Crowdfunding, where companies ask individuals to directly invest in their product, is being expanded to a new arena: real estate.
When many people think of crowdfunding, they think of sites such as Kickstarter. In that model, for example, a band might need money for a CD. They ask people to contribute, and, in return, those people get a CD or, if they donate a large amount of money, a private concert.
But crowdfunding is taking off to a whole new level. Real estate developers are starting to use crowdfunding sites to ask for contributions to their projects—and in return, you become an investor.
How Real Estate Crowdfunding Works
Take real estate investment company MainStreet as an example. They want to build a short-term rehabilitation center in Bloomington.
“We think there’s a massive opportunity, here in Bloomington, in Indiana more broadly and across the country for these short-term stay facilities,” says Mainstreet Chief Operating Officer Scott White.
The facility would offer an alternative to nursing homes and at-home care when people are discharged from the hospital. They plan to have eight to ten on-site common amenities such as a movie theatre, a music room, a hair salon, as well as two to three on-site restaurants. The goal is to provide patients with a “luxury experience.”
Traditionally to build this kind of a facility, Mainstreet would go to banks and investment brokers to get funding. But this time, the company’s leaders wanted to try a new approach.
“These types of investments in the past were available to institutions, to Wall Street, to those that had special access,” White says. “We want to democratize that.”
On a recent weekday in Bloomington, White is pitching the idea to a room full of potential investors. He’s hoping to raise $1.5 million of the project’s $13 million cost from individual investors.
He shows them diagrams of what the facility will look like, explains how their previous facilities have been built and what kind of return they have seen from those projects.
But not everyone listening to White’s presentation will be allowed to invest.
The JOBS Act allows companies to solicit investments through crowdfunding, but right now the Securities and Exchange Commission is limiting that to accredited investors–people who make at least $200,000 a year or have a net worth of more than $1 million.
The SEC is limiting the investment opportunities because this type of crowdfunding is still a relatively new phenomenon and because there’s an inherent risk in investments like the one Mainstreet is offering.
“The bad as I characterize it sometimes with these crowdfunding platforms is the potential for naïve investors being coupled with naïve entrepreneurs and the result of that can be something that is not satisfying for either of them,” says Todd Saxton, an associate professor and Indiana Venture Faculty Fellow at the IU Kelley School of Business in Indianapolis.
The Risks and Rewards of Crowdfunding
But so far, people seem to be willing to take that risk—especially for the 14 percent return Mainstreet says it can produce.
“That’s a pretty alluring figure, so I definitely want to go on their website and look at facilities that they have developed,” says Bloomington resident Lauren Cowen, who attended the investors meeting. “I’m actually going to go with a few people that were her today to a couple of the facilities in Carmel and Kokomo to see what they’ve been building.”
And that’s what makes real estate crowdfunding stand out from other investments. There’s actually a building, previously built facilities or, in the Bloomington case, a plot of land that potential investors can see. In fact, at the end of the presentation, Mainstreet executives were handing out directions to the site where the facility would be built.
“It’s very powerful because it’s local. You can see it. You can touch it. You can feel it. ” Saxton says. “That’s very different from putting an extra $1,000 in my TIACREF account that might grow at 5 percent to 7 percent. That’s not very personal. You really don’t know the companies or the founders that that money is going to.”
But Saxton says people need to think critically about any company before investing.
Crowdfunded real estate projects are popping up all over the nation—from Indianapolis to New York City, and most of the time, people use websites such as Fundrise or Crowdstreet to invest. That can provide added protection if you know the website is reputable, but it can also make the investment less tangible. So, Saxton says, investors need to check into the business’ track record, read all the fine print, and, make sure it’s legitimate.
This is especially important because SEC is in the processes of establishing rules that would open up crowdfunding to everyone–not just accredited investors.
That is something Mainstreet is excited about.
“We’re always looking to innovate. We call it positive dissatisfaction,” White says. “This is working great—how can we do it better? How can we improve on what we’re doing? And one of those things may very well be you’ve found success with accredited investors, now, when the rules are written, would you go more broadly to all investors? Absolutely.”
Since the investors meeting in Bloomington, Mainstreet has raised $1.8 million, which is more than it was originally seeking from individual investors.
That success, along with the success of other projects in the state, is prompting Mainstreet to rely more heavily on crowdfunding—a trend financial experts say is only expected to grow.