How Millennials Are Changing Commercial Real Estate: Crowdfunding (Pt. 1)
Many members of the so-called “millennial” generation (1982-2004) entered into the job market during one of the most difficult times in US history—the Great Recession. Loaded with student debt, no savings, big dreams, and the skills learned during internships, we had to come out of school and try to make a living when most companies were not only not hiring, but letting go some of their most seasoned employees. This difficult economic environment paired with the technological savviness of our generation has combined to make a meaningful and unique contribution to the growth of commercial real estate, which has been long overdue. One of the most interesting ways this creativity has expressed itself has been the establishment of alternative investment structures in commercial real estate, especially crowdfunding. Created by millennials for millennials, crowdfunding allows for comparatively small monetary investments to be made in commercial real estate, something that was previously off-limits for those that didn’t have substantial liquidity readily available.
“Created by millennials for millennials, crowdfunding allows for comparatively small monetary investments to be made in commercial real estate, something that was previously off-limits for those that didn’t have substantial liquidity readily available.”
At its most basic level, real estate crowdfunding raises money from multiple investors via an internet platform in order to fund projects collateralized by real property. This could be an acquisition, construction, stabilization, or rehabilitation, with the ultimate goal of selling the property at a profit after a set period of time. Crowdfunding currently serves a very specific niche in the real estate funding marketplace, filling the gaps where institutional investors would usually pass because of their traditional underwriting standards. Because of this along with crowfunded debt having significantly higher interest rates and shorter terms, it is highly unlikely that the crowdfunding platforms would even compete with banks or other traditional lending institutions, at least in the short term.
“Crowdfunding currently serves a very specific niche in the real estate funding marketplace, filling the gaps where institutional investors would usually pass because of their traditional underwriting standards.”
As is stands today, there are over 100 crowdfunding websites that have been established, but not all of them can be substantially verified, so sticking to the more well-known companies is usually best. How do real estate crowdfunding platforms work? Usually they take one of three forms:
1. Direct Investments: The crowdfunder is an organizer, providing a platform for investors to invest directly with real estate owners. Typically real estate sponsors will post projects on the platform’s website (for a fee) and investors can invest in a project they find appealing. One of the most well-known platforms for this structure is CrowdStreet.
- Pros: There are no fees for investors and limited fees for real estate sponsors; direct communication between investor and sponsor is permitted.
- Cons: There is no underwriting/screening process, so investors must rely on their knowledge of how commercial real estate works to screen the real estate sponsors and decide if a project is worth the investment.
2. Indirect (SPV) investments: The crowdfunder screens, underwrites, and approves real estate sponsors and their projects before listing them on their website. The crowdfunder then creates a special purpose vehicle (SPV) for the purpose of investing in the project, then sell interests in the project to investors in the form of equity (i.e. ownership stakes in the property) or debt (i.e. ownership interest in the loan on the property). An example of this type of platform would be Fundrise, which lists information on each project (including types, size, location, phase, term, capital structure, and current/projected returns) on their website. In exchange for the platform’s screening and underwriting process (and set-up of the SPV), investors will pay the crowdfunder fees up to 3% of their investment.
- Pros: A professional underwriting is performed and sponsors are screened before a project is offered to investors to help ensure project legitimacy; the crowdfunder takes care of collecting returns and distributing to the investors.
- Cons: There is a higher fee structure to both sponsors and investors, decreasing both sponsor and investor returns; communication between investors and sponsors is not permitted; if the crowdfunding platform should fail, sponsors may have a difficult time retrieving money from the project.
3. Software-as-a-Service (SaaS): The crowdfunder creates a fundraising software that real estate sponsors can use on their own website for their own projects. This format is very similar to direct investing above, except that the projects are offered on the real estate sponsor’s website as opposed to the crowdfunding platform website.
- Pros: Same as above.
- Cons: There is virtually no screening of the sponsors or projects since this is a service paid for by the real estate sponsors, so it is buyer beware.
– Thanks to Ross Speier of Alston & Bird for providing the background information on crowdfunding contained in this post. For legal advice regarding alternative commercial real estate investments and crowdfunding, he can be contacted at [email protected].