Intro To Real Estate Crowdfunding: Not All Models Are Created Equal
Real estate crowdfunding is a relatively new concept that is gaining steam among a broad range of investors looking to diversify their portfolios with the stable, income-producing asset class. But, as with most things, no two crowdfunding platforms are exactly alike — the various companies entering the fray differ widely in terms of investment offerings, minimum investment sizes and accreditation requirements. Being the co-founder and managing director of one such firm, I have a unique view of this nascent industry, including what potential investors should look for when determining which platform is right for them.
The Arrival Of Real Estate Crowdfunding
Crowdfunding has continued to gain in popularity following the Jumpstart Our Business Startups (JOBS) Act of 2012, a revolutionary law that created the opportunity to market private investments to the public for the first time. As a result, crowdfunding began to take off, enabling companies to reach a whole new class of investors. Real estate crowdfunding, specifically, has provided new ways for individuals to diversify their portfolios by directly investing in a tangible asset class that previously was only available to institutions, offering stable income and a hedge against inflation. This has really excited the investor community and is the impetus behind the continued growth of the commercial real estate crowdfunding industry today.
Before the JOBS Act and real estate crowdfunding, individual investors could generally only access institutional-quality real estate through real estate investment trusts (REITs) and private equity funds, which present their own limitations. REITs require individuals to invest in pre-constructed portfolios or strategies, while private equity real estate funds generally require cost-prohibitive minimum investments and lack transparency. Crowdfunding can alleviate these hurdles by enabling people to invest in individual assets with deal-specific business strategies and at lower financial barriers to entry.
Another potentially lucrative way to access real estate is through direct investment. However, owning and managing property can be burdensome, requiring an excessive amount of time, money and labor. The passive nature of an equity investment made through real estate crowdfunding can remove the stress and labor from the equation, allowing investors to put their money to work for them.
There are two primary real estate crowdfunding models investors should be aware of. The first is the Regulation A+ model, where companies can raise up to $50 million in funds from anyone. The downside to this model is that because investors are providing capital before the platform finds and invests in the underlying transactions, they relinquish the upfront transparency that allows them to assess the full scope of the benefits and risks associated with a potential investment.
The other model, 506(c), which is what we employ at ArborCrowd, allows accredited investors to access investment opportunities in specific assets. We believe this offers a heightened level of transparency to our investors, because they have the opportunity to review the underwriting, the sponsor’s business plan and the corresponding market fundamentals prior to committing their capital. This affords investors added peace of mind, as they’ll know exactly how their money will be deployed. However, to invest in a 506(c), investors must be accredited, meaning they must have an annual income of $200,000, or $300,000 for joint income. Also, this type of deal typically carries a minimum investment level.
While most crowdfunding platforms are primarily tech companies, in real estate crowdfunding, it is of the utmost importance for investors to entrust their hard-earned money to real estate professionals who understand the nuances of the real estate market above all else. Investors must do their research in order to choose the platforms, sponsors and deals that are transparent and backed by strong experience operating in various real estate cycles.
Real estate crowdfunding is a nascent industry that has seen rapid growth, and with that growth come challenges, opportunities and the need for great responsibility. As with any burgeoning industry, there are bad actors and companies that have come to market with misleading marketing and offerings with promises of unrealistic returns, which have brought negative attention to the industry. It is paramount, therefore, for responsible operators to make transparency their top priority in each interaction with investors to ensure they understand exactly what they’re getting into, the fees involved and what kind of outcomes they can realistically expect to see. Likewise, investors should know that they have a right to expect transparency and open lines of communication throughout the investment process.
If an individual is interested in investing in commercial real estate, they should understand that every investment vehicle offers a different return potential, liquidity and risk profile. For instance, the typical hold period for our investments is between three and five years, so our investors may not get the same liquidity they would with publicly traded REITs. However, they also aren’t subject to the volatility and unpredictability of public markets, where stock prices can fluctuate for any number of reasons. They’re also investing in a property with a specific business plan tailored to that property, whereas with a REIT, you’re investing in a strategy, and a portfolio will be assembled based on that strategy.
Like all investments, there are inherent risks in investing in real estate, regardless of the method of investment one may choose. It is therefore imperative for crowdfunding platforms to present investors with a comprehensive picture of these potential risks upfront, and for investors to demand this information to ensure that the deal aligns with their interests.
In Part II of this series, we’ll discover the differences between equity and debt investing in real estate crowdfunding.