You have probably heard of Kickstarter and other popular crowdfunding platforms that are used to obtain funding from individual investors for everything from independent movies and music to health care and legal expenses. In the past few years, crowdfunding platforms have also popped up to offer individuals a way to invest in commercial real estate (CRE) projects. This alternative form of financing could pay off for both investors and developers.
Birth of CRE Crowdfunding
The Jumpstart Our Business Startups (JOBS) Act of 2012 included crowdfunding provisions that allow early-stage businesses to raise capital from the general public. It also created “funding portals.” These are essentially internet-based platforms or intermediaries that facilitate such investments without having to register as brokers with the Securities and Exchange Commission.
Since 2012, more than 100 portals focused on CRE investments have launched and various investment models have emerged. For example, some platforms, such as Patch of Land and Crowd Street, let accredited investors (investors who meet certain income and net worth requirements) fund listed projects directly, typically with minimum investments of $10,000 to $25,000, and holding periods of three to ten years.
Other CRE crowdfunding platforms, such as Fundrise and Realty Mogul, allow people to invest in new entities formed for specific projects, rather than in the project itself. These may accept investments of $5,000 or less, with holding periods of one to three years.
CRE crowdfunding can benefit investors and developers alike. These platforms give many individual investors access to an asset class to which they might otherwise not have access. Some may see crowdfunding as a way to participate in the real estate market without making a significant cash outlay. The platforms also eliminate geographic barriers, listing projects and opportunities across the country.
But CRE crowdfunding also brings some potential problems. Crowdfunding rules impose inflation-adjusted limits on the amounts individuals can invest based on their net worth and annual income. Currently, if either is under $107,000, individuals can invest up to the greater of $2,200 or 5% of the lesser of their annual income or net worth over a 12-month period. If both annual income and net worth are equal to or exceed $107,000, individuals can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000.
Developers welcome another financing option. However, crowdfunding rules limit the amount developers can raise (currently $1.07 million annually) and require disclosures about financial performance and other information.
The minimum level of financial disclosure required depends on the amount of money being raised or raised by the developers in the prior 12 months. Following are the inflation-adjusted threshold amounts and a summary of the financial disclosure required:
- $107,000 or less: Financial statements and specific line items from income tax returns, both of which are certified by the principal executive officer.
- $107,000.01 to $535,000: Financial statements reviewed by an independent public accountant and the accountant’s review report.
- $535,000.01 to $1.07 million: If first time crowdfunding, then financial statements reviewed by an independent public accountant and the accountant’s review report; otherwise, financial statements audited by an independent public accountant and the accountant’s audit report.
Wave of the Future?
Over the long run, CRE crowdfunding could give traditional lenders a run for their money. Despite their drawbacks, these platforms provide a quick and cost-effective way to connect developers and investors.