Changes to Title II of the JOBS Act — Jumpstart Our Business Startups — may prove beneficial to real estate companies using a crowdfunding model, though most seem to be sticking with the previously accepted solicitation rules for now.
The outlook on Title III’s effects on the real estate industry is grimmer.
David Manshoory, CEO and founder of Asset Avenue, a new real estate crowdfunding platform, said his company is leaning toward using the existing 506(b) model of Title II, and doesn’t foresee Title III being widely used in the real estate sector.
“I think it’s going to be cost prohibitive, with respect to the real estate industry, to work with unaccredited investors, based on the pending legislation right now,” Manshoory said at the Crowdfund Global Expo last week at the San Diego Convention Center. “I’ve also talked to a lot of accredited investors who do not want their money pooled together with unaccredited investors … So I see capital-raising from unaccredited investors for real estate being a long shot.”
Jilliene Helman, founder and CEO of Realty Mogul, another real estate crowdfunding site, said Title III crowdfunding for unaccredited investors would be unworkable for real estate, but added that she wouldn’t be surprised if the Securities and Exchange Commission notched out a separate document specifically for this industry.
She said her main issue with the existing rules is the $1 million cap on investment under Title III.
“We’re capitalizing real estate transactions that are $15 million, $20 million, $25 million, $100 million transactions, and if you’re limited to $1 million, it’s cost prohibitive and timing prohibitive and marketing prohibitive,” Helman said.
Yet these real estate executives and others said the changes to general solicitation rules under Title II, which allows for the general solicitation and advertisement of specific deals, might bring more realistic change in the long term, though most are still sticking with a 506(b) model at present.
Manshoory explained that under the existing 506(b) model, crowdfunding real estate firms are able to advertise their companies in general terms, so long as no specific deals are mentioned.
Potential investors must go to the company’s site, self-certify that they’re an accredited investor, and typically wait out a 30-day cooling period before seeing specific deals, unless the investor had a pre-existing, substantive relationship with the issuer.
Under the new 506(c) model, companies are able to advertise specific deals to entice potential investors, but many say the price for that privilege is too steep.
“The SEC is basically saying ‘OK, let’s take it a step further — you not only want to advertise your company, but you actually want to entice someone by showing them a deal,’” Manshoory said.
“So I can go online, I can go on the radio and say, ‘I’m buying 123 Main St., Mr. Investor, come to my website because this is a great asset for you to invest in.’ The SEC read this as general solicitation, but in exchange for letting you entice someone with a specific deal, you now, as the website or the portal, need to take additional steps to actually verify that they’re an accredited investor.”
The SEC hasn’t detailed what, exactly, those steps should entail, but examples included tax documentation or bank statements as a way to verify the necessary income or net worth of more than $1 million.
Manshoory said there is hesitance on the part of high-net-worth individuals and potential investors to release this information, but DJ Paul, chief strategy officer at Gate Global Impact and the co-chairman of Crowdfund Intermediary Regulatory Advocates, said the documentation needed is essentially what’s required to open a bank account these days, and predicted this hesitancy would dissipate in a matter of months, as opposed to years.
Still, Realty Mogul and most probably Asset Avenue will stick with 506(b), Manshoory and Helman said.
“Right now in our company we see some challenges to 506(c),” Manshoory said. “There are obviously pluses and minuses to both, but we’re leaning toward a 506(b) model until we really see enough investors with respect to the real estate industry embracing this idea of opening up their financial returns and documents and sharing it with the company to invest in a deal.
"For decades, investors have not had to do that because they’ve been able to go the traditional 506(b) route and self-certify, so we’re leaning toward 506(b).”
And that model has worked well. Realty Mogul has crowdfunded 55 real estate properties since its launch in March 2013, although these deals often involve other, more traditional offerings as part of the final package. Helman said she has found that this investment option fills a void for high-net-worth individuals’ portfolios.
“The No. 1 thing that we focus on and a lot of feedback we got from investors is this need and appetite for current yield and current cash flow,” Helman said. “So at Realty Mogul, we focus exclusively on income-producing assets or debt assets that can pay an interest payment every 30 days.
“The void in the market that we fill is this ability for them to get access to direct real estate investments that have the opportunity to produce current income and current cash flow. But investors have expectations — we’re usually shooting for 8 to 10 percent cash-on-cash returns.”
Steven Cinelli, CEO of Primarq, also emphasized the value of diversifying portfolios via crowdfunded real estate, as well as the added benefit of access to residential real estate.
“If 90 percent of your net worth is tied up in your home equity, wouldn’t it be nice to sell 20 percent of it and stick it in your retirement account?” Cinelli said. “You wouldn’t want all of your eggs in one basket. You wouldn’t want all your assets in a single stock or asset class.
“And on the investor side, it gives them more access to residential real estate, which is something that’s not readily accessible.”
So while Title III has a ways to go before it affects the real estate industry, Title II’s modifications seem to pose a more immediate possibility for change.
"We're always looking at what's going on in the regulations to see if we're going to make a shift to our business, and there will be a time where we do," Helman said. "There will be a time and place where I think it makes sense to go out of general solicitation and general advertising, but for us, 506(b) has worked very, very well."