How To Raise Capital For Real Estate Projects
A guide to understanding capital raising for the modern real estate entrepreneur.
How Is Capital Raised?
A major rule of real estate development that is commonly observed is that developers almost always require outside financing to be successful. Since larger projects require a larger cash inflow and real estate projects are not completely risk-free, raising investment capital from alternative sources becomes necessary.
To break it down, raising capital for real estate projects comes in two forms. Developers need equity investments from investors as well as debt financing to kick-start their real estate project. Let’s dig a little deeper as to what these two strategies mean:
Debt Financing
Debt financing is an instrument which involves investors to act as lenders to the developers wherein they provide them with a certain amount of money in the form of a loan. A rate of return is then established based on the amount loaned as well as the interest rate.
Debt deals are usually involved during the early stages of a real estate project, when it’s still in the development phase and requires a kick-start. Since debt financing serves as the foundation of the capital stack, investors in the debt deal are prioritized during distribution of returns.
Returns in debt deals are not as great as equity investment deals but on the other hand, there is lower risk involved and the income from a debt deal is steady. If the developers default payments then the investors can exercise their right to force the sale of the property in order to receive payments. This process makes their investments airtight.
Equity Investments
The greatest enemy of equity investors are expenses and emotions.
— Warren Buffet
Equity investments on the other hand are quite different from debt financing. With equity investments, investors becomes a part-owner of your real estate project and their income is based on a mixture of rental income and share of appreciation of the project. This means that an equity investor’s earning potential is based on how successful the project turns out to be.
Yes, you read that right! Equity investment is prone to risk because of how it is structured but at the same time, there are greater returns involved, especially if you think about the appreciation value, should the property be sold.
With no cap on income and tax benefits, equity investments allow investors to earn a sizeable fortune through successful partnerships.
Under equity investments, there are yet again two more bifurcations. Namely, preferred and common equity. In the capital stack, preferred equity holds seniority over common equity investment and equity investors are paid after all the debts have been cleared from the bottom of the stack.
While common equity holders are the last ones to receive payment and are the most prone to risk, if a project does well, they can reap the greatest rewards with as much as 100% of the profits.
Raising Capital: Looking at the past
Before the JOBS Act, the real estate investments were only accessible to those who had deep pockets and were well connected in the industry. When it came to raising capital, it was the same story, developers often had to rely on private networks to fundraise their projects.
Since fundraising was a private affair, developers could not advertise opportunities which proved to be a major obstacle in their capital raising process. It was only giant developers with large cash reserves who were able to capitalize on their networks to find the right investment amount for their projects.
Despite booming private equity real estate markets from the year 2000 onwards, fund managers struggled to reach targets after the 2008 market crash and lack of growth-oriented partnerships and a wide investor base were some of the many reasons for such situations.
Since fundraising was limited to direct networks or personal connections, projects were often abandoned which resulted in a strew of unfinished buildings across cities. Absence of investment capital made it difficult for smaller real estate sponsors to reach their targets and bring their projects to fruition.
However, this situation changed with the introduction of the JOBS Act.
Innovations in Investments
Ever since the JOBS Act came into the picture in 2012, the entire investment landscape transformed significantly. While not aimed specifically for the real estate industry, the JOBS Act certainly helped define a new era of real estate investing.
Both real estate entrepreneurs and real estate investors saw a massive change in the ways people could now access investment opportunities. With the rise of crowdfunding platforms, traditional means of finding capital and investors soon paved way for a quicker and better organized method.
Both capital raising and real estate investment strategies have undergone major changes. Today, let’s look at the present and the future of real estate investing and understand the various strategies that can be employed.
Acquiring Capital Today: How do developers do it?
How do real estate developers unlock alternative sources for capital and streamlined their fundraising efforts? With the introduction of crowdfunding platforms, both sponsors and investors found a new means to interact and form investment partnerships.
With crowdfunding, capital raising no longer requires developers to have a prior direct connection with investors and can simply advertise their projects on the platform or on their own website and showcase them to potential investors.
However, despite a plethora of platforms on the rise, SEC regulations limits access to crowdfunding options for both investors and sponsors. For investors, accreditation becomes a mandate in order to unlock high-value opportunities while non-accredited investors have very limited options.
While there are platforms that allow non-accredited investors to participate in the new investment landscape, their entire investment journey is dictated by the platform itself with no room for self-exploration.
On the other hand, only institutional-level real estate developers are given access to crowdfunding platforms. Smaller developers whose area of specialty is single-family homes or even house-flipping don’t have the kind of principal experience or project volume required for said platforms and are often left out.
Given the parameters that are present on such platforms, how do real estate developers raise capital and finance their projects?
Raising capital through co-sponsorships
Capital raising for real estate developers doesn’t always have to be an individual process. In order to tackle larger deals, developers can form partnerships and raise capital together.
A co-sponsorship can help developers reach their fundraising goals much quicker than expected. A lot of developers fail to actualize process only because of lack of capital but with co-sponsorships, they can help bridge the gap.
Having said that, co-sponsorships in today’s investment climate are hard to forge without establishing trust. As a developer you have to showcase your credibility in the eyes of your partners. Showcasing your past performance as a developer can help you do that.
Accessing investor portals via crowdfunding platforms:
Another means of raising capital is to showcase your projects to sophisticated investors on crowdfunding platforms. Prior to the existence of such platforms, developers had to rely on private connections since advertising opportunities was not allowed.
A crowdfunding platform allows developers to reach out to prospective investors who can be presented with the opportunities as listings on the platform. This makes it relatively easier for developers to acquire capital from a large number of investors that are present on the online platform.
However, since the investors are not personal connections, the platforms cannot guarantee that developers would always be able to raise the capital they require. Another aspect of accessing online platforms is that not every developer can become a member.
The selection criteria for crowdfunding platforms tend to favor developers who have decades worth of principal experience and larger project volumes. Smaller developers with lower experience don’t necessarily make the cut.
Redefining Capital Raising: Modern Solutions
It’s clear that despite the presence of crowdfunding platforms, investors and sponsors trying to kick-start their investment journey are unable to do so. High entry points make it difficult for developers to access platforms.
As a sponsor, you also need a platform that can help you list your projects, track your lead pipeline and manage your investor base, all in one place. Moreover, sponsors also have to showcase their credibility to build trustworthy relationships with investors and make sure all their communications are streamlined.
Using investor management software can help manage a growing investor base but often these applications are built for institutional-grade investors and may burn a hole in your pocket if you’re just starting out. Lack of a comprehensive tool makes it difficult for sponsors to grow their business.
For sponsors with relatively lower principal experience who have great projects but lack the capital to actualize them, a comprehensive platform like MAST can be a great resource.
Not only does MAST offer a marketplace to list all your projects to attract capital, it also functions as an investor-management platform that brings together all the important processes of managing investors in one place. Sponsors usually have to spend their resources on social media outreach and accessing scattered investor portals to find potential investments.
With MAST, that part of the process is simply handled by us so that sponsors can focus more on building successful relationships with investors and scaling their business.
The Takeaway
Raising capital can be approached in a variety of ways. However, as a sponsor it is up to you to decide which strategy to go for depending on the capital you require. While going the traditional way by seeking friends and family to help raise capital is an option, there are more efficient ways in the current investment climate to help reach your fundraising goals faster.
Remember, at the end of the day, no matter which strategy you choose, the important thing is building relationships and a reputation for success.
