Ask Benjamin Miller, co-founder of the Washington, D.C.-based online real estate finance company Fundrise about crowdfunding and he will tell you, as he told the House Committee on Small Business several months ago, that “the Internet will do to capital what it did to media and commerce: it will completely disrupt the status quo.” In short, it will be transformative.
An online platform, Fundrise allows investors to browse offerings, invest online, manage investments through a Web portfolio, and receive potential returns automatically.
Before there was a JOBS Act (see “What Is Crowdfunding?” below), Miller and his brother Daniel, frustrated at institutional investors’ lack of enthusiasm for a proposed small development in an emerging neighborhood in Washington, D.C., devised an alternative solution. What if you could raise equity capital from a large group of individual, local investors who are deeply familiar with the neighborhood and enthusiastic supporters of redevelopment?
The Millers were no real estate novices; they hail from a 40-plus-year-old family company, Western Development Corp., that has built more than 20 million square feet of commercial space in the city. The brothers are managing partners of WestMill Capital Partners, which they founded in 2010 to focus on urban mixed-use development. But navigating from their “Ah-ha” moment to bringing Fundrise to fruition took time and considerable expense. Miller explained that a provision of Regulation A of U.S. Securities and Exchange Commission (SEC) rules would allow them to reach out to unaccredited investors (defined as anyone who does not have an individual or joint net worth of at least $1 million, excluding the value of his or her primary residence, or whose income is below $200,000 in each of the two most recent years or whose joint income with a spouse is below $300,000 for those years). They registered with the SEC, which took nine months, and currently are selling shares only to residents of Virginia and the District of Columbia. They did not want to do anything “not by the books,” Miller said. And contrary to what some may have expected, he added, the public was “a very tough critic, very sophisticated, and asked tough questions.”
Their first offering, with WestMill as the developer, was to transform the vacant 5,380-square-foot 1351 H Street, N.E., into an Asian restaurant and market. It took them three months to raise $325,000. Their second project raised $250,000 from 14 investors in a week.
Their most ambitious project to date is The Griffith at 965 Florida Ave., N.W., a proposed 370,000-square-foot mixed-use development. A joint venture of Fundrise, MRP Realty, and Ellis Development Group recently won the right to purchase the 1.45-acre site from the city. The offering size was $300,000; investors could pledge $100 to $10,000. Returns are projected in the 8 to 10 percent range, with principal payout projected to take three to five years. This offering raised pledges of $974,100 among 661 potential investors. Determining who will be able to invest will be a conundrum for the developers to resolve.
“When we started, this was a totally novel idea,” Miller said. “Now, everyone is talking about it and wants to do it. The biggest surprise to me is how fast the culture has changed around this idea. The norms are changing so quickly.”
Fundrise currently is working with other developers — including Forest City Enterprises — in Washington, D.C., New York, and Los Angeles who are keen on broadening their investor bases. The company is very selective in choosing which developers to work with. “We’re the gatekeepers,” Miller said. In a year or two, Fundrise expects to be working with 100 developers and raising more than $10 million for one deal.
What Miller calls the democratization of real estate investment “will scale faster than anyone expects,” he said.
What Is Crowdfunding?
Think of it as Kickstarter or Indiegogo for real estate. (Some background for crowdfunding neophytes: these are Internet-based platforms that enable individuals all over the world to fund creative projects like films, musical compositions and festivals, books, and more.) In April 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act, which was designed to streamline the process through which startups and small businesses could raise funds by selling equity capital and soliciting small investments over the Internet. C. Forbes Sargent III and Meyer H. Potashman of the Boston law firm Sherrin and Lodgen LLP offered a summary of a few of the Act’s key provisions on crowdfunding:
- The new law creates an entirely new exemption from registration under the Securities Act, which will permit companies to publicly offer and sell up to $1 million in securities over a 12-month period without needing to register.
- These sales, known as crowdfunding transactions, will be facilitated over the Internet and will be subject to several restrictions, including the following: If an individual investor’s annual income or net worth is less than $100,000, he or she may invest no more than the greater of $2,000 or five percent of his or her annual income or net worth. If his or her income or net worth is higher than $100,000, then he or she may invest no more than 10 percent of annual income or net worth and never more than $100,000.
- A new type of broker, known as a “funding portal,” must be used to facilitate the sale. The funding portal will be required to register with the SEC and other organizations (such as state regulatory authorities), and to confirm that the investors satisfy the investment requirements and can bear the risk of the investment.
- Companies that use the crowdfunding process will have to file with the SEC and disclose certain information to the parties involved, such as their business plan, a description of the company’s capital structure, and the intended use of the proceeds. Audited financial statements will be required for offerings of more than $500,000. After the offering, the company will need to file ongoing reports with the SEC, based on rules to be determined by the SEC.
How will the crowdfunding provisions of the JOBS Act affect the real estate finance market? It’s too early to tell, because the SEC has not issued final rules. Although SEC Chairman Mary Jo White has said that issuing these rules (now past the deadline called for in the legislation) is a priority, she has not yet stated an estimated timetable. In an unusual move, however, the SEC has opened the subject up to pre-rulemaking comments by the public and received the virtual equivalent of a forest’s worth of such comments.
Speaking on background, an SEC spokesperson said that the agency is always worried about the possibility of “fraudsters” getting into this business. Although the JOBS Act does have some protective language regarding due diligence, there will be much uncharted territory in crowdfunding. For example: How well will the financial professionals — the portals — do their jobs? How will results be reported to investors once an offering is completed? How will investors be able to keep track of their investments?
Crowdfunding for real estate is not an entirely new phenomenon. Numerous players have entered the field, including CrowdStreet, Patch of Land, Realty Shares, iFunding, Realty Mogul, and Globerex. (See “Online Equity Exchange Makes Its Debut,” Development, Fall 2011, p. 16.) Although each of these platforms has its own niche and strategy, with different levels of minimum investment, all are geared toward accredited investors who meet specific requirements for net worth and/or annual income. By contrast, crowdfunding under the JOBS Act will open the field to many more smaller investors.
For more information:
sec.gov/spotlight/jobs-actcomments.shtml (public comments on SEC regulatory initiatives under the JOBS Act)