Challenges and Opportunities for Crowdfunding

The nascent, fast-growing phenomenon of crowdfunding in real estate financing hasn’t yet scratched the surface of its potential, according to participants in a panel at ULI’s 2014 Fall Meeting in New York City.

“It’s the creation of a whole new industry,” said Rodrigo Nino, president and chief executive officer of Prodigy Network, one of numerous growing players in real estate crowdfunding. The latter only superficially resembles the fundraising mode of websites such as Kickstarter and Indiegogo, which were started to allow users to donate money to artists, musicians, filmmakers, and people doing community service projects, as well as to small entrepreneurs looking for seed money to develop tech gadgets.

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As the panelists explained, when the U.S. Congress passed the 2012 Jumpstart Our Business Startups (JOBS) Act, it legalized equity crowdfunding, in which companies could raise significant money from accredited investors—that is, those who could demonstrate a net worth of at least $1 million or annual income of $200,000 or more. Crowdfunding sites are required to register with the U.S. Securities and Exchange Commission, either as funding portals or as investment brokers. While the initial users of equity crowdfunding were tech companies, the concept quickly spread to real estate, which previously had offered smaller investors the opportunity to invest in big commercial projects only indirectly through the vehicle of real estate investment trusts (REITs). The Wall Street Journal reported in June that newly minted crowdfunding operations already had raised $135 million from investors who wanted a piece of individual properties.

Until now, big commercial real estate remained the province of big institutional investors and billionaires, Nino explained. “It wasn’t accessible to the general population,” he said. “It didn’t make sense.”

Though numerous crowdfunding firms are emerging, there is enough variety in funding models and strategy—and enough potential investors—that they aren’t yet really competing with one another, according to panel participants.

“It’s a question of diversification,” Nino explained. “Until at least 10 percent of everyone’s portfolio is invested in commercial real estate, we’ll all have plenty of business.”

Nino said that his firm, which started out in technology services but migrated into real estate, has grown without advertising or even a full-blown transactional website. “We signed all the documents offline, but we still managed to handle a lot of investors,” he explained.

Another panel participant was Benjamin Miller, cofounder of Fundrise, whose website has attracted 36,000 investors for what he calls “below the radar” commercial projects that are in the $35 million-and-below range. He said that crowdfunding offers modest-sized developers access to thousands of investors, and the potential to build a reliable base that will support future projects as well. “This will be a permanent source, instead of the way private equity dealers do it now,” he said.

Unlike Kickstarter, in which prospective filmmakers only get to actually make their movie if they attract enough donors within a time limit, there is more stability in real estate crowdfunding. Fundrise, for example, guarantees funding for developers and then backfills as it attracts investors, Miller said.

“It has very big promise for changing how people think about real estate,” Miller said. “People don’t know who owns their built environment. That will change as people see they can own part of it.”

Kevin B. Swill, chief operating officer of the Carlton Group, said crowdfunding creates an opportunity for “people who want to invest, but don’t have $50 million.” Doctors, attorneys, and successful small business owners are all potential crowdfunding participants.

Carlton, which started out as an advisory firm, before branching out into purchasing and managing property and eventually into crowdfunding, has a different model than Fundrise. It concentrates on projects with a value of $100 million or more, Swill said. The firm also shops for potential projects in Europe and Asia as well as the United States.

Panelists said that vetting investors and attending to other details in the still-evolving crowdfunding space are critical steps. Swill said that his firm hired consultants to educate them about crowdfunding’s nuances, and uses outside consultants to help with accreditation and “all the way through closing.”

Moderator Douglas S. Ellenoff, a partner at Ellenoff Grossman & Schole LLP, noted that different revenue models for crowdfunding firms have regulatory constraints. Firms that collect commissions, for example, must be registered and licensed as securities dealers.

“You need to pick the right attorney,” Nino said. “Securities attorneys are not always up to speed on what is going on right now . . . if an attorney is not on Twitter, don’t go with the guy.”

Though crowdfunding in real estate is very different—and more closely regulated—than the original contributory mode of crowdfunding, panel participant Darren Powderly, cofounder of CrowdStreet, acknowledged the inspiration provided by sites such as Kickstarter. “The arts often innovate, and that’s what happened with crowdfunding,” he said. “You were starting this band or whatever . . . and it migrated to commercial real estate.”