Crowdfunding Real Estate, with the SEC's Blessing
Proponents of crowdfunding say the technology could disrupt and democratize the financial industry. Skeptics say it's prone to fraud, with few investor protections.
Now a New York startup is trying to harness the power of the Internet to raise capital for real estate developments, with less risk and greater transparency for the small-time participants than most crowdfunding platforms.
The skepticism about crowdfunding is fueled at least in part by the fact that "there is little to no" Securities and Exchange Commission oversight, says Allen Shayanfekr, a principal at Sharestates LLC.
Real estate crowdfunding platforms typically structure these transactions as private placement regulation D memorandums, he notes. For at least some of the proposed projects on its website, Sharestates plans to instead use an investing agreement that must comply with Regulation A, "which undergoes SEC review and qualification before any sales of the shares."
Full deal information disclosure also is a must that "will bring much more transparency to the table," allowing investors to make educated choices, he says. In addition, "unlike other platforms," Sharestates does not limit investor benefits "to a specific sum of money."
Investor rewards are proportional to capital: Investors who provide 50% of the purchase price receive 50% of the rewards. Some deals also provide preferred investor returns that distribute payments to investors first, "before Sharestates makes a penny," Shayanfekr says. (It typically is an equity partner in each project and does not collect a percentage of the funds raised in each transaction as its fee.)
The ability to receive proportional distributions based on their ownership share, which can be as small as $100, "is a bigger deal for smaller investors" who typically do not have the know-how or capital to invest in real estate and can benefit the most from the cumulative power in numbers, he adds.
"Our platform brings these small investors together and empowers them to participate on the same terms a single larger investor would." Participating investors will be owners in the properties like any other typical investor, "but instead of owning the whole property they will own a slice of it."
Investor interest in crowdfunding appears to be on the rise. The inaugural Crowdfinance conference in New York in December sold out fast. The conference website trumpeted the activity as a way to democratize the flow of capital "by the pooling of monies from a large crowd of individual investors as opposed to big institutions and Government entities." Data on the sector is scarce, however, feeding the suspicions of skeptics.
"Each offering stands on its own," explains Shayanfekr. "And it's important to always read each offering memorandum in its entirety because the terms may change from project to project."
To further help investors get comfortable, Sharestates has partnered with Atlantis Organization, a Great Neck, N.Y., company with 10 years of real estate financing experience including title insurance, escrow real estate purchase agreements.
Atlantis will review the agreements to make sure "investments are secure at every level," including regulatory compliance and due diligence, says Radni Davoodi, co-founder of the firm.
Crowdfunding still is so new, insiders say, that regulators have not yet caught up with the new phenomenon.
The SEC deadline on public comments to proposed regulation that resulted from the Jumpstart Our Business Startups (JOBS) Act signed by President Obama in 2012 is approaching.
In his submitted comments, Competitive Enterprise Institute Senior Fellow John Berlau argues the proposed rules could result in "costly, paternalistic requirements on crowdfunding" that will lock ordinary investors out of startup capital.
He notes that eBay and other electronic marketplaces show that the SEC did not need to reinvent the wheel but can allow equity crowdfunding to exist "with minimal government regulation," similarly to what exists already but tailored for equity ventures.
"Local businesses and their communities would also benefit. Instead of going online to find a buyer with $1.2 million, a gas station owner could crowdfund by selling stakes to his regular customers," Berlau wrote.
Another firm in this field, Groundfloor, claims to be the nation's first crowd lending website for the financing of multifamily loans. Its stated goal is to develop "real estate financing that harnesses the breadth and scale of the Web" to reduce housing dependence on large financial institutions and accredited investors.
This is a new wealth-generating asset class with "the promise of opening new investment possibilities for all," says Brian Dally, co-founder and CEO of Groundfloor. His Atlanta firm is offering "a piece of the secured real estate lending pie for the non-accredited 98%."
For its newest property, Groundfloor plans to raise $275,000 to fund the refinancing a group of five rental townhomes in Woodstock, Ga. The loan will be secured by the property until repaid after a five-year term. Investors will receive interest payments throughout the term, and a share of the appreciation of the property value.
"Economically optimal financing structures don't always fit with the requirements of traditional bank lending and on occasion banks stop lending on asset classes that offer exceptional risk adjusted return potential," says Rick Tuley, a developer working with Groundfloor. The platform "is addressing unmet needs for underserved markets. I look forward to adding to the early proof that crowdlending works for independent developers and unaccredited investors alike."
Investments start at $100. Groundfloor connects independent developers seeking alternative funding outside the traditional banking structure with mass-market investors. Interest rates offered to investors are determined by an algorithm that benefits the earliest who pledge to invest. For example, more than 69 investors are currently set to earn 8.75% interest or more on the inaugural Groundfloor project. "The offered rate decreases incrementally as projects near full funding."