Crowdfunding Picks Up the Pace

Platforms that allow retail investors to participate in the market are experiencing steady growth but have yet to weather a market slump.

In the eight years since it was authorized by the JOBS Act, crowdfunding has gained a foothold and then some in real estate investing. Sponsors have raised billions of dollars through vehicles that enable retail investors to place capital in a wide range of assets and initiatives.

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“Last year was a real turning point, because real estate crowdfunding deals got so much bigger and the industry became more mainstream,” said Mark Roderick, an attorney who specializes in crowdfunding and fintech at the Lex Nova law firm in Cherry Hill, N.J. “The platforms started out raising money for single-family home ‘fix-and-flips,’ and now they’re raising $15 million for commercial properties.”

And fundraising through Internet platforms appears to be just beginning. Palo Alto, Calif.-based RealCrowd, a marketplace that primarily connects investors with equity-seeking sponsors, saw a threefold year-over-year increase in the amount of capital it raised in January, said Adam Hooper, the platform’s CEO. He anticipates raising $300 million this year, which would match the total raised by the firm from 2013 through 2019.

Meanwhile, CrowdStreet, a similar marketplace, brought in $500 million for sponsors in 2019 alone, doubling its total volume to roughly $1 billion since its April 2014 launch, reported Tore Steen, co-founder and CEO of the Portland-based platform. “Crowdfunding is raising only a tiny fraction of the $300 billion that’s flowing into commercial real estate on an annual basis,” he said. “I hate to liken it to ecommerce in the 1990s, but that’s where we are.”

Origin Investments has partnered with Cedar Street Investments to develop the $64.5 million Pilsen Gateway, a 202-unit apartment project in Chicago's Pilsen neighborhood. Origin Investments provided some $16.5 million in equity through its QOZ Fund, which is focused on new developments in qualified opportunity zones. Photo courtesy of Origin Investments.
Origin Investments has partnered with Cedar Street Investments to develop the $64.5 million Pilsen Gateway, a 202-unit apartment project in Chicago’s Pilsen neighborhood. Origin Investments provided some $16.5 million in equity through its QOZ Fund, which is focused on new developments in qualified opportunity zones. Photo courtesy of Origin Investments.

Joining the club

Though the JOBS Act allows sponsors to solicit the general public, the U.S. Securities and Exchange Commission restricts participation largely by wealth. Only accredited investors with a net worth of at least $1 million, or who can meet a high income standard, can participate in Regulation D private placements, while investment in Regulation A+ deals is technically open to anyone.

The number of crowdfunding sites has shrunk considerably from the hundreds that popped up in the months immediately after the Jobs Act took effect in 2013. Proponents estimate that only 10 sponsors or so are doing the vast majority of today’s real estate deals.

Most platforms raise equity, while a smaller number raise debt. Some that started out by offering single-property investments have created funds. The platforms also tailor their offerings to specific investor types, either by limiting them to accredited investors or opening them up to a broader audience, although they occasionally cross those lines. Regardless of the strategy, real estate crowdfunding operators see huge growth potential.

“Traditionally, institutional real estate funds have raised money from pension funds—but are pension funds growing today?” said Ben Miller, co-founder and CEO of Washington, D.C.-based Fundrise, which has raised $1 billion in equity across some 20 funds. “All of the real estate platforms are moving to retail investors, because in order to grow, they have to find new capital sources.”

In September, CrowdStreet raised $25 million in equity in three hours to help finance Parkway Properties Investments' $80 million acquisition and rehab of 100 Edgewood, a 306,000-square-foot office building in Atlanta. The asset is in an opportunity zone, and sponsors are targeting an internal rate of return of 15 percent and hold period of 10 years. Photo courtesy of CrowdStreet.
In September, CrowdStreet raised $25 million in equity in three hours to help finance Parkway Properties Investments’ $80 million acquisition and rehab of 100 Edgewood, a 306,000-square-foot office building in Atlanta. The asset is in an opportunity zone, and sponsors are targeting an internal rate of return of 15 percent and hold period of 10 years. Photo courtesy of CrowdStreet.

The Key Test

For all their early success, however, it is worth remembering that crowdfunding platforms have prospered during an long real estate expansion. Crowdfunding observers acknowledge that the strategy must still prove that it can weather a slump.

“In a downturn we’re going to see deals that were underwritten too aggressively or that took on too much leverage—all kinds of variables that we just can’t see right now,” predicted Ian Ippolito, a tech entrepreneur turned real estate investor who founded Real Estate Crowdfunding Review, a Tampa, Fla.-based firm that tracks the industry. “There will be a round of consolidation, and the players that emerge will be the strongest.”

To put investors in the best position to endure a recession, crowdfunding executives contend that they’re exercising extra vigilance in this extended period of peak property prices, approving only deals that meet an institutional investment standard.   

“We’re definitely passing on more deals,” said Allen Shayanfekr, co-founder and CEO of Sharestates, a Great Neck, N.Y.-based firm that has provided some $2.3 billion in loans to sponsors since 2015. “We probably saw $5 billion worth of deals last year and closed about $800 million in loan volume, whereas in earlier years we were closing a higher ratio.”

Similarly, real estate fund managers using crowdfunding to solicit capital have become more risk-averse when selecting assets. “It has been a challenge, but we remain disciplined,” said Michael Episcope, principal and co-founder, Origin Investments, a Chicago-based fund manager that has raised $400 million across three funds since adopting a crowdfunding model. “A deal that we project to be a 12 or 13 percent return may pencil out at 22 or 23 percent by another sponsor, so I think some investors are going to get caught.”

 In October 2017, investors using the ArborCrowd platform provided $3.2 million in equity to renovate and rebrand Quarry Station, a 306-unit apartment complex in San Antonio. The property was sold two years later for more than $49 million, generating an internal rate of return of 20.3 percent. Photo courtesy of ArborCrowd. 
In October 2017, investors using the ArborCrowd platform provided $3.2 million in equity to renovate and rebrand Quarry Station, a 306-unit apartment complex in San Antonio. The property was sold two years later for more than $49 million, generating an internal rate of return of 20.3 percent. Photo courtesy of ArborCrowd. 

Cautionary Signs 

Crowdfunding supporters are quick to point out that money has always been made and lost in real estate, and deals on their platforms don’t always perform as expected. But some crowdfunding firms are advertising risky deals without proper due diligence, warns Adam Kaufman, co-founder and COO of ArborCrowd, a three-year-old New York-based platform that has raised more than $30 million in nine offerings. The platform provides equity for select sponsors that borrow debt from its Arbor Realty Trust affiliate.

“These deals are just starting to life-cycle, and in the next two, three or four years, they’ll start to go down,” Kaufman predicted. “It will be interesting to see how the SEC or consumer protection agencies react.”

In some cases, platforms that are backed by venture capital funds are under pressure to show rapid growth, Kaufman said. But such expectations don’t align well with real estate investment, which requires patient research to uncover quality deals. Observers suggest that the RealtyShares platform, which collapsed in the fall of 2018, couldn’t scale up fast enough to convince venture capital funds to keep backing it.

Some crowdfunding executives come to real estate investment with a technology background and may lack the expertise to understand the problems with an asset or deal structure, Kaufman said. Nor do Individual investors typically have the sophistication to spot them, he added. What’s more, while many crowdfunding firms offer a plethora of educational tools for investors, some platforms still put too much emphasis on returns and not enough on risk, which could turn out badly for investors, RealCrowd’s Hooper argues. He’s hoping to avoid that outcome.

“We’re focused on gaining a fundamental understanding of the risks involved in real estate investing and communicating that to prospective investors,” he said. “Getting away from a purely return-driven investment decision can help prevent a lot of the challenges that we think are coming to the platforms.”

Read the March 2020 issue of CPE.