Real Estate Crowdfunding – Navigating the Securities Laws
Real estate is one of the largest asset classes available to investors. However, with some limited exceptions, it is an asset class historically dominated by institutional and high-net worth investors due to high minimum investments and transaction costs, regulatory restrictions and ongoing operating costs.
Crowdfunding has the potential to open up the real estate investment market to a far wider pool of investors, and in turn, provide developers and sponsors with an easily accessible alternative source of financing.
Crowdfunding generally refers to raising capital for a specific project or venture in relatively small amounts from a large number of investors utilizing the internet and social media. The crowdfunding market has been expanding quickly with over $16 billion raised globally in 2014. Within the real estate sector, crowdfunding grew by 156% in 2014, just breaking the $1 billion mark, and the expectation is that real estate crowdfunding will surpass $2.5 billion in 2015.
Like most capital raising activities, crowdfunding requires compliance with various state and federal securities laws. Likewise, many of the same registration exemptions available under applicable laws and regulations for securities offerings in general (and exemptions recently enacted specifically for crowdfunding) are available to permit developers or sponsors (“issuers”) to raise capital through crowdfunding. Summarized below are the primary regulatory registration exemptions employed by developers and sponsors in raising capital for real estate investments through crowdfunding.
- SEC Rule 506(b)—U.S. Securities and Exchange Commission (SEC) Rule 506(b) of Regulation D allows the issuer to raise capital from “accredited” investors and up to 35 non-accredited investors. An accredited investor is generally defined (with regard to individuals) as a person with a net worth (or joint net worth with the person’s spouse) of $1 million at the time of the investment, or an individual with an annual income of more than $200,000 (or joint income with the person’s spouse of more than $300,000) in each of the last two years. Investors will usually be asked to certify in a questionnaire that they meet the criteria to be considered accredited.
Rule 506(b) requires that the non-accredited investors who participate be given substantial disclosure and information regarding the investment (including financial information, a description of the business that is the subject of the proposed investment, and other material information). Under Rule 506(b), an issuer is prohibited from making a general solicitation seeking investments or conducting advertising regarding the investment (including print advertisements, articles, TV or radio broadcasts, or internet advertisements). Certain qualified investors can receive promotional information regarding the offering on a password-protected page of the issuer’s website, but clearly the limitations on advertising make 506(b) somewhat challenging to use crowdfunding for marketing an investment opportunity.
- SEC Rule 506(c)—SEC Rule 506(c) of Regulation D permits offerings made to accredited investors only. As a result, the scope of potential investors in Rule 506(c) is more limited than 506(b) offerings. However, since the offerings are limited to accredited investors who are presumed to have a certain level of investment sophistication, unlike under Rule 506(b), the issuer is permitted to engage in general solicitation and advertising the offering. Since general solicitation is permitted, issuers are required to take steps to verify that all participating investors are accredited. The Rule does not prescribe the specific steps that must be taken, and they may vary depending on the situation, but often the issuer will need to review supporting documentation from prospective investors (and counsel should be consulted in advance to analyze the level of verification that is warranted for a specific offering).
- Regulation A Offerings---Under Regulation A (sometimes casually referred to as “Regulation A+” since its most recent amendment) adopted pursuant to the JOBS Act, two new classes of offerings are available to issuers and investors.
- Under Tier 1, an issuer is permitted to raise up to $20 million in any 12-month period. Offerings are not limited to accredited investors and anyone can participate. The issuer, however, must file an offering document (called a Form 1-A) with the SEC that describes the issuer and the offering in detail. Unlike under Rule 506(b), issuers are permitted to make general solicitations.
- Under Tier 2, an issuer is permitted to make offerings of up to $50 million in any 12-month period. As with offerings under Tier 1, both accredited and non-accredited investors can participate. However, a non-accredited investor is subject to a cap on how much he or she may invest in the offering (no more than 10% of the greater of an investor’s income or net worth). The issuer is required to make a Form 1-A filing with the SEC and is permitted to make a general solicitation
- Proposed “Crowdfunding” Regulation—The SEC has proposed new rules that, if enacted, would permit a new class of smaller offerings conducted over the internet. The proposed Regulation Crowdfunding under Section 4(a)(6) of the Securities Act of 1933 would allow issuers to make up to $1 million of offerings in any 12-month period under the rules. Both accredited and non-accredited investors can participate, but all investors in this type of offering will be subject to caps on the amount they can invest, based on their income and net worth. The novelty in this new type of offering is that an issuer will be required to use a single intermediary to conduct the offering (such as a broker or web funding portal) and the offering must be conducted over the internet. As with some of the other types of offerings, issuers will be required to file offering documents with SEC describing the issuer and the proposed investment.
It is certainly not surprising that the capital raising marketplace is starting to take advantage of the vast reach and economic efficiencies of the internet, as witnessed in so many industries. The use of the internet to raise capital for real estate investments through crowdfunding offers developers and sponsors the ability to raise funds in smaller denominations and, accordingly, provides access to investments in specific real estate projects or ventures to a considerably larger pool of potential investors. However, securities laws are complex and rapidly changing, and no offering should be undertaken – by means of crowdfunding or otherwise – without appropriate legal review to ensure compliance with applicable federal and state securities laws.
 Massolution’s 2015CF-The Crowdfunding Industry Report
 Massolution’s 2015CF-RE Crowdfunding for Real Estate Report
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