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Although still in its early stages, crowdfunding for commercial real estate has come far as a means for increasing the availability of capital to borrowers and allowing more people to invest in real estate. But with regulatory concerns still looming, just how far will this method of raising funds be allowed to progress, and how quickly?

Recently, Real Estate Forum sister publication GlobeSt.com polled readers about their views on crowdfunding, asking, “Will the proposed changes to the JOBS Act, requiring less-stringent barriers to crowdfunding, help or hurt crowdfunding?” Of the 128 votes that came in, 75 (59%) said the proposed changes would help, adding that lessening the requirements will open more channels of investment, and any favorable ruling will increase its viability; 25 (20%) said the changes will hurt crowdfunding, and that removing the safeguards will invite more fraud; while 28 (21%) responded neither, that it's a niche product that targets a niche category, and opening it to more investors won't increase its market share. It's apparent that most people think loosening the restrictions on who can invest will be a positive step for the CRE arena, although there are still some concerns about this move inviting fraud—a major caveat with online investing.

GlobeSt.com also interviewed Paul S. Rutter, of counsel at Gilchrist & Rutter and a board member of the UCLA Ziman Center for Real Estate, about the risks that crowdfunding presents. While Rutter admitted that crowdfunding has facilitated investors' participation in commercial real estate deals, there are still real risks, as there are in any financial transaction. “For investors making an investment in a loan, the risks are similar to those taken by any lender. The borrower might default; there could be a loss of income from defaulted interest payments and a loss of principal from a failure of the borrower to repay the loan,” said Rutter. He added, “In the context of an equity investment through crowdfunding, the risks are similar to any other syndicated equity deal. The limited partners/members who invest are at risk of dilution through the investment of additional capital, whether to meet cost overruns, to pay deductible losses on insurance claims, to satisfy third-party claims and to pay for ongoing capital expenditures and leasing expenses.”

Nevertheless, as long as investors are aware of and prepared for the risks, crowdfunding stands a very good chance of becoming a mainstream method of fundraising. As Roman Rosario, co-founder of RealCrowd, says, “We are seeing a more educated real estate investor participate in online CRE investing, and the less experienced investors are taking the time to educate themselves—our investor content (ebooks, etc.) has seen thousands of downloads.” He also notes that “the average investment that an investor makes per deal is rising; whereas our previous average was approximately $70,000, more recent offerings are closer to $90,000 and $100,000 per investor.” Rosario explains that some of the factors that contributed to this are trust, track record and transaction flow.

Is crowdfunding legit? 

According to industry research by Crowdsourcing.org and the World Bank, crowdfunding generated $5.1 billion in funding transactions in 2013 and will surpass $300 billion in funding transactions by 2025, Judd Hollas, CEO of EquityNet, tells Forum. “CRE is an industry that is quickly adopting crowdfunding as a viable alternative to traditional funding methods. As the crowdfunding industry grows, we will see those in the CRE industry obtain funding as quickly and efficiently as those in all other industries.”

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Those in the crowdfunding space are buoyed by the way the format has been accepted as legitimate in mainstream CRE channels. Adam Hooper, founder and CEO of RealCrowd, says, “It's been amazing the change in perception that we've seen in the past six to eight months. This has gone from a fringe experiment on the side to a legitimate, acceptable way to raise capital. Again, keep in mind the basic mechanics of crowdfunding are no different from the bread-and-butter syndications over the past decades. The biggest difference is the means by which the real estate companies can meet, market to and manage these investors through an online platform.”

The digital component to crowdfunding is partly responsible for its exponential growth. Darren Powderly, co-founder and VP of real estate at CrowdStreet Inc., tells Forum, “Real estate crowdfunding is quickly gaining recognition from industry leaders as a major component in the future of fundraising. Capital providers and users alike are researching how online fundraising, a.k.a. crowdfunding, can help make their businesses more efficient. The early adopters have mainly been small to middle-market real estate developers and operators (sponsors) who have benefitted not only from successful fundraises, but also from valuable learning from the experience. Based on interviews with hundreds of real estate operating companies, there is broad-based support for moving the fundraising and investor-relationship management process online, which will help drive the industry forward over the next few years.”

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Changes to how crowdfunded programs are marketed to potential investors have also helped the process progress more quickly. Ryan G. Smith, senior vice president of RCS Capital, which hosts the We Are Crowdfunding platform, tells Forum, “The major new development was Title II of the JOBS Act, which now allows firms to advertise to accredited investors. Therefore, if firms are operating by current regulations, crowdfunding is as legitimate a source of financing as syndicates have been for decades. Crowdfunding simply allows greater accessibility to that process.”

Naturally, the amount of legitimacy crowdfunding has achieved varies according to how comfortable people are with online investing, which has increased as traditional lenders have adopted stricter underwriting guidelines. Joe Elias, co-founder and COO of Loquidity.com, tells Forum, “Real estate is one of investment crowdfunding's later adopters and has really picked up within the past nine months. However, this sector has quickly become the most-popular asset class for investment crowdfunding raises that take advantage of new general solicitation rules implemented by the SEC.”

He continues, “The 'early adopters,' in our case, are those investors comfortable with placing investments online or those who come through our existing network and, therefore, trust our platform and, more importantly, our team's ability to execute. As traditional institutions continue to practice restrictive lending, particularly for gap financing and higher loan-to-value ratios, investment crowdfunding will become an important part of the capital stack for many sponsors and syndicators.”

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In fact, many leading commercial real estate companies are now embracing crowdfunding, says Dan Miller, co-founder of Fundrise. “We are starting to see larger companies turn to crowdfunding for bigger, more-notable projects in major markets around the country,” he says. “We recently received funding from national real estate leaders such as the CEO and CIO of Silverstein Properties Inc. and James Ratner and Debbie Ratner Salzberg of Forest City Enterprises—which, to us, validates that real estate crowdfunding is here to stay.”

Jilliene Helman, founder and CEO of Realty Mogul, tells Forum, “The legitimacy of crowdfunding is growing every day. While most commercial real estate professionals had never heard the term a year ago, more and more sponsors are looking to crowdfunding to raise small-balance equity-and-debt capital today.”

Even outside of the crowdfunding platforms themselves, the format is being recognized as a legitimate source of financing for commercial real estate transactions, “but it's an emerging source,” Joaquin de Monet, founder and managing principal of Palisades Realty Advisors LLC, tells Forum. “Folks have created platforms and the technology around those platforms to allow accredited investors to sign up on their websites to get access to deals, and they've been successful at getting developers and operators to post deals on their websites in a way that's helping them to finance their projects. From that standpoint, it's been a success. I expect it will continue to have exponential success, but obviously there's been more talking about it than activity.”

Gary M. Tenzer, principal and managing director at George Smith Partners, tells Forum, “The concept is still in its infancy, as the enabling legislation only became law in April 2012. Lenders look at crowdfunded equity similar to typical syndicated equity, and they will still want to see the sponsor have some personal skin in the game.

EFFECT OF REGULATION AND OVERSIGHT ON ITS PROGRESS

Allowing solicitation of crowdfunding opportunities to accredited investors was a major milestone for the fledgling industry, but talk of pending SEC rulings that could change the definition of an accredited investor has raised concerns about how this will impact everyone involved. Helman says regulation and oversight for qualifying investors will have a significant impact on crowdfunding's growth. “The SEC is in discussions now to change the definition of an accredited investor. If those new regulations prohibit more investors from making investments, it will have a substantial impact on how quickly crowdfunding will progress.”

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Smith says, “While most of the discussion is typically focused on the JOBS Act and what Title III will mean for crowdfunding, new questions on the definition of an accredited investor may have the largest impact on crowdfunding. Although the industry is waiting on legislation, the crowd has spoken, and it's clear online investing is here to stay.”

RealCrowd operates solely in the general solicitation or 506(c) space, so every investor that comes through its platform has a higher level of scrutiny than those platforms that are focusing on traditional 506(b) offerings, relates Hooper. “A simple check-box to self-certify is not enough to ensure that these investors are accredited. The proposed regulation to increase the minimum thresholds on accreditation shouldn't impact us too much. The average net worth of those we have verified on that basis is near $9 million—well above the proposed updated numbers.”

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Adam Chapnick, chief strategy officer at Asset Avenue, says regulation and oversight are important to protect investors and the general public. “Frankly, to have no regulation or oversight whatsoever wouldn't be a positive step for crowdfunding progression overall. That being said, tighter regulation around what the SEC defines as 'accredited' will certain affect the growth rate of investment-based crowdfunding. An expanded definition will help crowdfunding growth accelerate by helping more individuals to play in this arena.”

ANTICIPATED PROGRESS OVER NEXT YEAR

Helman says CRE crowdfunding has emerged from its infancy this year and that investors on the Realty Mogul platform alone are on track to invest more than $50 million in CRE. “If 2014 was the emergence of crowdfunding, I think 2015 will be the coming of age for crowdfunding. I anticipate more than $1 billion will be capitalized through crowdfunding and online capital markets in 2015.”

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Hooper says the industry has made tremendous progress in the past year, “especially since general solicitations have only been legal for slightly over a year. We've had $750 million of real estate opportunities on our platform in the first year, and our pipeline is many multiples of that. 2015 will be another huge year for growth, and we anticipate seeing more institutional players (both capital providers and sponsors) getting involved.”

When CrowdStreet presents at leading industry conferences such as ULI and NAIOP, it receives a high level of interest and questioning from sponsors and investors alike, says Powderly. “Those companies already using crowdfunding are raising capital, expanding their individual and institutional-investor networks and gaining national brand recognition as innovators. A welcome development is the rapid increase of private-equity real estate firms and institutional investors who have capital to deploy and want to benefit from the opportunities available on the CRE crowdfunding portals.”

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De Monet says, “I think crowdfunding will continue to progress in terms of more platforms, more established firms and companies being able to expand their product line. Some have only debt capabilities, while others have mezzanine and still others are investing into single assets. Hopefully, it will emerge into commingled funds and the average ticket for funding will also improve over time.” He adds that he views crowdfunding as complementary to traditional avenues of finance. “To me, the early stages of crowdfunding are about increasing the pool of accredited investors. We use private capital—high-net-worth and ultra-high-net-worth investors—and we will be able to increase our pool of potential investors through crowdfunding.”

The volume of crowdfunded financing will increase over the next year as long as there is a perception that the economy is continuing to expand and that real estate values are still increasing, says Tenzer. “When real estate fundamentals and the general economy begin to turn down, I would expect that new capital would become harder to raise.” While he views crowdfunding as competition to traditional avenues of finance to some degree, he cautions, “the crowdfunding industry must be very wary of growing too fast by taking on the marginal deal. If only a few crowdfunded investments go bad, there will be considerable negative publicity and a resultant reputational risk for the crowdfunding industry at large.”