For the past three years, I have been following the real estate crowdfunding sub-sector and have been excited about the potential for growth thanks to advances in technology, changes in investor preferences, and policy reform. I have always felt the startups that ultimately win this market will possess amazing access to deal flow and an extremely savvy management team that is skilled in real estate, technology, and public policy. After reading an article from Mattermark entitled, “Read The Fine Print Before You Turn To Equity Crowdfunding,” and conducting my own research on the JOBS Act’s Title III equity crowdfunding provision, I felt the need to share my thoughts on the provision and the implications it has on the future of real estate crowdfunding market before the roll out of the law on May 16, 2016. Below are summaries on I) My Prior Opinions on Real Estate Crowdfunding Market, II) Title III of the JOBS Act and lastly III) Title III Implications on My Real Estate Crowdfunding Investment Thesis.
I. My Prior Opinions on Real Estate Crowdfunding Market
When I started blogging about tech startups and venture capital opportunities “in earnest” (I promise no pun intended) in November of last year, I identified the real estate industry as one that was primed to be disrupted by tech-enabled businesses for the next five years. In my second post, “Location, Innovation, & Optimization,” I recognized the key driver of my bullish call on the CREtech industry as being technologies ability to quickly provide access and transparency to data.
I went on to write in “It’s Crowded in Here” about the CREtech’s crowdfunding sub-sector market opportunity thanks to market trends caused by the intersection of the real estate, banking, technology, and public sectors. I felt that the space was ripe for disruption thanks to distinct market opportunities and challenges highlighted below. (Note: I’ve bolded the concepts that are impacted by the launch of Title III regulation)
- Antiquated Banking Practices: Many banks and financial institutions follow underwriting guidelines that do not meet the needs of bridge loans for small to medium-sized real estate developments
- Advantages of Crowdfunding: Peer to Peer marketplaces use tech to make loans simple & fast; seamless technology also reduces lead times need by banks for closing deals
- Access for Passive Real Estate Investors: Crowdfunding provides diversification and insider access to private transactions that were historically limited to personal network
- JOBS Act Impact: In 4Q15, the SEC adopted rules to permit individuals (both accredited and non-accredited) to invest in securities-based crowdfunding transactions based on certain investment limits
- Regulatory Changes: Although the JOBS Act opened the opportunity for a “democratization” of equity, there are still regulatory pressures that limit a larger investor pool; successful start-ups need to be well versed in the regulation to take advantage of the opportunity
- Outsider Network for Deal Pipeline: Tech enabled services have usually disrupted industries by leveraging their “outside perspective.” However in RE space, one obstacle is breaking into the network. For startups to create value in this industry, they need to provide good deal flow and, therefore, need a strong network in the industry
- Lack of Awareness from Established Real Estate Community: Sponsors and Investors may lack awareness of RE crowdfunding platforms; it’s something new and current real estate professionals might not understand the use case for lending platforms
II. Title III of the JOBS Act
On May 16th, one of the most contested provisions of the JOBS Act will be set in motion. Title III of the JOBS Act, will allow for the first time in our country’s history unaccredited investors the opportunity to invest in private companies. So in mid-May, the democratization of equity will finally come to fruition and opportunity for all will be right at everyone’s fingertips, right? Not so fast Bernie Bro.
With all regulatory efforts, there will be some (or a lot of) strings attached. The proverbial string, in this case, is that companies who opt in for Title III fundraising must comply with regulatory filing requirements and incur overhead costs far above and beyond those applicable to existing forms of fundraising. If a startup raises money under Title III, “the startup is subject to GAAP accounting, which requires reviews by public accounting firms, in some cases auditing by public accounting firms, as well as additional disclosures, compliance, and filings” (according to Mattermark article). The accounting requirement will not be a one-time cost, but an annual recurring cost.
The intentions of democratizing equity in private companies will more than likely not be reached thanks to the likely adverse results of Title III. For entrepreneurs, the adverse implications include higher operating costs (thanks to the required accounting standards) and the SEC standard that once a company reaches 500 unaccredited shareholders and $25 million in assets, it will be forced to go public. This issue will likely cause sophisticated venture capitalists and angel investors to shy away from startups that have conducted Title III fundraising rounds.
III. Title III Implications on My Real Estate Crowdfunding Investment Thesis
Given the strings on the opportunities presented by Title III it is important that management teams think carefully about their strategies for product offerings for the unaccredited investor target market. I still believe that companies in the real estate crowdfunding space that are the captains of industry five years from now will have taken full advantage of this policy by meeting the needs of customers, real estate development firms, and their own investors.
Venture Capitalists that cover this industry should look for startups that have a strong expertise in public policy and are constantly testing the regulatory standards in a creative manner. I would imagine that startups could develop small micro E-REITs for the unaccredited investor group that features quality risk/reward development projects that are under the $1M limit. With small micro E-REITs, startups could get around the regulation that limits a startup to 500 investors with a $25M in assets. Those startups that have platforms that will only feature large commercial real estate development projects may simply never decide to introduce a product offering for unaccredited investors.
Ultimately, I think the Title III provisions for equity investing has made it more difficult for any new entrant to garner sufficient market share in the unaccredited target audience. However, I do believe for the right team with the right deal pipeline there is an amazing opportunity to take advantage of the market conditions.
What do you think? Feel free to share with me your thoughts in the comments section on the implications of Title III on the real estate and traditional crowdfunding landscapes.
Earnest Sweat is a Startup Adviser that specializes in mentoring startups within the fin tech, ed tech, and real estate tech sectors. If you have any questions, comments or requests please connect with Earnest through LinkedIn, Twitter, or AngelList.
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