Crowdfunding: An Alternative Financing Tool for Real Estate Development

by Mark Shipman

Crowdfunding as a potential source of financing for real property development in Oregon has been a hot topic lately. A lot has been written about different real estate projects in Oregon, and the greater Northwest and various developers’ reliance, in part, on crowdfunding as a funding mechanism.  This new activity was stimulated by a 2012 federal law that allows companies to advertise investment opportunities directly to investors under certain guidelines and requirements.  This article briefly discusses crowdfunding, the different types of crowdfunding, some limitations, and practical considerations.

What is Crowdfunding?

Crowdfunding, or crowd financing involves the collection of money from supporters (the “crowd”) to fund an initiative.  The initiatives can be charitable (e.g. a nonprofit where you donate for a relief cause, or to support creative music or film ventures), or commercial (e.g. financing the start of a new company or sale of a new product).  The supporters contribute to an organization (the “platform”), which connects the initiative director and the crowd together. Kickstarter, a popular website that raises funds for creative projects, is one current example of crowdfunding.

Types of Crowdfunding

There are four general types of crowdfunding models. In charitable based models, supporters contribute money, but do not receive a financial benefit in return.  They may get a commemorative item or a thank you for contributing in return for their donation.   With compensation based models, supporters contribute money, but do receive a monetary benefit in the form of an item of some value.  The item can be a product, or a pre-release of an item that the money was contributed to produce (independent music/movie).  Credit based models are where a supporter contributes money and negotiates for a certain rate of return on the contribution.  With credit based models, the supporter is like a lender/creditor and the recipient is like a borrower.  The last type is a commercial based model, where the supporter receives shares of or interest in the company in exchange for the financial contribution.  It is with this last type of crowdfunding where real estate developers and investors will find another source for financing and investing.

Commercial Based Crowdfunding

Currently, the Securities and Exchange Commission (SEC) allows for the investment in real estate projects under Regulation D, through the sale of securities to accredited investors. An accredited investor is generally someone that has more than $1 million or more in liquid assets, or $200,000 in annual income.

Under the JOBS Act, the Securities and Exchange Commission (SEC) is working on adopting rules that would regulate the investment for small real estate projects under changes to Regulation A. This would allow companies to raise capital by offering securities to unaccredited investors using the internet.  Under the proposed rules, individuals with annual income less than $100,000 could invest a maximum of 5% of their annual income.  Those with higher incomes could invest up to 10%.  Companies using the crowdfunding model permitted by Regulation A could only raise $1 million a year.

Practical Considerations Surrounding Crowdfunding

Before you run out and file for a new portal, or think about investing in a project, there are a couple of things you should consider, including the following:

  • Only licensed brokers or attorneys that routinely handle securities will be able to advise you in such matters.
  • The proposed SEC rules (Reg A) will provide a safe harbor for investors/developers to look for opportunity to either invest or secure money for real estate projects on a small scale. Portals or projects that don’t fall within the Reg A rules can still qualify for crowdfunding, however these will need to be approved by the SEC as a security under a separate process.
  • Crowdfunding investments are not liquid. In Some cases, you may need to hold the ownership interest for a year or more from the date of investment.
  • Setting up a new platform or portal for a project will take time (many months) to get approval through the SEC.
  • There are additional reporting requirements for crowd-financing that are not present with other real estate investments. Similar to an annual stock reports, the portal company will need to file annual reports with the SEC, investors, brokers, and potential investors.
  • There could also be subscription/investment fees that will be attached to your contribution.

Conclusion

Crowdfunding under the JOBS Act may not be the answer for everyone looking to invest, or seeking additional financing for real estate projects. However, it will provide more opportunities for investors to participate in real estate investments.  Once the SEC passes the new regulations, there will be an increase in internet-based platforms offering real estate investment opportunities.  If you have any questions about how this issue may affect your business, please call an attorney in our Real Estate and Land Use Group.