SEC Finally Pulls Trigger on Crowdfunding Rules

In a move that was both long delayed and much anticipated, the U.S. Securities and Exchange Commission adopted the final rules implementing Title III of the JOBS Act.
Marshall Saunders

Marshall Saunders

In a move that was both long-delayed and much-anticipated, the U.S. Securities and Exchange Commission on Friday adopted final rules implementing Title III of the JOBS (Jumpstart Our Business Startups) Act. Title III allows non-accredited investors to participate in securities-based crowdfunding investments, subject to certain investment limits, and limits (to $1 million) the amount of money an issuer can raise using the crowdfunding exemption.

An investor with an annual income less than $100,000 can invest up to $2,000 or 5 percent of gross income, while one with an income of over $100,000 per year can invest up to 10 percent of gross income. In addition, there’s an absolute annual limit of $100,000 per investor to all crowdfunding ventures.

The rules will go into effect 180 days after they’re published in the Federal Register.

“There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need,” SEC Chair Mary Jo White said in a prepared statement.

A recent analysis by Monetarex of 255 private placement filings across 27 real estate crowdfunding platforms found that crowdfunding has remained very small, yet steady, at 0.4 percent of all real estate transactions for the past two years. The analysis concluded that, so far at least, “crowdfunding grew with the market[,] not ahead of it.”

Another report, released earlier this year by crowdfunding consultancy Massolution and titled “2015CF-RE: Crowdfunding for Real Estate,” stated that globally, real estate crowdfunding volume surpassed $1 billion in 2014, with campaigns ranging from less than $100,000 to more than $25 million. The report forecast an increase in crowdfunding to more than $2.5 billion this year, with growth even stronger in commercial and industrial properties than in multi-family.

This seemingly small rule enactment portends major changes in CRE investment and especially in CRE investors, say three experts who spoke with Commercial Property Executive.

To date, the largest crowdfunding markets have been the largest CRE markets, namely California, New York, Florida and Texas, says Jilliene Helman, CEO of Realtymogul.com. “The dominant product types have been multifamily and retail, however we have also financed office, self-storage, industrial and hospitality real estate. We … tend to focus on existing properties with some value-add component.”

“Title III will make it easier to finance smaller real estate projects, but will have less of an impact on the broader CRE market,” Helman continues. “Because there is a $1 million annual cap per issuer, you will not be able to raise substantial amounts of money via non-accredited investors.”

Till now and in his experience, says Marshall Saunders, co-founder and managing partner of SaundersDailey, Minneapolis, crowdfunding has been used mostly for multi-family projects (along with a few single-family fix-and-flip deals), typically about four to 40 units in size. He expects that to change, based on “two huge gaps in real estate and investment.”

First, he points out, a $5 million to $20 million project can get funded right away, but projects in the range of roughly (depending on the market) $200,000 to $1.2 million are often too large for one individual and too small for traditional CRE funding, so that niche is underserved.

Second, Saunders notes, “There’s a huge gap for investors.” There are about 8 million accredited investors in the United States, he says, versus about 40 million potential investors newly eligible under Title III who might like to invest directly in real estate.

“There’s a huge pool of people out there,” Saunders says, and many might be happy to put, say, $2,500 into a $500,000 multi-family project of four to 10 units. Other CRE possibilities of a size where crowdfunding could be significant include strip malls and rehab projects, he says.

Scott Picken

Scott Picken

Scott Picken, CEO and founder of Wealth Migrate, a global real estate crowdfunding platform, is perhaps even more bullish. “This is going to have a massive impact” over the long term, he says, not least because “Cycles change,” and the best opportunities arise when cash is hard to come by. Investors always need cash, and Picken sees 21st-century culture as favoring collaboration.

The biggest impact of expanded crowdfunding will be not on the industry but on the investors, he says. “You can be a part of the capital stack. You don’t have to be all of it.”

Some people will participate for the investment, some for the ego, says Picken. He recalls with a laugh an uncle who owned “one hair on the tail” of a racehorse, but in his uncle’s mind, that was his racehorse.

Similarly, he says, “Even if someone owns a doorknob on a shopping mall,” he or she will feel a sense of ownership and be more likely to shop there.

Saunders agrees that empowerment and that feeling of a very tangible investment, as in driving down the street and thinking, “I own part of that coffee shop,” comprise a big part of crowdfunding’s appeal to individual investors.

He does acknowledge the potential for fraud, saying “I know we have to try to protect people.”

The Massolution report notes another potential pitfall: “[B]roader and efficient access to capital may result in less appealing deals seeking crowdfunding as an alternative in cases when more traditional avenues don’t avail. This could portend adverse selection as a result, which may have a dampening effect on the space overall.”

Still, the adoption of Title III elicits almost pure optimism from both Saunders and Picken.

Though the latter concedes that crowdfunding is now “the smallest drop in the ocean” of CRE investment in the United States, he predicts a degree of growth similar to the early years of the Internet. “This is a catalytic change equivalent to the printing press.”