With the increasing prominence crowdfunding has attained over the course of the last decade, I’m sure you’re broadly familiar with the concept of crowdfunding. You’ve probably heard of people using GoFundMe (see our review) to try to cover medical expenses and other personal emergencies. You’ve probably also heard of crowdfunding a la Kickstarter (see our review) in which backers contribute to the funding of a board game or gadget or male romper in exchange for rewards in the form of the board game/gadget/romper in question and/or related goodies.
However, if you’re involved in a real estate venture, it’s now possible to solicit investment in real estate via crowdfunding as well. As I’ll explain, this is a relatively recent phenomenon, but by allowing owners of real estate to launch publicÂ crowdfunding campaigns, funding can be drawn from a much broader pool of investors than was previously possible.
Let’s talk about exactly what real estate crowdfunding is and how it can benefit your real estate business.
Real Estate Crowdfunding & The Jobs Act
Prior to 2012, it was illegal to offer investment in the form of a public campaign in the US, as public solicitation of securities was forbidden by SEC rules. Therefore, real estate crowdfunding was out of the question.
However, the idea of what crowdfunding could be changed significantly when the JOBS Act of 2012 was signed into law. The passage of the Act was framed as a response to the lack of capital available to startups in the wake of the Great Recession, as it legalized the crowdfunding of securities. Subsequently, a great number of real estate crowdfunding sites have popped up.
What Is Real Estate Crowdfunding?
Let’s be precise when we discuss real estate crowdfunding. The term encompasses two different forms of crowdfunding: equity-based and debt-based.
Equity-Based Real Estate Crowdfunding
When you open up your real estate venture to equity investment, investors become co-owners of the property in question and stand to profit in proportion to their ownership stake in the property. These profits come in the form of rental income and/or property appreciation.
Debt-Based Real Estate Crowdfunding
With debt-based real estate crowdfunding, you offer investors the chance to lend to you. In return, the investor is paid back the principal plus interest. Mortgages and hard money loans are examples of debt investments in a real estate context.
(For more general information on the differences between different forms of crowdfunding, our article “Types of Crowdfunding For Business: Debt, Equity, Or Rewards” is a good place to start.)
What Do These Differences Mean For Your Campaign?
The substantive difference between these two forms of real estate crowdfunding is that debt investment is safer than equity investment for the investor, but also less potentially lucrative. If something goes wrong and the property in question is foreclosed on, debtholders get paid before equity holders do, so there’s a smaller potential downside for the debt investor. Equity investors bear much more risk.
On the other hand, if the real estate venture does particularly well, equity investors get a share of the windfall profits whereas debt investors do not — they simply get interest on the loan. Equity investment is more high-risk-high-reward than debt investment when it comes to real estate. Keep in mind the type of investments your particular real estate project is likeliest to attract when setting the terms and structure of your real estate crowdfunding campaign.
In order to do this, however, you’ll need to understand what the capital stack is.
What Is The Capital Stack?
The capital stack is key to understanding commercial real estate financing (not so much residential real estate). The capital stack is comprised of the different layers of financing arrangements that go towards funding real estate projects. It delineates where investors stand in the pecking order relative to one other.
This is how investors are prioritized, with the highest-priorityÂ investors on the bottom:
- Common Equity (lowest priority)
- Preferred Equity
- Mezzanine Debt
- Senior Debt (highest priority)
Essentially, the risk increases the higher you are on the stack, but so do the returns. Here’s more information on the capital stack.
What Businesses Stand To Gain From Real Estate Crowdfunding?
Let’s discuss the two primary types of businesses that stand to benefit from this new market sector. The first should be fairly obvious.
Real Estate Developers
I can hear you right now: “No kidding, genius.” Of course real estate crowdfunding would appeal to real estate developers. The thing is, it’s the newer developers who stand to gain the most benefit from real estate crowdfunding. That’s because the more established firms have extensive pre-existing relationships with investors and other sources of equity. Crowdfunding isn’t necessarily going to be a priority for them.
Those who have entered the real estate business more recently, however, have every reason to explore crowdfunding. Launch a crowdfunding campaign through one of the many real estate crowdfunding sites out there, and you’ll gain access to investors that you just didn’t have previously — and these investors are the very investors who simply didn’t have easy access to real estate investment opportunities before crowdfunding and the JOBS Act came along.
Many real estate crowdfunders add value by pooling investors into an LLC or other entity specifically set up for the purpose. That way, investors don’t have to be dealt with individually.
Who else can take advantage of real estate crowdfunding to fund their business, you ask?
Real Estate Crowdfunding Platform Owners
This answer shouldn’t come as a shocker either. Think about it, though: real estate crowdfunding is a very new industry, having only just been legalized by the JOBS Act. There may never be a better time to get in on the ground floor of the industry than right now.
Of course, before you launch your real estate crowdfunding business, you’ll need to determine a) what types of financial products can be offered to investors on your site, b) what category of real estate to specialize in (commercial, residential, etc), c) how to build your web platform, and d) how best to market your platform to attract the attention of investors. But if you do your due diligence and manage to answer these big questions, you’ll be entering a field poised to expand by leaps and bounds over the next decade.
It’s estimated that the crowdfunding industry as a whole will be worth more than $300 billion by the year 2025. There are bound to be hiccups along the way, but if you’re thinking that the industry might be for you, this is the time to give it the ol’ college try.
1995 was a great time in which to launch an internet search engine. 1970 was a good time to get in on the polyester industry. Some industries present particular opportunities to attuned entrepreneurs at certain defined points in history. Are we in one of those periods now with respect to real estate crowdfunding? Obviously, nobody can say for sure, but all signs point to “Yes.”
Crowdfunding involving investments is legally complex, and federal prosecutors have unlimited resources. Therefore, be sure to get legal guidance from professionals before making the leap into real estate crowdfunding. But if you have the means and the inclination, this is the time to make your move. Don’t be left holding a bag full of woulda-coulda-shouldasÂ while less-talented entrepreneurs rake in those real estate crowdfunding dollars that could have been yours!
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