Crowdfunding investments in Real estate is an emerging trend that enables smaller investors to be a part of lucrative projects with minimal investments. In this blog, we will discuss how crowdfunding investments in real estate unlock profitable investment opportunities for individual investors, thereby helping them to achieve their investment goals in the long run.
What is Crowdfunding?
Crowdfunding is the arena of investment that works on the basis of accumulating sourcing capital from a ‘crowd’ of investors. In simple words, it refers to a group of potential investors and entities who pool money together to meet a common investment goal.
In real estate, this principle enables real estate investors to raise huge capital for investing in various sophisticated real estate assets. These assets include retail centers, multifamily apartment buildings, office, and corporate buildings, industrial and hospitality as the five major types. Usually, when these projects are too expensive for an individual investing entity, they choose to seek crowdfunding.
Crowdfunding proves to be the best way to raise a lump sum amount of capital. Hence, by obtaining smaller contributions from a large base of investors, the original investor can access institutional projects with minimum resources and lesser risk.
How does crowdfunding work in real estate?
Real estate crowdfunding allows investors to participate in a diverse range of properties, without actually purchasing or managing them directly.
Therefore, in crowdfunded real estate, the process starts with a Sponsor or a General Partner. These General Partners (GPs) identify an asset and arrange to finance its purchase. So they create a syndicate, where they solicit venture capitalists to invest. These syndicates are also known as Special Purpose Vehicles (SPVs).
Furthermore, the Sponsor is also responsible for tending to the management of the assets including its redevelopment and stabilization. Also, the Sponsor oversees the eventual refinancing and disposition of the asset.
In addition to this, the Sponsors must register on a crowdfunding platform that connects the sponsors with potential investors. It makes sure that the sponsors receive the best, most lucrative deals in the market. Furthermore, the platform must ensure that the platform investors meet the regulatory requirements. Sometimes, the crowdfunding platform also collects funds on behalf of the sponsors.
Next investors in the Syndicate, become limited partners of the real estate asset. This is because they contribute partially to the deal’s capital needs in exchange for shares of any profits the deal produces during its final profitable sale or rents.
However, the US Securities and Exchange Commission (SEC) allows only accredited investors to partake in crowdfunding real estate investment.
Who is an Accredited Investor?
The term ‘Accredited Investor’ refers to an investor or an institution that is privileged to trade sophisticated, unregistered securities. Any entity can qualify as an accredited investor if they satisfy one or more of the criteria. These include their net income, net worth, the status of governance, professional experience, or asset size.
In the United States, the general guidelines of the SEC carefully define the Accredited Investor status. According to it, to become an accredited investor, you must have adequate financial sophistication to cushion potential risky investments. Therefore, anyone with sufficient capital resources who require lesser protection by regulatory disclosures from inherent risks in the unregistered securities is ideal Accredited investor.
What allowances do the Accredited Investors enjoy?
Accredited Investors enjoy certain significant allowances as in:
- Legal authorization to trade securities unregistered with SEC norms. Consequently, a number of companies are readily bent on offering securities to these accredited investors.
- Accredited investors have the privileged access to angel investments and venture capital investment funds. Moreover, they can also partake in deals involving sophisticated, complicated, and high-risk investments.
What are the accredited investor requirements for crowdfunding investment in real estate?
Accredited investors include high-net-worth individuals (HNWIs), stockbrokers, banks, insurance companies, and trust-fund workers. The norms of recognition as an accredited investor might vary from each local jurisdiction. However, In the U.S. Rule 501 of Regulation D of the Securities Act of 1933, defines an accredited investor as someone who :
- Must have an annual income over $200,000 ( or $300,000 as joint income with a spousal equivalent ) for the last 2 years with the potential to earn the same amount or possibly a higher income in the current year. The individual should have attained the income either alone or as a joint income with a spouse over the last two years.
- Has an individual net worth exceeding $1 million in assets at the time of the purchase. They can either have this net worth individually or jointly with their spouse. However, this value does not consider the value of the person’s primary residence.
- Qualifies as a general partner, an executive officer or even the director of the company that issues the unregistered securities.
August 26, 2020, however, saw a change in the definition of an SEC accredited investor. This is because the SEC introduced a new accredited investor definition.
Therefore, the SEC now acknowledges any individual having professional knowledge, experience, or certifications as an accredited investor. The SEC also considers individuals having certifications, designations, or credentials. Moreover, the knowledgeable employees of a private fund are now also granted accredited status. In addition to this, SEC and state-registered investment advisors are now included as accredited investors.
However, the individuals seeking accreditation must present a credit report for the evaluation of any past debt to the companies.
Read Lilypads’ blog here on Accredited Investors to know more about the topic in detail.
How did the JOBS Act revolutionize crowdfunding investments in real estate?
The Jumpstart Our Business Startups, popularly known as the JOBS Act, was signed into act by President Barack Obama. It came into effect from the year 2012. Some of the major highlights of the JOBS Act that introduced a much-needed change in the crowdfunding scenario are:
- It eased the regulations on reporting and advertising for various funds who are trying to raise capital for investing
- It allowed companies with net worth or revenue below $1 billion to share only the necessary financial statements with their stakeholders.
- This Act permits non-accredited investors to invest their shares in startups through methods of Crowdfunding. Furthermore, the JOBS Act also permitted them to participate in small IPOs.
- This Act intended to boost the small sector businesses in the post-financial crisis circumstances. This eventually led to entrepreneurs to start new businesses and experience growth in their current business. Moreover, it also helped the citizens to restart their jobs.
Benefits of Crowdfunding Investments in Real estate:
Crowdfunding investments in real estate ensure the protection of investors from misleading fundraising models. Apart from this, Crowdfunding provides several other interesting benefits to the investors, a few of which are:
- Ease of accumulating capital:
Small real estate sponsors and developers get a platform to market their projects to a great audience of potential investors
- Less management pressure:
Contrast to traditional financing methods, equity crowdfunding ensures even distribution of responsibility and risk factors within the syndicate. Also, the power of active management gets evenly spread among a large number of investors rather than on an individual entity.
- Profitable returns:
Even with minimal investments and management, a single, sophisticated crowdfunded real estate generates huge returns to many non-accredited investors at once. Therefore, these smaller investors can diversify their portfolios across several crowdfunding investments across various asset classes. Hence, it minimizes the risk of loss and increases their scope of further collaboration between accredited and non-accredited investors in the future.
It is a known fact that real estate is the playground of the rich and privileged. However, in recent times, with the regulations of the JOBS Act and the emergence of multiple real estate crowdfunding platforms, real estate investing is a reality for individual investors as well. Hence, crowdfunding breaks through the barriers of sophistication and higher costs of entry, thereby allowing retail investors to enter the property investment arena, at just a fraction of the cost and generate attractive returns alongside their accredited counterparts.