Prior to 2012, investing in commercial real estate was for the very wealthy. Smaller investors had limited options to participate directly in commercial real estate deals such as multi-family apartments, student housing, retail centers and offices.
That all changed on April 5, 2012 when President Barack Obama passed the Jumpstart of our Business Startups Act (JOBS Act). While there were many components of the JOBS Act with significant changes to regulations, in this blog post, we provide a simple overview on the opportunity this opened up for smaller investors to participate in crowd-funding of real estate deals but also highlight the risks.
JOBS Act in Less Than 100 Words
The JOBS Act reduced the regulatory burden for smaller companies to raise capital. To encourage economic growth, the Act enabled the creation of crowdfunding platforms to publicly raise investment capital. This included 1) increasing the number of options for offerings to be exempt from SEC registration and 2) permit issuers to use general solicitation and advertising to offer their securities as long as they take reasonable steps to verify that an investor is considered an accredited investor.
To learn more about accreditation requirements, take a look at our blog post on Accredited Investors.
Crowdfunding Real Estate
Over the next 5 years after the JOBS Act, a large number of online real estate crowdfunding platforms emerged. The platforms played an intermediary role between real estate deal sponsors and investors. Today, there are over 100 different online real estate crowdfunding platforms that raise capital from investors to participate in commercial real estate deals. Commercial equity real estate deal minimums have dropped significantly. Today, an investor can participate in a equity deal for as little as $25,000. While this is still a significant amount of capital for most investors to place in a single equity deal, it is quite a bit lower than before the JOBS Act. Real estate debt investments have lower deal minimums. Investors receive fixed income for participating in the "banking" of a loan with a fixed interest rate.
Crowdfunding opened up the door for small investors to participate in complex real estate deals but created a new dilemma.
Crowdfunding is just that - "crowd" and "funding". The focus in on quickly raising capital from investors. There are a large number of crowdfunded deals available across many different platforms. How does an investor assess the quality of any deal. Every deal comes with Private Placement Memorandums (PPMs), Operating agreements, financial analyses and market analyses.
In speaking with many investors, we find that most get attracted by the marketing materials but prefer not to read the PPMs or assess the quality of the financials on the deal. They get attracted by eye catching Internal Rate of Returns (IRRs) on the deals that show 25% annualized returns. The reality is that commercial deals do fail and investors can lose all their capital.
So how does an investor assess these complex deals?
Don't Jump From the Deep End if You Cannot Swim
Commercial real estate investing is not simple. Just like you would not jump from the deep end of the pool if you could not swim, don't invest large amounts of capital in a single deal only to see it fail a few years later.
If you do chose to participate in these direct offering deals, seek help. Find someone with knowledge in commercial real estate and invest by their side. Learn how they made their decisions on which deals to invest in. Once you feel comfortable that you can tread on your own, then start moving to the deep end of the pool.
Commercial real estate investing is a great way to diversify your portfolio beyond the stock market. But just like the commodities market or Forex market, learn to swim first.