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Portals Positioning To Tap Small-Cap Crowdfunding Equity

Sep 9, 2013

Imagine buying a 4 or 5 percent stake in a small-cap retail complex undergoing a value-add repositioning by a local entrepreneurial asset manager - without ever actually speaking to another transaction participant from due-diligence to closing. Or even making an on-site visit for that matter.

While we're unlikely to see such syndications processed entirely sans human conversation or physical inspection for a few years, that's the general technological gist behind a growing number of officially registered online "portals" being established to facilitate crowdfunding of commercial real estate.

As MarketBeat reported last year after President Obama signed the Jumpstart Our Business Startups (JOBS) Act, loosened securities registration and online capital-raising regulations appear to hold plentiful promise for democratizing small-cap property investment in particular.

And given the roster of multi-disciplinary teams around the country registering portals linking project sponsors with individual investors, it's pretty clear a lot of savvy professionals believe deregulated crowdfunding can be a game'changer especially in the small-balance space.

Of course only time will tell whether crowdfunding ultimately proves to be an appropriate platform for real estate equity (or debt) syndication. The process includes a lot of moving parts - which must be coordinated with exceptional cost efficiency to effectively achieve financial goals of sponsors, investors and portal facilitators. And early financial disasters or feared fraudulent activities could spook the emerging marketplace.

Meanwhile, no shortage of pioneering portal teams with expertise in real estate investment and finance, as well as information technology and regulated capital raising, are already actively signing up project sponsors and registering accredited and even non-accredited prospective investors. While implementation of some of the JOBS Act-related rules already allows online solicitation to accredited investors (the highest-earning 2 percent or so), final publishing of additional pending rules will also allow several hundred non-accredited investors to participate in individual property syndications.

Although start-up teams are pursuing varying portal platform and financial models, it's pretty clear much of the early activity will entail syndicating ownership of small-cap income properties overseen by proven local operators. Indeed real estate brokerage and investment veteran Darren Powderly, a co-founder of the CrowdStreet Inc. portal based in Bend, Ore., expects that the bulk of projects his team syndicates will be valued in the $500,000 to $5 million range.

Sponsors seeking access to the investor capital pay portal fees to list their projects and take advantage of proprietary software technology, and in some cases closing fees at funding as well. While the CrowdStreet team is aiming to secure the bulk of its revenues from sponsors and avoid investor fees, other portal platforms seek closing commissions from investors, and in some cases annual maintenance fees also.

And at least a few portals will look to infuse internal capital and participate in some of the ventures they syndicate - even as a sponsor in some cases.

The successful portals will be able to efficiently process a profitable volume of activity online - which necessarily entails disseminating all manner of property and program details, sponsor backgrounds, pertinent market data, securities offering particulars and the like. The fundamental model entails specifying the sponsor's share pricing and minimum capital-raise target within a designated offering period, then escrowing investor commitments until the target is hit (or returning capital if the effort comes up short).

Other portals either already actively syndicating or signing up sponsors and investors include (in no particular order) Fundrise, iFunding.com, Realty Mogul, Prodigy Network, RealtyShares, RealCrowd and Crowd Funding Real Estate.

It's pretty clear much of the syndication activity will follow the traditional "waterfall" asset manager/investor financial model - with investors purchasing preferred shares allowing the sponsor a split of profits once designated return hurdles are achieved. In fact Realty Mogul analyzed 32 investment opportunities (totaling $375 million) submitted by 25 prospective sponsors over the past year or so, and noted that more than half of them specifically designated 8 percent as the preferred return rate (with sponsors typically seeking 20 to 30 percent of subsequent profits).

Realty Mogul and others are also tinkering with syndicating small-balance debt. In fact its first closed transaction raised $110,000 in first mortgage debt helping the sponsor buy and rehab a Los Angeles duplex.

For his part CrowdStreet's Powderly sees room for maybe a dozen active portals in the equity real estate crowdfunding era's early years - with successful investment programs no doubt helping determine the survivors. Hence no surprise that portals are taking pains to stress their meticulous "pre-vetted" sponsor due-diligence - with many specifying that just 2 percent of submitted projects will be listed. And as Powderly also notes, access to early-stage capital will likely be another herd-thinning factor.

"And we think investors will do their own vetting of sponsors" beyond the considerable information available through the crowdfunding portals, Powderly relates. Indeed the CrowdStreet team expects that relatively shallow-pocketed investors will look to secure pieces of properties in their own and surrounding communities, and alongside locally based developers they're familiar with or even know personally.

Powderly envisions a lot of crowdfunding capital raises initially in the $250,000 to $500,000 range, with individual shares priced in the $5,000 to $10,000 vicinity - although some projects may offer stakes of $1,000 or even less. But he also anticipates that some larger established sponsors might occasionally look to capitalize maybe 10 percent of a good-sized new project with crowdfunding equity, while also investing internal and partner capital and leveraging moderately.

And assuming the crowdfunding marketplace progresses, average share sizes will likely end up in the $25,000 to $50,000 range in coming years, Powderly anticipates. Or in some cases a developer of an institutional-grade high-rise might look to syndicate $100,000 shares to numerous accredited investors (non-accredited investor activities are limited by income levels).

Powderly is also quick to acknowledge that crowdfunding isn't likely to become a significant component of the CRE investment and finance marketplace - or even its small-cap sub-sector - any time soon.

"We're navigating uncharted waters here."



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