Crowdfunding is growing ever more popular within the commercial real estate industry. This method of pooling investment capital to purchase real estate has been around for many years. But it got a major boost in 2012 with the passage of the Jumpstart Our Business Startups (JOBS) Act, which allowed nonaccredited U.S. investors to place their money in properties.
The new legislation also made it possible for developers and other real estate professionals to market projects to a larger group of investors and raise money more easily. The crowdfunding process helps real estate investors to easily plant a stake in commercial properties while diversifying their portfolios. Additionally, crowdfunding platforms help loan originators to solicit funds and close loans. Mortgage brokers should know about the inner workings of commercial real estate crowdfunding.
Finding a niche
Crowdfunding is a way to raise money for a variety of businesses and their real estate projects. The idea is a simple one: A project can quickly raise a lot of money when many people invest a small amount.
Crowdfunding is much like placing capital in a real estate investment trust. In both cases, investors are putting their money into a general pool. With crowdfunding, however, these people are likely to be investing in a specific project, may receive a percentage ownership of the fund, and the annualized cash returns can be generous (as much as 10% to 20%).
Such ease of use has helped the global real estate crowdfunding market to reach $8.3 billion in value as of 2020, with the U.S. and Canada accounting for the largest shares of this figure. According to the website CrowdCrux, investors received an average preferred return of 8%.
Additional research conducted by GowerCrowd showed that an estimated 60,000 individual investors participated in real estate syndications offered through crowdfunding platforms in 2020. The median value for one of these real estate offerings in 2020 was about $7 million.
The broker’s role
Commercial mortgage brokers can partner with crowdfunding enterprises just like they can with any other mortgage lender. The process is the same, but the source of the funds is different than with traditional models.
Mortgage brokers can initiate a request for financing through a crowdfunding platform. These capital sources can actually fund a deal much more quickly and inexpensively, with fewer requirements for entry than a traditional commercial lending institution can. This is a clear benefit for commercial mortgage brokers and their borrowers.
As far as downpayments go, they vary depending on the project. As the crowdfunding source becomes more familiar with the borrower, the downpayment requirements for an individual or their company may be reduced. On average, a mortgage broker can expect to receive a fee for their services of 1% of the requested loan amount.
Crowdfunding benefits the broker as an alternative source of funding with a higher level of convenience and ease than a banking institution. And this benefit makes more funds available across the commercial real estate sector as a whole.
Competitors and colleagues
Commercial real estate crowdfunding can impact loan originators because, on some level, this form of funding is a competition. But there are ways in which the two processes can work together.
Investment-based crowdfunding platforms differ from lending-based platforms in the sense that the first type requires investors to purchase unlisted shares or debt securities issued by businesses. But as long as a crowdfunding platform offers a path to the secondary market, the difference between a loan agreement and a debt security is blurred.
One benefit of crowdfunding, in general, is that investors don’t need much money to take part. For instance, the popular crowdfunding site Fundrise requires a starting investment of only $10. This lowers barriers for people who, for example, want to invest in real estate but may not have a downpayment saved. What’s more, these real estate crowdfunding platforms make the investing process fast and simple for anyone who is new to the game.
This benefit for investors consequently becomes a benefit for loan originators, who can create pages on crowdfunding sites to gain funds for their projects. Real estate crowdfunding is typically either equity based or debt based. With equity-based crowdfunding, an investor makes a capital investment and receives an equity stake in the project. The investor holds shares as a limited partner.
Should an investor opt for real estate debt, they invest in the debt needed to fund the acquisition, development or improvement of an asset. There are pros and cons to each of these approaches. Typically, debt investors get repaid sooner than equity investors, but this also means that debt investors earn a lower return on their capital outlay than equity investors.
Avoiding risk
Real estate crowdfunding can be risky. Investors may be placing their money into a company without a substantial financial history. This means that an investor could lose some or all of their money.
It’s important to keep in mind that modern real estate investment platforms have only been around for 10 years or less, making some traditional investors wary. And while some platforms are open to nonaccredited investors, others are only for accredited investors — people who either have a net worth of more than $1 million or an annual income of at least $200,000.
For a commercial mortgage professional who is just learning about these capital sources, it’s important to choose the right crowdfunding platform. Higher returns mean higher risks, too. All parties should read the rules of an investment project so that they know what they’re getting into on either end of the transaction.
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From the low barrier to entry to the diversification of risk, commercial real estate crowdfunding is packed with benefits for new and seasoned investors, as well as project sponsors and mortgage brokers. With a little know-how, it’s easier than ever to break into this world and start reaping the rewards.
To avoid risks, brokers and their borrowers should not only research real estate crowdfunding but the commercial mortgage industry as a whole. This is the best way to ensure the selection of a smart
investment. ●
