can lower the minimum investment and eyes on the project and can steer customers include more investors. It is noteworthy that to the property, especially if it is a hotel, only 47,000 people made investments in apartment building or retail establishment. private real estate equity partnerships in 2012.8 According to the Securities and 5. Enhanced Reporting and Account- Exchange Commission, in the United States ability there are about 8.3 million accredited inves- Because crowdfunding platforms are pri- tors, so crowdfunding could potentially, marily focused on providing information, they greatly expand the investor pool. And once should be able to provide individuals with high the rules are nalized, non-accredited inves- quality information in a timely and easy to tors will also be able to invest. understand format. In terms of accountability, an interesting analogy is the rating system 3. Lower Fees on the Web site eBay. People who sell goods Most of the crowdfunding sites emphasize on eBay worry a great deal about their rat- that crowdfunding enables more money to go ings and reputation. As the crowdfunding into the property than investments in private industry gains scale, it should become easier REITs and private partnerships. Part of the for investors to obtain objective information reason is that the Web sites charge substan- about the track record of dierent sponsors tially lower fees for raising capital than the and greater uniformity in the way returns are brokers and nancial advisers who are paid calculated and reported. as much as 10% of the capital raised. To cite one example of the fees currently being Disadvantages charged by private REITs, Brent Hunsberger claims that the “Georgia-based Wells REIT II 1. Investors Overestimate Their Inc., raised $6 billion from investors since Expertise 2004. But it used only about $4.7 billion to Crowdfunding Web sites promote the idea buy real estate, according to the company's that because all of us interact with real latest quarterly nancial report.” One of the estate, we have the expertise to select good benets of the transparency described above investments. They also claim that knowing is that by explicitly detailing all investment the specic property in which your money is fees there is a high likelihood that competi- being invested reduces the risk. These tion will drive down the fees. concepts directly contradict what many nancial advisers, like Mark Severs at Morgan 4. Benets of Having Local Investors Stanley, recommend. Severs stresses the There are advantages to having local importance of diversication and believes that investors involved in real estate projects. investors are generally better o investing in They can provide sponsors with suggestions indexes and mutual funds rather than in indi- about what is and is not acceptable in their vidual stocks or individual properties. Most community. If the project needs regulatory experienced real estate investors have approval, local investors can sometimes help learned that investing in real estate requires

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 9 The Real Estate Finance Journal signicant expertise that goes well beyond limited partners. Conicts of interest are in- the knowledge acquired by working in an of- evitable, such as the decision about whether ce or shopping at retail stores. Theoreti- to renew an existing lease or look for a new cally, an investor could hire a real estate tenant and earn a lease commission. expert to examine the leases, physical attri- Megan Hammond, who is the managing butes, valuation and market competition for a director of the real assets portfolio for the property in which they want to invest, but Dartmouth endowment, highlighted the impor- that would add signicantly to the cost. tance of having like-minded, limited partners. 2. Unrealistic Projections When an investment gets in trouble, she pointed out, the investors need to work col- In looking at some of the prospective laboratively, whether that means investing investments on the crowdfunding web sites, more money or replacing the general partner. we were struck by what seemed like very If investors have dierent expectations, time high returns. In many cases, sponsors adver- horizons, expertise and nancial capability, tised internal rates of return of 19% to 22%. agreeing on a workout plan or funding a The emphasis seemed to be on eye catching capital call can become a nightmare. returns rather than risk-adjusted returns. In the current investment environment, these The Players returns seem optimistic. Even when it came In trying to understand the current state of to investments in rst mortgage debt the real estate crowdfunding, we looked at seven investments advertised returns of 8% to 10%. of the most successful crowdfunding Web Since banks are currently making construc- sites. We selected them based on: the tion and acquisition loans at 4% to 5%, it is number of deals completed, estimated equity puzzling that investors are able to earn a 400 raised for real estate investment, overall visi- basis point premium, unless the quality of the bility and total venture capital invested in the credit is low, the time horizon is very short sites to further develop their platforms. While and/ or the risk is very high. Many investors there are currently over 30 sites attempting expecting outsized returns are likely to be to raise equity or debt capital for various real disappointed. estate transactions, these seven Web sites 3. Lack of a Personal Relationship to are on the cutting edge and provide a good the Project Sponsor and to Other overview of the current state of the industry. Investors The revenue models for these seven The key to successful real estate investing crowdfunding sites dier in interesting ways. is selecting the right general partner with Some sites charge a fee to the sponsors for properly aligned incentives. When a sponsor the use of their technology and asset man- raises money from “family and friends,” the agement platform. Others charge sponsors personal relationship with the investors adds based on the amount of capital raised or for an extra incentive to treat the investors fairly. the due diligence costs to list a deal. Some In crowdfunding, the sponsor does not know Web sites charge investors a percentage of his or her investors. Over the course of the their quarterly distributed cash ow as an investment, the sponsor will make hundreds annual asset management fee or for using of decisions that impact the returns to the their technology. How these sites will ulti-

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 10 Crowdfunding for Real Estate mately create a sustainable business will net worth, earns over $200,000 annually or undoubtedly change when and if they achieve meets some of the other requirements under a substantial scale. Regulation D of the Security and Exchange Commission rules.9 As Chart A indicates All seven Web sites are willing to list there are substantial dierences between investments anywhere in the United States. Similarly they all draw investors from across these seven web sites, especially in terms of the United States and some even welcome the minimum investment required for a person non U.S. citizens. To invest on most of these to invest in one of the properties listed on sites, an investor must be accredited, mean- their Web site. ing that he or she has over $1 million in liquid

Chart A Platform Type of Prop- Spon- Type of #of Equity Mini- Amount of (Name on erty and Type sor Investor Deals Raised mum Investor- the Web- of Investment Done (Esti- Invest- Sponsor site) mate) ment Interaction Fundrise Commercial & Exter- Accred- 19 $10M10 $10011 Medium Residential nal ited Equity & Debt Non- accredited Prodigy Commercial Internal Accred- 5 $250M12 $100,000 High ited, Equity Foreign Realty Mo- Commercial & Exter- Accred- 6713 $19M14 $5,000 Low gul Residential nal ited Equity & Debt iFunding Commercial & Exter- Accred- 18 $26M $5,000 Low Residential nal & ited /Equity & Debt Internal Ground- Residential/ Exter- Non- 5 $0.25M $100 Low oor Debt nal accredited Realty Commercial & Exter- Accred- 33 $8M $5,000 Low Shares Residential nal ited Equity & Debt RealCrowd Commercial/ Broker Accred- 8 $3M $25,000 High Equity ited

Fundrise some real estate investments for non- accredited investors who qualify as local Fundrise was founded in 2010 with the investors.15 goal of “democratizing local investment” and Fundrise recently raised $31 mil- allowing non-accredited local investors to lion of venture capital from the Collaborative “build their own city.” Today, the platform Fund and Renren, a large social networking provides a range of private real estate invest- company based in China. Other investors in ments for accredited investors. It also oers Fundrise include prominent real estate execu-

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 11 The Real Estate Finance Journal tives of Silverstein Properties, Rising Realty private real estate investment. Realty Shares Partners, the Ackman-Zi Real Estate Group, is backed by General Catalyst Partners, 500 and Loopnet. Startups, and Greg Framke (former COO of E*Trade). Prodigy iFunding Prodigy is a New York based company that raises money only for its own deals. Prod- iFunding's platform currently appears to igy's founder and CEO is Rodrigo Nino, a na- utilize a similar business model as Realty tive of Columbia. It rst came to prominence Mogul and Realty Shares. The Web site marketing the Trump SoHo hotel focuses primarily on equity investments in condominium. Recently Prodigy shifted its residential “x and ips,” but has completed focus from U.S. investors to international a few commercial deals. It recently partnered investors. It raised $171.8 million of equity with one of its sponsors, who is building a from 3,100 investors to build a 66-story $250 million condominium project in New tower in Bogota, Columbia. Of all the crowd- York. So far iFunding has raised $7 million of funding Web sites we studied, Prodigy seems equity for this condominium project and to have the highest prole properties. hopes to raise an additional $48 million.17 Former New York Governor David Paterson Realty Mogul recently joined the sta at iFunding. Realty Mogul refers to itself as “a market- Groundoor place for accredited investors to pool money online and buy shares of pre-screened real Groundoor is a peer-to-peer lending site estate investments.”16 Investors on Realty for small residential, development projects Mogul's platform invest directly into a newly based in the Raleigh-Durham Research formed entity controlled by Realty Mogul. All Triangle. The site has successfully raised interaction between the sponsor and inves- capital from non-accredited investors in tors is ltered through Realty Mogul. Thus Georgia and anticipates using other intra- far, Realty Mogul has oered a mix of equity state crowdfunding exemptions to solicit investments in commercial deals with experi- interest from investors in Arizona, Illinois, enced sponsors and debt investments on Massachusetts, and Virginia. Groundoor residential “x and ips.” Realty Mogul has closed its rst round of funding with Band- raised $9 million of venture capital in a round width Labs and the American Underground. led by Canaan Partners. RealCrowd Realty Shares RealCrowd allows real estate operating Realty Shares is an online investment companies to post information about their platform attempting to become “the projects and connect to accredited investors E*TRADE of private real estate.” The site who invest directly with the sponsor along- contains a mix of equity investments on com- side their existing limited partners. The spon- mercial properties and peer-to-peer lending sors that raise capital through RealCrowd on residential “ips.” Investors pool capital are responsible for vetting the investors to into funds that hold an interest in a specic, ensure that they are accredited and for cor-

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 12 Crowdfunding for Real Estate responding directly with investors. The site vice president of investment Joe Stampone has raised $1.6 million in a seed round from said, “We easily could have raised the capital Data Collective, Y Combinator Partner Garry from our existing investor base, but by using Tan, Reddit co-founder and author Alexis crowdfunding we are branding ourselves as Ohanian, and a collection of real estate and a forward thinking group and as thought wealth managers. leaders in the industry.” Further, when dis- cussing the process of raising capital online, Two Representative Deals Stampone “found Real Crowd very easy to use because the site connects us directly In writing this article, we reviewed more with potential investors. We chose that site than 30 deals that have raised money or are because we wanted access to high-net worth currently raising money through one of the investors with whom we could develop long- crowdfunding platforms. These deals ranged term relationships.” from rst mortgages for “x and ip” residential projects to equity stakes in large Another example of a property where a commercial properties. The variety of invest- crowdfunding site raised the required equity ments gave us the sense that these Web capital was the Hard Rock Hotel in Palm sites are trying out lots of ideas to see what Springs. Realty Mogul raised $1.56 million in works. equity to recapitalize this property. The current owner, Kittridge Hotels & Resorts sought In one deal that received considerable in- the capital in order to recoup some of its vestor interest, Real Crowd raised $400,000 initial investment and to make improvements for Atlas Real Estate Partners, a New York to the property like upgrading the swimming City based investment rm. The $400,000 of pool. The deal is structured as an 8% pre- equity was roughly a quarter of the total ferred return with excess cash ow and equity. Atlas used this money to acquire Fort residual proceeds split 80% to investors and Davis Center, a 44,147 square foot, 100% 20% to the sponsor. The sponsor projects a leased oce/retail center located in Wash- 16% total return over a ve-year hold. ington, D.C. In analyzing this hotel investment several Fort Davis Center is in an up-and-coming aspects of the underwriting stood out. It ap- neighborhood of Washington D.C and is pears to be highly leveraged with at least a anchored by the Department of Human Ser- 75% loan to value ratio including mezzanine vices, which occupies 59% of the property. debt. Over the ve years, the sponsor proj- The acquisition was nanced with a 10-year ects that the REVPAR, (or “Revenue per xed-rate CMBS loan. Atlas structured this Available Room,” a common hotel revenue investment so that investors receive an 8% metric) will increase by 38% from $111 per preferred return and then a share of ad- available room per night to about $154 per ditional cash ow and residual prots on sale available room per night. One other interest- or renancing. Overall, Atlas projects that ing aspect of the deal is that Realty Mogul investors will receive an overall return in the has built in some special perks for investors: teens. “In addition to sharing in the income from the When asked why they decided to use hotel through quarterly rental payments and crowdfunding to raise part of their equity, any appreciation of the hotel when it is

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 13 The Real Estate Finance Journal eventually sold, investors will receive a Hard Based on the JOBS Act and the new rule Rock Hotel Palm Springs Owners Card,” 506C sponsors can still raise unlimited which entitles investors to discounts on amounts of money from accredited investors stays, room upgrades, dining credit and and can now use broad based advertising special treatment at the pool.18 like their Web sites to generate interest. However, under rule 506C of the JOBS Act, Regulatory Issues the sponsors now have more responsibility in The Jumpstart Our Business Act (JOBS) ensuring that their investors meet the accred- Act was signed into law on April 5, 2012. ited investor criteria. Under the old rules, all The SEC is currently writing and circulating that was required of the sponsor was that key rules. But the JOBS Act is already hav- their investors check a box stating that they ing an impact by allowing crowdfunding Web are accredited. Under the new rules, the sites to broadly publicize their private equity crowdfunding Web sites are required to investments. Until the SEC completes its obtain additional proof of eligibility. rulemaking, most crowdfunding Web sites Title III are only making their investments available to accredited investors.19 Once the SEC rules Title III of the JOBS Act focuses on the are nalized, non-accredited investors will rules allowing non-accredited individuals to also be able to participate in these crowd- invest in crowdfunded oerings. The SEC is funded investments. currently nalizing these rules and seeking comments from the public. For crowdfunding The two parts of the JOBS Act that most Web sites part of the motivation for including directly govern crowdfunding are Title II and non-accredited investors is to broaden their Title III. investor base. Many of these Web sites also assert that people should be able to invest in Title II properties in their local communities. Crowd- Previously, the SEC provided real estate funding makes it possible for investors to put sponsors an exemption from full registration as little as $100 into a private equity of its securities when they did a “private investment. Before the JOBS Act and the placement” (Rule 506B under Regulation D). ability to solicit investments through the Sponsors were able to raise as much money Internet, it would have been cost prohibitive from as many accredited investors as they to allow such small investments. wanted as well as 35 “sophisticated” investors who were not accredited. Nonetheless, Crowdfunding Web sites like Fundrise and this rule prohibited general solicitation in Groundoor are not waiting for the SEC private securities oerings regardless of the rulemaking to accommodate non-accredited, type of investor. Sponsors therefore could local investors. Both make some of their not advertise their deals publicly through investments available to non-accredited newspaper ads, television or radio com- investors by raising capital through Regula- mercials, public seminars, or unrestricted tion A or through intrastate crowdfunding Web sites. Sponsors generally put numbers laws. A number of states have enacted on each private placement oering and kept statutes favorable to crowdfunding and a detailed records of each individual who number of additional states are seriously received a copy of this material. considering passing similar measures.

Conclusion slip. In a similar vein, he noted that “in the early stages the seven groups mentioned in It will be interesting to see how crowdfund- this article, seem to be fairly responsible. But ing evolves over the next few years. While if this approach gets more traction it may at- there are advantages to investing in real tract less reputable players.” Professor estate with people you know, the Bernie Poorvu also guessed that crowdfunding “will Mado scandal is the latest examples of how work better with existing properties than “face to face” relationships do not necessar- development deals.” The amount of equity in ily protect investors. Apparently, Bernie development deals “is often hard to pin Mado did not even know how to use the down.” Internet. In contrast, most of the leading crowdfunding Web sites have hired people It is interesting to note, where crowdfund- with considerable real estate experience to ing has taken hold. As one might expect, in screen investments and sponsors. It may, in the United States, many early adopters are fact, be more dicult for con men to commit located in Silicon Valley. But interestingly, the fraud through the leading web sites with the largest crowdfunding investment, as de- transparency and written documentation that scribed earlier, was made in Bogota, is required. Furthermore, the combination of Colombia.20 For countries like Colombia crowdfunding and social media may drive where the capital markets are less developed poor performing sponsors out of the market and where there are fewer options for inves- relatively quickly. tors who want to put money into commercial real estate, crowdfunding may gain traction On the other hand, inexperienced inves- quickly. Similarly, for international investors, tors may not fully understand the risks. Naïve crowdfunding may be an attractive way to investors are easily lead to believe that invest in U.S. real estate. because a building is tangible their downside is protected. The reality is that many of the For those who are optimistic, the Lending real estate investments we reviewed were Club provides an interesting analogy. Lend- opportunistic with high leverage and/ or sig- ing Club started in 2007 and does peer to nicant leasing challenges. Investors could peer lending, enabling investors to make easily lose their whole investment. Many of unsecured personal loans to prescreened the investments that we looked at projected borrowers. In the rst year, the Web site very high internal rates of return. In today's made $4.8 million in loans. In the rst three real estate environment it may be possible to months of 2014 it raised and made $781 mil- achieve these returns, but only with high risk lion in loans and topped $4 billion in loans investments. since inception.21

Bill Poorvu, emeritus professor at Harvard Arthur Segel, the Poorvu family professor Business School, points out a subtle but of management practice at Harvard Business important tension between quality control and School, recently ran a program for 180 earning fees from transactions. Since these seasoned real estate professionals. After do- Web sites earn fees based on the volume of ing a session about crowdfunding for real transactions there will be pressure, as there estate he asked the audience if they thought was in underwriting commercial mortgage it would work. “Everyone under 40 thought it backed securities, to allow the standards to would work,” according to Segel, “and every-

The Real Estate Finance Journal E Summer/Fall 2014 © 2014 Thomson Reuters 15 The Real Estate Finance Journal one over 40 believed it would not work.” insurance companies, employee benet plans, and trusts. In order for an individual to qualify as an accred- Time will tell. ited investor, he or she must accomplish at least one of the following:

1) earn an individual income of more than $200,000 NOTES: per year, or a joint income of $300,000, in each of the 1http://www.oxforddictionaries.com/us/denition/ last two years and expect to reasonably maintain the americanenglish/crowdfunding. same level of income. 2http://www.forbes.com/sites/ryancaldbeck/ 2013/06/23/crowdfunding-trends-which-crowdfundin 2) have a net worth exceeding $1 million, either g-sites-will-survive/. individually or jointly with his or her spouse. 3Slide show by Jonathan Axelrad, Partner, Good- win Procter: http://www.goodwinprocter.com/˜/media/ 3) be a general partner, executive ocer, director or 691FFF61D0A549E9AC55242CB6CCFCE6.pdf. a related combination thereof for the issuer of a secu- 4 http://astudentoftherealestategame.com/my-upd rity being oered.An employee benet plan or a trust ated-thoughts-on-crowdfunding-for-real-estate-and-a n-interview-with-realtyshares/#more-8452. can be qualied as accredit investors if its total assets 5Realty Mogul survey of private real estate are in excess of $5 million. syndications: https://www.realtymogul.com/sites/defa 10https://s3.amazonaws.com/fundrise-content/we ult/les/A%20Look%20at%20Current%20Market%20R bsite-documents/fundrisemarketingonepagerint ates%20and%20Trends%20for%20Real%20Estate%20 eractive.pdf. Syndications.pdf. 11 6 Using Regulation A oerings. Realty Mogul survey of private real estate 12 syndications: https://www.realtymogul.com/sites/defa The majority of this amount was raised for proj- ult/les/A%20Look%20at%20Current%20Market%20R ects outside of the United States. ates%20and%20Trends%20for%20Real%20Estate%20 13https://www.realtymogul.com/statistics. Syndications.pdf. 14https://www.realtymogul.com/statistics. 7Realty Mogul survey of private real estate 15https://www.realtymogul.com/help. syndications: https://www.realtymogul.com/sites/defa ult/les/A%20Look%20at%20Current%20Market%20R 16https://www.realtymogul.com/help. ates%20and%20Trends%20for%20Real%20Estate%20 17http://www.rew-online.com/2014/01/07/ifundi Syndications.pdf. ng-to-build-250-million-condo-tower-on-fulton-street/. 8 Barguess, Scott and Vladimir Ivanov, Capital 18https://www.realtymogul.com/investment-oppor Raising in the U.S.: An Analysis of Unregistered Oer- tunity/16570. ings Using the Regulation D Exemption, 2009-2012. 19 9 See supra for accredited investor criteria. According to Investopedia, “Accredited Investor is 20 a term used by the Securities and Exchange Commis- Max Raskin, “Crowdfunding for Real Estate: Buy sion (SEC) under Regulation D to refer to investors a Slide of a Skyscraper,” Bloomberg Businessweek, who are nancially sophisticated and have a reduced January 24, 2013. need for the protection provided by certain government 21Lending Club Web site: https://www.lendingclub. lings. Accredited investors include individuals, banks, com/.