Crowdfunded Real Estate vs REIT

01.29.2018

Since the signing of the JOBS Act in 2012 and more specifically the changes to Regulation D, which previously restricted the direct solicitation of investors, crowdfunding platforms for commercial real estate have seen tremendous growth.

The initial passing of the JOBS Act in 2012 allowed for direct solicitation but limited it to accredited investors. Accredited investor meaning any person with an annual income of $200,000.00 a year for the past two years, or an individual’s net worth exceeding $1 million dollars, excluding their primary residence.

However, since that time Title III of the JOBS Act has created a pathway for non-accredited investors to participate in equity crowdfunding. There are some limitations for the consumer's protection which limit a non-accredited investor to contribute either $2,000.00 or 5% of their annual income or net worth if they make less than $100,000.00 per year, or up to 10% of their annual income or net worth if that amount exceeds $100,000.00.

So now that equity ownership in a crowdfunded real estate project has created a pathway for main street investors what are some key things an investor should consider.

  1. Platform – Unlike a more traditional REIT, the investors in crowdfunded real estate get to directly choose which projects in which they invest. The selection of the company you choose to invest with could have drastic implications. You should make sure you understand how capitalized the company is, what types of due diligence they perform when selecting their assets, their experience with real estate and management. Most importantly understand the operating agreement.
  2. Liquidity – If considering a crowdfunded real estate project in which you have direct equity, consider the potential need for your capital. In many cases, your capital will be tied up for a period of time. The amount of time varies from project to project but it is not uncommon for the time frame to exceed 10 years. You will not be able to move in and out as with a REIT. Some platforms will offer an exit but generally at a severe discount to current market price.
  3.  Risk Reward – Having a direct equity stake in a real estate project will generally provide more upside than your more traditional REIT, however, it comes with greater risk. One such risk is the need for additional capital. Many times a real estate project will have a need for additional capital, and a capital call is made to the investors of the project. This is when the understanding of your operating agreement is vital. You must understand how the company will treat these capital calls. In my findings, the company usually deals with this in three ways. 1. You directly add your required share of the additional capital to the project, 2. Your equity gets diluted or 3. You get to borrow the money with interest, in which that money gets paid back from future cash flow in a preferential manner.
  4. Control – While crowdfunding provides more control over the direct selection of the asset, realize that the crowdfunding company maintains control over the asset. Some may find it hard to have a direct equity stake in an asset but have no say in the operations of the asset.

The growing trend of crowdfunded real estate should be one that is approached with caution. This is an industry that is not as tightly regulated as what you might see in a more traditional REIT. This is definitely an avenue for investors that are seeking higher reward, but understand that this will come with much higher risk. The growth in popularity will no doubt lead to more platforms that are less concerned with future returns, and more interested in the fees they can generate.

Caveat emptor