Crowdfunding: The evolution of real estate investing
Commercial real estate investing is no longer an exclusive club reserved for the likes of Donald Trump. Crowdfunding and the access that it has created is truly revolutionizing commercial real estate investing for accredited investors.
Investing directly in commercial real estate has traditionally been a bit of an “old school” process. Investors often had to know the right people and be ready to put up a significant chunk of capital to buy a stake in an office building, apartment community or shopping center. Two big changes have occurred in this landscape to bring commercial real estate investing into the 21st century and into the reach of accredited investors.
First, new legislation passed as part of the Jumpstart Our Business Startups Act or JOBS Act in 2012 provided the catalyst to launch crowdfunding. The basic premise behind crowdfunding is to raise capital from a large number of individuals. Enacted in September of 2013, Title II of the JOBS Act allows sponsors, namely developers, operators or others who are raising capital from private investors, to broadly market those opportunities directly to qualified accredited investors through a process known as general solicitation.
The other essential ingredient to crowdfunding is the technology platform that has brought both transparency and efficiency to the online investing process. Essentially, technological platforms are providing solutions to real estate sponsors to connect directly to retail investors. Real estate sponsors are now able to leverage the power of the Internet to offer investment opportunities directly to accredited investors around the country in a more efficient, scalable and repeatable manner and utilize the technology now available to them to streamline investor relations.
Real estate within reach
The passage of legislation and advent of new technologies has combined to make direct real estate investing more accessible today for accredited investors than it ever was in the past. Crowdfunding enables accredited investors to invest in institutional quality commercial real estate in smaller increments than what was previously offered in the offline world. Traditionally, the minimum buy-in amount for real estate deals structured through a partnership or LLC started at $100,000 to $200,000.
Online platforms allow sponsors to reach a larger and more geographically diverse pool of investors. Equally as important, these platforms allow sponsors to manage those investor relationships more efficiently. Therefore, rather than raising $200,000 from five to ten investors, sponsors can now use an online process to reach 30 to 40 accredited investors who want to invest $25,000 to $50,000 into a deal.
Lower minimum investment amounts and a much broader range of investment choice mean that investors, for the first time, are truly able to assemble a diversified portfolio of direct real estate investments. Increasingly, investors are utilizing crowdfunding platforms to allocate investment dollars across different property types and different regions of the country.
Consider how firms such as Schwab and Ameritrade revolutionized the financial investment arena by creating an online marketplace. We believe that the same level of transparency, democratization of information and access to investments that transformed the securities industry is now transforming commercial real estate investing. Investors have the ability to identify, analyze and place capital in real estate from their computer or tablet.
Technology platforms are continuing to evolve to help investors to both access and manage their real estate investments. For example, one of the new features at CrowdStreet is greater functionality that we have added to our online “Investor Room”. Certain CrowdStreet investors have invested in three or four different deals. To address our evolving investor needs, CrowdStreet has added a portfolio view function that better illustrates how all of those investments are performing with enhanced charting and graphing capabilities. Investors can now see how an individual property is doing, such as actual versus targeted distributions and returns, and they can also look at an overall portfolio summary with performance and composition data.
How to get started
The first step is for investors is to determine how much they want to allocate towards direct real estate investments as a percentage or dollar amount of their overall portfolio. Second, formulate a game plan for diversifying that allocation. For example, do you have a preference for a particular asset class, such as a senior housing, office or multifamily properties?
The next step is to do your homework. The rise of equity crowdfunding has created a proliferation of firms, and much like any other investment, investors need to examine their options carefully. Some basic guidelines to consider when evaluating crowdfunding firms include:
- Look at the company’s track record — The quality and types of projects that a crowdfunding firm has both completed and currently has listed on its platform will help you to decide whether the firm is a good fit. CrowdStreet, for example, focuses on institutional quality assets, such as office buildings, assisted living facilities, self-storage and apartment properties, while other companies specialize in smaller scale, entrepreneurial projects such as fix and flip rental housing.
- Look at the team behind the platform — Crowdfunding is not just a technology platform, and it is not just real estate. It also involves private equity capital formation. So, investors should make sure the sponsors have real estate, technology and private equity fundraising expertise.
- Ask questions about a crowdfunding firm’s screening process for both sponsors and properties — Reputable crowdfunding firms will have a vetting process to identify experienced industry professionals and qualified deals.
- Watch out for hidden fees — Crowdfunding is not a one-size-fits-all platform. Different firms have different business models. At CrowdStreet, our philosophy is that we are providing accredited investors with access to institutional quality deals. Sponsors pay a fee to use CrowdStreet as a third-party intermediary in the fundraising process. However, we do not charge fees to the investors who use the platform. Other crowdfunding platforms do charge fees to the investor, and in some cases, they charge fees to both the investor and the sponsor.
- Understand the risks — Real estate, by its nature, is an illiquid asset class that carries a degree of risk. Investors must be comfortable with the terms and potential downside of a particular investment. In order to mitigate those risks, it is important to invest with a crowdfunding platform and sponsor that have experience and credibility.
More growth ahead
Crowdfunding has entered the market at a time when the appetite for real estate as an alternative investment is on the rise. Real estate is an attractive play for a number of reasons. Many people like real estate to diversify their broader investment portfolio, while others view real estate as a hedge against inflation. In common practice, property owners typically raise rents as operating and financing costs rise. Real estate also has the potential to offer attractive returns and steady cash flow relative to other investments in what remains a historically low interest rate environment.
One might argue that individuals can already access real estate investments through vehicles such as buying shares of real estate investment trust (REIT) stocks or funds. The distinction here is that crowdfunding gives investors the opportunity to buy a stake in a specific property, such as an apartment building in Houston or an office building in New Jersey. Publicly traded REIT stocks, for example, entail ownership in the REIT operating company, which makes them derivative of direct real estate ownership.. As a result, there is an important distinction between direct real estate investing and other real estate investing alternatives.
Data clearly shows that both deal sponsors and investors are embracing this new era of online real estate investing. The estimated $1 billion in online capital formation sourced directly from retail investors for real estate crowdfunding in 2014 is expected to jump to $2.5 billion this year, according to industry data from Massolution. The crowdfunding research firm also forecasts that online capital formation will reach the tens of billions of dollars within the next three to five years.
For the first time in history, accredited investors have the opportunity to invest directly in institutional quality real estate, literally, at their fingertips. Ultimately, we believe that we are in an exciting period of transformative change as it relates to the growth and continued evolution of the online real estate investing marketplace.
Tore C. Steen is CEO & Co-Founder of CrowdStreet, a crowdfunding platform that connects accredited investors with high-quality, professionally-managed investment real estate investment opportunities.