If you’re familiar with crowdfunding then you’ve probably heard of the JOBS Act (Jumpstart Our Business Startups Act). Many of us in the startup community have seen the rise of crowdfunding through platforms like Prosper.com, AngelList and KickStarter, and we largely considered the impact on the tech startup community alone. But in the last year since the act was passed it has become clear that impact will be far more broad, affecting entrepreneurs of all stripes. In particular, real estate crowdfunding may be one of the biggest impacts of the JOBS Act.
Perhaps the oldest form of entrepreneurship, real estate investors have been buying and selling property since long before there was a tech sector. And, following the massive downturn in real estate values during the “Great Recession” it has become clear that the $250 billion U.S. commercial real estate (CRE) finance market is ripe for disruption. I had the opportunity to meet with a true real estate veteran a few weeks ago. During our meeting he shared countless war stories that dated back several decades. The larger story arc that he told was one of two parallel universes. He began by sharing his experience some 50 years ago when he worked at a large public company. He recalled that back in the 60’s, the cafeteria was filled with mid-level employees checking the Wall Street Journal for only one reason?—?to see how their company’s stock and, hence, their pension was performing. In time, these same folks would get curious and read other sections of the Journal. A decade or so later, Charles Schwab had the crazy idea that individuals?—?just like those reading the paper in the cafeteria?—?might be interested in directing their own investment strategy… and he was right. Today, Schwab does $4 billion a year in revenue with about 12,000 employees. And E-Trade, which further pioneered the automation of the self-directed investor movement, does about $2 billion a year in revenue with 3,000 employees.
Most telling about my meeting, was how this veteran of development, acquisitions and finance drew a straight line comparison to the real estate market. Although he was no technophile, he saw that the future of real estate finance would move away from the institutional domination of the present to a world where individual investors could own a piece of a high-quality, professionally managed real estate asset.
Why is the time ripe for real estate crowdfunding? Presently, the commercial real estate investment industry suffers from overregulation, a heavy reliance on nervous banks and an inequitable relationship with the strong-armed hedge funds that provide capital when the banks are unwilling. The anticipated JOBS Act regulations?—?currently in development at the Securities and Exchange Commission (SEC)?—?may very well be a partial remedy for this broken market.
So how exactly will the JOBS Act affect the real estate finance market? No one knows for sure until the SEC issues final rules on the matter. But the act itself has certain requirements and the SEC has issued proposed rule changes, both of which provide some guidance.
Among other things, the JOBS Act has several key provisions that will shape the real estate crowdfunding market:
- The law ends the ban on advertising (or “general solicitation”) in certain private offerings?—?specifically Reg D Rule 506 offerings?—?but only if all the purchasers in the offering are accredited investors and the issuer “takes reasonable steps to verify that the purchasers are accredited investors”;
- It increase the number of shareholders a company may have before being required to register its common stock with the SEC and become a publicly reporting company. These requirements are now generally triggered when a company′s assets reach $10 million and it has 500 shareholders of record. The new regs will likely change this so that the threshold is reached only if the company has 500 “unaccredited” shareholders, or 2,000 total shareholders, including both accredited and unaccredited shareholders;
- It provide a new exemption from the public registration requirement for certain types of small offerings, subject to several conditions. One of the conditions of this exemption is an annual limit on the amount each investor may invest in offerings of this type?—?an amount which would be capped at 5–10% of that individual’s net worth or annual income.
- The regs will likely also include mandated reviews of financial statements for offerings up to $500,000, and audits of financial statements for offerings greater than $500,000
- The regs will raise the limit for securities offerings exempted under Regulation A from $5 million to $50 million, thereby allowing for larger fundraising efforts under this simplified regulation.
Yes, we’ll have to wait for the final SEC rule making before we know for certain how the new crowdfunding law will affect real estate investing. But I think it’s safe to say that the next several years will see a noticeable shift in favor of the savvy, individual investor.