Crowdfunding is all the rage these days and real estate crowdfunding might be the prettiest girl at the ball. It's linked to tangible assets in an improving market. People understand the process around buying a property. The amount of capital required an entrepreneur needs to raise for a given property is comprehensible and (one hopes) imminently feasible.
But how does it actually work? What are investors actually buying? How and when is the money raised?
But how does it actually work? What are investors actually buying? How and when is the money raised?
The answer to these questions is that there is no single answer. Processes will vary depending on the jurisdiction, the type of asset, the type of investment structure and the type of investors. We've set out a few of the questions and options below.
When is the money raised and when is the property purchased?
Although it would be preferable to raise funds based on a specific property, this seems unlikely to work for at least the first few properties that any Manager/Syndicator crowdfunds. In order to raise funds for a specific property, the Manager/Syndicator would either need to (1) purchase the property with cash and then raise the funds, or (2) somehow get a property under contract without a pre-approved mortgage or proof of sufficient funds and seek to raise the required amount between putting the property under contract and closing.
Option 1 entails a large capital commitment and increased risk.
Option 2 is unlikely to work in the absence of an extremely active and liquid investment community/market due to the timing given that the Manager/Syndicator would have approximately 30 days to raise the funds.
Another option is put the property under contract, agree to take out a mortgage with a 10%-20% down payment (as required), raise the funds and then either (1) decline to take out the mortgage (if the funds are raised before closing), or (2) pay off the mortgage with the funds once raised. As above, option 1 raises the risk profile. Option 2 may result in material additional costs and penalties, including prepayment of the mortgage.
Let's look at the Timeline
The timeline below assumes that the Manager/Syndicator raises funds for the purchase of a property in a specific market (i.e. geographic location).
Days -60 through Day 0: Listing and Fundraising
The total amount to be raised, based on property type;
2. Funding process:
Days 30 through Day 270 (for example): Renovating and Renting or Selling
Conclusions
It's hard to know exactly how many of the new real estate crowdfunding companies are intending to structure their investments and offerings. The timeline and structure we've set out above is just one example. Much of the decision making revolves around issues of timing, disclosure and liquidity. As the market grows, as certain Managers/Syndicators gain prominence and credibility and as the crowdfunding market opens up to non-accredited investors, we expect real estate crowdfunding to evolve into a fundament sector of the market.
There are new applications for the sector developing each day. We're always looking to support new innovative approaches that add value, and encourage an open dialogue around these models to find sustainable frameworks. If you have any thoughts and comments on what we've discussed below, please do get in touch with us.
Photo Credit: Philip Taylor: https://bit.ly/p/bDwfRq
When is the money raised and when is the property purchased?
Although it would be preferable to raise funds based on a specific property, this seems unlikely to work for at least the first few properties that any Manager/Syndicator crowdfunds. In order to raise funds for a specific property, the Manager/Syndicator would either need to (1) purchase the property with cash and then raise the funds, or (2) somehow get a property under contract without a pre-approved mortgage or proof of sufficient funds and seek to raise the required amount between putting the property under contract and closing.
Option 1 entails a large capital commitment and increased risk.
Option 2 is unlikely to work in the absence of an extremely active and liquid investment community/market due to the timing given that the Manager/Syndicator would have approximately 30 days to raise the funds.
Another option is put the property under contract, agree to take out a mortgage with a 10%-20% down payment (as required), raise the funds and then either (1) decline to take out the mortgage (if the funds are raised before closing), or (2) pay off the mortgage with the funds once raised. As above, option 1 raises the risk profile. Option 2 may result in material additional costs and penalties, including prepayment of the mortgage.
Let's look at the Timeline
The timeline below assumes that the Manager/Syndicator raises funds for the purchase of a property in a specific market (i.e. geographic location).
Days -60 through Day 0: Listing and Fundraising
- Manager/Syndicator raises funds by providing information to potential accredited investors, including:Buyer/Manager: credentials, experience, background checks
The total amount to be raised, based on property type;
- target amount, including:
- cost of property;
- renovations;
- other costs (e.g. closing costs); and
- if debt structure, interest rate and costs should be considered.
- Manager/Syndicator should consider contributing 10%-20% of the total amount raised
- Fix and flip (potentially best for loan/debt structure); or
- Buy, hold, rent (potentially best for equity structure)
- Interest rate to be paid to investors (8%-10%); or
- Potential equity share including: target purchase price (range), target investment in property (renovation), target rental income (as applicable), length of holding and target sales price (range).
- Market (upmarket or downmarket, finished or requiring heavy renovation)
- Geographic location
2. Funding process:
- Investors express non-binding interest in fund, including the amount they would like to invest.
- Once the total amount required is reached (or usually exceeded to allow some investors to pull out), investors execute investment agreement.
- Funding closed.
- Investors transfer money to account of Manager/Syndicator.
- Manager/Syndicator finds property.
- Manager/Syndicator (now "Buyer") secures contract for property (closing process (assumed to be 30 days) starts).
- Title of property acquired by Buyer.
- Seller receives money for property.
Days 30 through Day 270 (for example): Renovating and Renting or Selling
- Renovations are made, as required.
- If equity structure is used, the proceeds from the rent and sale are distributed according to the equity structure.
- If debt structure is used, interest is paid to investors until the property is sold. The loan is repaid to investors upon sale of the property.
Conclusions
It's hard to know exactly how many of the new real estate crowdfunding companies are intending to structure their investments and offerings. The timeline and structure we've set out above is just one example. Much of the decision making revolves around issues of timing, disclosure and liquidity. As the market grows, as certain Managers/Syndicators gain prominence and credibility and as the crowdfunding market opens up to non-accredited investors, we expect real estate crowdfunding to evolve into a fundament sector of the market.
There are new applications for the sector developing each day. We're always looking to support new innovative approaches that add value, and encourage an open dialogue around these models to find sustainable frameworks. If you have any thoughts and comments on what we've discussed below, please do get in touch with us.
Photo Credit: Philip Taylor: https://bit.ly/p/bDwfRq
About the author - Dan McNamee
Dan is a U.S. trained and qualified lawyer (New York) with extensive experience in capital markets and M&A transactions in the United States, Europe, Asia and Africa. This background has provided extensive exposure to rules, regulations and regulators (including the SEC and FINRA) governing many forms of capital raising in the United States. With this foundation in the traditional capital markets space, Dan is seeking to help grow the crowdfunding market in the United States in a manner that encourages capital formation, protects investors and meets the extensive requirements of the nation’s regulators.
Born and raised in Cleveland, Ohio, Dan has worked and lived throughout the United States, in London and elsewhere in Europe. In his spare time, Dan has contributed a significant amount of pro bono work to a number of organizations, including the Clinton Health Access Initiative, and enjoys suffering as he watches Cleveland’s consistently terrible sports teams lose.
Dan is a U.S. trained and qualified lawyer (New York) with extensive experience in capital markets and M&A transactions in the United States, Europe, Asia and Africa. This background has provided extensive exposure to rules, regulations and regulators (including the SEC and FINRA) governing many forms of capital raising in the United States. With this foundation in the traditional capital markets space, Dan is seeking to help grow the crowdfunding market in the United States in a manner that encourages capital formation, protects investors and meets the extensive requirements of the nation’s regulators.
Born and raised in Cleveland, Ohio, Dan has worked and lived throughout the United States, in London and elsewhere in Europe. In his spare time, Dan has contributed a significant amount of pro bono work to a number of organizations, including the Clinton Health Access Initiative, and enjoys suffering as he watches Cleveland’s consistently terrible sports teams lose.
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