Although the economy is showing signs of recovery in fits and starts, the traditional commercial real estate lending market is still tight for many developers. A number of non-traditional, non-bank financing sources have blossomed in response, with crowdfunding at the forefront.
“Crowdfunding” takes its name from crowdsourcing, and is based on a similar model. A crowdfunded project is financed by a large pool of backers, who each contribute a small amount towards a development goal. Crowdfunding typically takes place on a web-based platform, such as RealCrowd, Groundfloor, and FundRise, allowing developers to reach a huge number of contributors.
Unlike the traditional development model, which requires large lump sums of cash, crowdfunding has a low-capital entry requirement (often allowing pledges of $100 or less), and gives investors greater control over which projects get funded.
Previously, the only other option for the small-capital investor was to invest in a Real Estate Investment Trust (often shorthanded to “REIT”). Purchasing a share in a REIT allows an investor to buy into a professionally managed portfolio of existing investment properties. REITs offer only indirect ownership, however, and can have relatively high fees required to support the trust’s management.
In contrast, crowdfunding offers investors the opportunity to select specific projects, rather than a portfolio, without hefty management fees. The crowdfunding development process is theoretically more transparent because progress reports and dividend payouts are posted on the Internet as the project progresses.
It’s too soon to tell whether crowdfunding is merely a fad or whether we’re really seeing a change in the way projects are funded. Driven by the 2012 JOBS Act mandate, the SEC is currently mulling over comments to proposed crowdfunding rules. Regulators are expected to complete the rules by the end of 2014, which, when promulgated, could significantly help or hinder the future of crowdfunding. But for now, banks and REITs are certainly taking notice of this new upstart competitor.