Most crowdfunding, or “peer-to-peer,” real estate marketplaces specialize in bringing to accredited investors opportunities in commercial real estate, a unique asset class that acts and behaves differently from many other investment classes like stocks or bonds. Judging by the growth of this market space, these companies are quite evidently filling a real market need. A recent article in this magazine, however, cast some doubt on the viability of this new industry—so perhaps it’s worth reviewing the reasons why the industry is catching on so fast.
Why P2P Real Estate is Here to Stay
Peer-to-peer real estate marketplaces give accredited investors a chance to invest “passively” in commercial real estate—i.e., separating their investment income from any significant time commitments. This is how investments in stocks and bonds work—investors aren’t actively working with the company, and it’s not their day job, they just want to help finance the company’s growth. Active investors, on the other hand, may want a new source of financing—one that is familiar with their business—since banks and other institutions are often ill-suited for their needs.
Peer-to-peer real estate marketplaces now can solve for each of these situations. Real estate investors who need a bridge loan to help with their renovation project on that “fixer” can turn to these marketplaces to get their financing—because contrary to what some might think, major banks and financial institutions are just not a good alternative for these admittedly riskier loans. Traditional lenders often follow hyper-rigid guidelines and stick to lending on “stabilized” properties, rejecting those in disrepair or that require more than a minimal amount of renovation. Banks can also be slow-moving—good rehab properties can go off the market a lot faster than a commercial bank can approve a mortgage for it. A private market for rehab loans had thus already developed long before crowdfunding companies came along, since an interest rate premium can be demanded for these loans. Technology-focused online lenders who are focused on these types of loans can often act quicker and provide more competitive pricing than other private lenders in this sector.
On the flip side, P2P marketplaces now offer accredited investors a chance to participate (sometimes indirectly) in the making of those loans. They also allow those investors to participate in ownership positions (and thus the potential equity upside) in larger commercial properties—something that had previously been out of reach for many. Equity investments in such properties can provide these investors with all the associated tax benefits of commercial real estate ownership without the associated management headaches.
Here are some other reasons why crowdfunding has caught on with accredited investors:
Better Access to Deal Flow. Unless an investor specializes in a particular sector of commercial real estate and has developed good deal sources, it’s tough for individuals “dabbling” in this sector to develop a good pipeline of potential projects. Peer-to-peer marketplaces provide a means of leveraging the expertise of professionals in this respect. Partnering up with an investment platform that features property listings and the necessary stats that go with them can allow investors to participate in some of these potentially “better” deals, rather than missing out on them completely.
Lower Minimum Investment Amounts. Commercial real estate projects tends to involve relatively large properties—and a sponsor looking to raise $5 million (for example) is not likely to be interested in an investor unless that investor can bring at least $100,000 to the project. Peer-to-peer real estate marketplaces allow investors to pool together smaller investment amounts into a single larger investment that is attractive to a sponsor. They also allow larger investors to more easily diversify across different properties.
Tax Benefits. The tax benefits of direct participation interests in commercial real estate can be attractive. If properly structured, deductions related to depreciation, interest expense and other items help to shelter or defer the taxes on cash distributions. Some or all of these tax benefits may be recaptured at the time of the property’s sale, but in the meantime investors may have tax-free use of the distributed cash. For persons not wanting to invest actively, peer-to-peer real estate marketplaces allow them to participate in such tax benefits in ways that may not have been available to them before.
Some Pre-Review of Transactions. Although individual investors must ultimately bear the risks of their investment, it’s hard to see how it could be a negative that some P2P marketplaces perform a degree of pre-review of various opportunities and the information relating to them. At the company where I work, Realty Mogul, for example, the debt offerings relate to loans where there is an equity cushion; generally involve a first-position lien; and the borrowers both maintain some of their own money at risk and provide a personal guarantee. On equity transactions, the property and its location are assessed and must pass muster with our own internal investment committee—and we reject a lot more opportunities than we accept. In all cases (both debt and equity), we run criminal, background and credit checks of the borrowers and sponsors.
Sponsors – How Structure Matters
The article earlier referenced also questioned why sponsoring real estate companies would be interested in working with those P2P real estate marketplaces who structure themselves as the “money partner.” The answer lies in the value that such structures bring to sponsors.
There Can be a Lot More Money Available to Sponsors. Crowdfunding can significantly expand the capital pool available for a sponsor’s projects.
Structured, Single Entity Investors Make Life Simple. A larger, pooled investment vehicle acts just like any of a sponsor’s other high net worth investors. The use of a broker-dealer partner also helps to assure that the sub-syndication is legally compliant.
Less Work, with Increased Brand Recognition. The crowdfunding company will generally handle all of the communications, distributions and tax reporting for its underlying investors. The sponsor is presented to thousands of accredited investors—and thus gains a huge increase in brand recognition—without all of the related chores.
Value on All Sides
Sponsors thus gain real value with structured investment vehicles. Investors realize the benefits discussed above, and also often gain increased negotiating strength (via the P2P company) and better insight into “what’s market” as they gain the expertise offered by the P2P company.
That expertise is often deeper than some may realize. At the company where I work, for example, most of our investment committee members have more than 15 years’ experience in real estate investment. We also regularly publish extensive surveys of real estate syndications we review—and the last such review, for example, involved properties worth nearly $5 billion in total. Companies like ours provide increased transparency to the marketplace—an important feature, given the somewhat opaque world of real estate private placements.
Finally, active real estate investors looking to have P2P platforms lend on their projects gain speed, simplicity and consistency. Technology can help make application processes straightforward and simple. With a few key parameters—the location of the property, the purchase price, the rehab budget, the borrower’s own income & net worth, and a few other items—technology can often generate a letter of intent almost immediately. Capital can thus be ready for rehab projects nationally, using technology that provides not only competitive pricing and great leverage but fast and consistent answers.
Real estate has proven to be one of the most effective investment vehicles for generating recurring, passive cash flow. Until recently though, other than through a REIT holding a pool of numerous properties, an average investor had little prospect of participating in commercial real estate investments. The advent of real estate P2P marketplaces, or “crowdfunding,” has allowed people without pre-existing industry connections to participate in specific real estate projects, and with smaller individual investment amounts, than ever before. At the same time, sponsors and borrowers realize real value from these companies. In view of those benefits, turning “bearish” on the nascent real estate crowdfunding industry seems like a risky bet.
Lawrence Fassler is the General Counsel of Realty Mogul.
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