What is Real Estate Crowdfunding?
Sure, most of us have heard of crowdfunding due to the likes of Kickstarter: send a small donation and receive a gift or a “thank you” for your contribution and maybe even a prototype. Look at Facebook’s recent $2 billion purchase of Oculus VR. This company cut its teeth on a Kickstarter campaign that raised $2.4 million from backers in exchange for early prototypes, t-shirts, and posters. Needless to say, when backers saw the payday that Oculus enjoyed, they were rather irked to say the least. Kickstarter backers were never promised any equity due to a few SEC rules, so what did they get out of that 83,333% return? Well, the harsh reality in this case is if you have no equity in a deal and no profit sharing arrangements, the company unfortunately owes you nothing besides the thank you gifts you received for the donation.
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So, how does this apply to real estate crowdfunding and how does this all work? Kickstarter is one thing, but as the real estate angle is exploited, a quick Google search makes it sound as if everyone is getting rich and coming together to make great real estate deals at 15-20% returns. People are sitting at home, buying real estate all over the country, and watching the returns roll in without lifting more than a few fingers. As with most “sweet deals”, there is a catch.
Kickstarter’s business model is donation based for a very good reason, and here’s why. If you are looking to join the crowd and hop on the crowdfunding bandwagon for anything, especially real estate, you may be a bit disappointed if you don’t earn an individual income of more than $200,000 per year or a joint income of $300,000. If you do happen to earn this much, you might be let down again if you do a personal financial statement (recommended!) and find out you don’t have a net worth exceeding $1 million–hold on now, before you start grinning, you also have to exclude your primary residence! The strict requirements above are all due to the fact that real estate crowdfunding is only currently available to accredited investors. An accredited investor has these net worth and income restrictions mentioned above.
Despite all of the bad news for non-accredited investors, there is a silver living that should keep future investors of all income levels on the edge of their chairs:
1) The Securities and Exchange Commission (SEC) is “mulling over” a change to the accredited investor criteria. Crowdfunder’s Chance Barnett claimed that Q3 and Q4 of 2014 would see changes to this, but the SEC, a government entity, unsurprisingly has many ways of delaying their mulling overs…stay tuned!
2) There are also talks that the SEC may also open up equity crowdfunding to non-accredited investors, removing any barriers to entry. I’ll bank on #1 happening way before the SEC kills off the accredited investor rule altogether, but that is only my opinion.
For the time being, several sites out there who are leading the charge are iFunding, CrowdStreet, FundRise, RealtyWealth, PatchOfLand, and Realty Mogul. Some of these sites allow you to apply to their site in order to “list a deal.” If you are looking to raise capital through these sites, you have to choose whether you are looking to raise debt or equity. This is rather straightforward–if you raise debt, you are basically looking for private money lending or “crowd lending” in that case. If you raise equity, you are getting others to be equity partners on the property you are seeking to purchase and you are not expecting a cash repayment on your contribution, besides what your equity awards you, in the form of appreciation and cash flow.
For example, if you are buying a $1M apartment complex, you could probably get $800K from the bank, but you’ll end up having to cough up $200K somewhere to satisfy that 20% down payment. If you crowdfunded some of your equity with an agreement that you retain principal control of the property, your investors could contribute a portion of that $200K, perhaps all of it, to help you achieve a low to no money down situation.
Before proceeding down any path, please research each one of the real estate crowdfunding sites to get a good idea of what is required for those seeking equity and debt investors, since that is out of scope for this article and may or may not have the same accredited investor regulations, despite others. There are also complexities regarding syndicates and equity partners that is best left to an attorney.
One thing is for sure, the hype and appeal of crowdfunding isn’t going away any time soon. I’ll leave you all with one of the most unusual crowdfunding projects out there, the RoboRoach, which has actually raised $12,000 already. Yes, you too can perform surgery on a live cockroach and control it with your smartphone. What? You don’t have a cockroach handy? That’s okay, because one or more can be included in the box. The human race should be so proud.
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