When investors big or small seek a profitable real estate opportunity with little effort, their quest often leads to crowdfunding investments. But there are risks associated with crowdfunding that investors need to consider.
Real estate crowdfunding, along with crowdfunding in general, is creating a lot of media buzz and appears to be attracting the attention of an increasing number of investors. Real estate crowdfunding grew 156% in 2014, passing the $1 billion mark, according to Massolution’s “2015CF-RE Crowdfunding for Real Estate” report, which projected $2.5 billion in investments this year.
Crowdfunding sprang from the JOBS Act of 2012, whose stated purpose was to facilitate capital formation for small businesses. The law gave start-up companies, including crowdfunding firms, the green light to market directly, through social media and the Internet, to a large pool of accredited investors—those with a net worth of more than $1 million, not including their primary residence, or an annual income of more than $200,000 for the past three years ($300,000 with a spouse).
However, the doors to real estate crowdfunding have opened wider this year with the adoption of new rules—called Regulation A+—by the U.S. Securities and Exchange Commission that give start-up companies the ability to raise up to $50 million annually not only from accredited investors, but also from non-accredited investors—namely, ordinary consumers.
Under the new rules, non-accredited investors will be allowed to annually invest up to 10% of their income or net worth, depending on which amount is greater. Before this, only accredited investors (or non-accredited investors in a state with its own equity crowdfunding provisions) were allowed to invest in start-ups through equity crowdfunding. Regulation A+ does require issuers to have their offerings approved by the SEC. However, issuers are allowed to “test the waters” to measure investor demand before undertaking a full-blown offering.
Still waiting on the regulatory sidelines is one of the JOBS Act’s more controversial provisions. Title III would exempt from registration the offer and sale of crowdfunded securities under the Securities Act of 1933. This exemption would allow for the sale of securities on an Internet-based platform to an unlimited number of unaccredited investors without registration. The sales can be conducted through either registered broker-dealers or SEC licensed “funding portals.”
The loosening of securities regulations for online investment is expected to fuel the growth of real estate crowdfunding and related Internet sites, which still represent only a fraction of the capital raised for real estate debt and equity in the U.S.
The Pitfalls
While crowdfunding may have its upsides, it definitely has its potential pitfalls, especially for investors who are not experienced in the complex and risky world of real estate assets.
The purpose of this commentary is not to throw cold water on the crowdfunding movement, but to point out four potential danger areas that investors should be aware of.
Knowledge And Experience
Real estate is an extremely complex and challenging asset that requires extensive and deep experience in the areas of acquisition, development, finance, construction, management and marketing. Critical factors that go into assessing real estate investments include location, market status, ownership, condition of the property, operating expenses, occupancy rate, access to transportation and surrounding businesses and properties.
Analyzing these and other variables that affect a property’s value requires professionals with solid knowledge and experience in real estate.