REAL ESTATE CROWDFUNDING
Introduction
You don’t need to fully own something to enjoy it. That has become the mantra of the sharing economy – a model that has had a seismic effect on how we think about ownership. But the sharing economy has not only transformed practically all industries; it has also irreversibly rewritten the rules of investing.
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In the face of the digital revolution and the growing popularity of peer-to-peer exchanges, investment has become much more transparent and inclusive than ever before. The elimination of the middleman along with our need to be in greater control has secured the unprecedented success of crowdfunding platforms.
However, there’s one branch of crowdfunding investment that remains relatively untapped: real estate (at least related to the size of the asset class). With the potential to reach $300bn in volume by 2025, it’s considered the fastest-growing field in crowdfunding.
As this exciting field rapidly expands, more and more people are looking to get into real estate crowdfunding. So what should they know before getting started?
Starting from early 2000, many players have started to think about alternative equity and debt collections to support a wide range of entrepreneurial ideas, and also, something to help people get their dreams come true. Crowdfunding is an interesting method to let demand and supply meet more easily. In the real estate industrymany players have started their journey and in this summary we aim to provide the business community with the state of the art about this phenomenon.
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What is crowdfunding
Crowdfunding is defined as a collection of equity and debt to be invested in several kind of projects through a web-based platform able to create opportunities by matching lenders and sponsors. Different stakeholders take part to it, the majority of them is below defined:
â–º Crowdfunder: backer, donor, investor and, in some cases, private and public institutions;
â–º Beneficiary-investee: small companies, NGOs, individuals, start-ups, product, project, initiative or ideas;
â–º Crowdfunding online platform: tool able to connect crowdfunders with the beneficiary or investee, that is remunerated through commissions from both crowdfunder and beneficiaries;
â–º Third party verifier and other service providers: those parties who support platforms and beneficiaries/investees by providing services as, in example, due diligence, legal support, tax structuring, project monitoring.
â–º Sponsors: those providing assistance in designing and running crowdfunding campaigns on a probono basis or on a commercial one.
Typically, crowdfunding platforms are differentiated on the basis of the kind of project they support or on the basis of the geographical coverage.
Crowdfunding offers a sustainable way to easier invest savings, gaining returns and, in the case of equity crowdfunding, becoming part of projects that would otherwise be out of reach for an individual. Moreover, the use of internet has allowed to cut both communication costs and transaction ones through electronic payments. In addition, crowdfunding websites create transparency and more open communication with investors. These factors are essential for the success of a crowdfunding campaign but also for the growth of the platform. On the other hand, it is necessary to build trust which is essential for the financing of the projects. With regards to the regulatory framework, it varies substantially across countries and based on the model used, the project sponsor and beneficiary. However, in some countries generic provisions are applied to protect investors when there is a lack of legislation. In other countries, there are specific requirements like registration and other governance and reporting requirements in equity and lending crowdfunding or banking license in case the platforms operates like a banks. Lastly, there could be the possibility for some platforms to be monitored at federal level along with state-level agencies.
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Real Estate crowdfunding is a relatively new concept, which applies fintech logic to capital collection for Real Estate investments. The capital raised is used in order to purchase, develop or refurbish a Real Estate asset with the aim of subsequent use or transaction. Thanks to the nature of the crowdfunding mechanism, users can diversify their portfolios by investing in a variety of properties generally through a low minimum investment amount required.
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The typical Real Estate crowdfunding structure is mostly applicable when a development company in the market desires to build or refurbish an asset located in a location with a high growing potential. Crowdfunding takes place among the different sources of capital aimed to finance its investment, Including Capital expenditure forecasted in its business plan.
The success of the investment and its returns depend on some drivers, such as: the platform's ability to select projects (independence), the operator's track record and the amount of initial equity. In addition, Real Estate crowdfunding platforms act as service providers for developer companies and their projects. The capital structure of a project includes: preferred equity, common equity, mezzanine debt, senior debt and crowdfunding which is used in a complementary way to the other means of financing. Therefore, crowdfunding players must be able to adapt flexibly to meet their sponsors’ requests.
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Real Estate crowdfunding models
There could be platforms specialized either in equity crowdfunding or in lending crowdfunding and “hybrid” models which deal with both.
Lending: This model is based on the lending of capital through platforms, which work as financial intermediaries. It matches people that have excessive liquidity with third parties that are looking for loans through the web.
The yield usually is given by the interest rate, which can be fixed or indexed. The object is the subject loan, not the specific use of the amount lended to the borrower. However, in certain cases, it is possible to obtain an extra return linked to the sale of the property. Main risks of lending crowdfunding: Late payments: there is no certainty that borrowers will be able to repay investors on time. Mortgage: the crowdfunding platforms are not allowed to register a mortgage on the asset. The RE Company which borrows the money acquires the property of the assets and gives it as a mortgage guarantee to a third party (SPV) that holds it as a guarantee for all lenders.
Equity: This model enables to distribute the risk of enterprise on a larger number of investors who, in case of failure, would face a smaller loss. The backer receives shares of a company, usually in its early stages, in exchange for the money pledged.
One share of the company is purchased and the return will be generated by the exit value achieved. In fact, there will be a difference between the sale price of the property (exit) and the previously invested capital. Main risks of equity crowdfunding: Capital gain/loss: The success of the operation depends on the variable price of shares. So if the project fails, the difference between the exit value and the invested capital will be negative, therefore investors lose money. Liquidity risks: Shares in smaller or early-stage companies are illiquid and subject to volatility. Investors might find it difficult to access their money after the investment.
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Real Estate Crowdfunding: Opportunities for growth
Real Estate Crowdfunding is a fast-growing industry which has still some unexploited potential. It can work effectively as a source of financing upon certain conditions and type of projects. Among many we have identified different opportunities for which Crowdfunding may represent a solution.
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1)Development and value-add projects
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Real Estate Crowdfunding is suitable to all those investments made with the mindset of reaching high returns (i.e. revamping and improving an asset); • This entails the investment of considerable amounts in CAPEX, the so-called “Developments” and “Value Added” projects; • Developers usually finance these projects through banks’ debt and shareholders’ equity. In addition, the use of crowdfunding among equity sources of capital is becoming popular; • The returns are based on the high premium the investor gains at the exit, when the renewed asset is placed on the market for sale.
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A lot of appeals is also on the offering side, developers, renovators and real estate player could massively benefit by this new channel.
· There’s a concrete problem for developers in Spain: the lack of funds to start their projects, principally due to restricted financing provided by banks. There’s a 20/30% gap that need to be filled and actually is provided by alternative financing. We’ve been testimonial of this problem directly and you can read to the attached Economista’s research published recently.
· A meeting organized by Proimba (Baleares associations of promotors) with a specialized investment firm is a further confirm. You are well conscious that only solving this problem will be possible to close more deals and servicing traditional banking channel. Big scale operator like Aedas, Neinor or Socimis are well equipped to face this issue but medium to small operators (the traditional ones in Baleares) could suffer.
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Different skilled financial players have noticed it are active in this area, using proprietary and clients’ money to invest at attractive returns.
The turning point is to comprehend that we’re not anymore talking about alternative financing but about complementary financing.
It could be solved principally in two macro different ways:
1. raising funds with real estate syndications, assuming the role of limited partners within different agreements like partnership, funds or JV.
2. Being active on crowdfunding space: raising equity or debt publishing the offer on a regulated platform.
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We know well this business, the different platforms and regulations, the business models and the cost and revenues structures.
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Conclusions
Although Real Estate crowdfunding started in response to a gap in the provision of capital, now it is becoming a stand alone industry. Before the development of crowdfunding, the features of the Real Estate market were high (expensive) investments with the requirement of a high minimum capital, operational costs and restrictive regulations. These made it difficult for ordinary investors to have a direct access to Real Estate investment opportunities.
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Nowadays, Crowdfunding has opened the Real Estate market to a large and various number of investors, Investors can access this market for a low-threshold entry level, a lower fee structure due to the disintermediation of financial consultants and agents, while enjoying the same portfolio benefits as a direct investment. Moreover, Real Estate crowdfunding gives more options to investors in terms of model, location, timing and sectors (residential, commercial, student housing, etc). Real Estate crowdfunding offers a way to generate returns without the burden of direct ownership and without the impact of stock volatility. In addition, in some countries there are substantial tax advantages. Crowdfunding grants developers a cheaper and faster access to capital. The developer chooses crowdfunding financing as it allows to get in touch with a large number of investors and potential new members. As a result, developers increased their visibility at a media level. In addition, the access to capital is very rapid. compared to traditional capital raising, the time is reduced by more than 50%.
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With regards to the European market, Real Estate crowdfunding is relatively young and characterized by: the attraction of new players to enter in the booming Real Estate investment market and by the demand for the alternative finance due to the market gap.
Therefore, crowdfunding can be an additional instrument available in the financing mix for Real Estate projects.
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​Looking at the future, a positive and dynamic growth is expected in real-estate crowdfunding, supported by an industrial consolidation. What allows platforms not to fall apart is the presence of technology and its various applications and/or the incorporation and usage of data for underwriting. The remaining platforms will improve the services offered both in terms of quantity and quality giving the kind of credibility and efficiency that is attractive for investors and sponsors. In conclusion, crowdfunding Real Estate is growing rapidly all over the world, mainly due to the evolution of the market. As a consequence, investors’ appetite for this type of financial product is gradually strengthen, attracting new players towards fintech market, including millennials.
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