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STATESIDE: Playing to the crowd

Last month, Mainstreet marked two milestones in its fundraising history. First, the Indianapolis-based senior housing developer held a final close on its first real estate fund, raising approximately $50 million from family offices and high-net-worth individuals. It also launched its first crowdfunding offering, seeking to raise $1.5 million for a new medical resort development in Bloomington, Indiana.

The Mainstreet Bloomington investment is identical in profile to the dozen projects in the fund, according to Scott White, chief operating officer. “This is an experiment for us,” he told PERE. “We’re testing to see if the same deal will sell in a different medium.”

Although small, the crowdfunding offering has larger implications for the firm. Within 24 hours of the Mainstreet Bloomington offering going live via crowdfunding website CrowdStreet, the developer had raised more than $200,000. “If we get a good reaction that we could raise money pretty quickly, we could raise some kind of fund or pool multiple deals in a fund format,” said White.

As a smaller-sized firm with smaller investors, Mainstreet appears to be an ideal candidate for real estate crowdfunding, which involves raising money through the Internet from accredited investors – individuals with annual incomes of at least $200,000 or net worth exceeding $1 million. Although the firm was founded more than a decade ago, Mainstreet is new to raising pooled funds, having previously collected capital on a deal-by-deal basis.

While the institutional real estate market largely has recovered, the ‘sub-institutional’ sector, traditionally comprising small local investors borrowing from commercial banks, still is lagging behind, observed Bonnie Burgett and John McDonald, then graduate students at the Massachusetts Institute of Technology, in their 2013 thesis, “Democratizing Commercial Real Estate Investing: the Impact of the JOBS Act and Crowdfunding on the Commercial Real Estate Market.” Therefore, “the sub-institutional market will be the likely sector to immediately benefit from crowdfunding,” the authors wrote.

Interestingly, Burgett and McDonald went onto start their own real estate crowdfunding platform, SourcedCapital, which officially launches next month. “I think that a lot of people in the larger, more institutional space are not as immediately attracted to this method,” said Burgett, who will be chief operating officer at SourcedCapital. Still, “the notion of raising capital online is not going away.”

Burgett pointed to peer-to-peer lending platforms such as Prosper and Lending Club, which initially were the domain of individual investors but increasingly have been attracting hedge funds and other large institutions. “Something similar could happen for crowdfunding in the real estate space,” she said. 

Meanwhile, real estate crowdfunding platforms have seen explosive growth in the past year. When Burgett and McDonald first began talking about starting their own business in February 2013, there were only two other real estate crowdfunding groups, she noted. By the time they began working on their platform last September, there were close to 15 platforms.

It’s important to note that, although the typical real estate crowdfunding offering raises fairly small amounts of capital compared to a traditional real estate fund, many have the capacity for larger equity hauls. While Title III of the JOBS Act allows companies to raise a total of no more than $1 million through crowdfunding offerings each year, it actually is not yet legal since the US Securities and Exchange Commission has yet to propose rules to implement the provision.

Instead, SourcedCapital and other crowdfunding platforms, such as RealtyMogul, are said to be using Rule 506(c) under Regulation D of the Investment Company Act. That provision has no limit for how much can be raised through a private offering.

Not that large offerings necessarily will become a regular occurrence on real estate crowdfunding platforms. “If you’re running a $1 billion fund and things are going okay, I can see why they’d be a little resistant to change,” McDonald acknowledged.

Even some smaller groups aren’t yet convinced. For example, Drum Hill Partners, a New Canaan, Connecticut-based real estate developer, is planning to raise its first commingled real estate fund in the near future but isn’t opting to use crowdfunding at the present time. One disadvantage of crowdfunding is the lack of personal contact between the LP and GP, said Greg Fieber, a principal at the firm. With a traditional real estate fund, “you’re getting an in-person, up-and-close meeting,” he said. “It’s really important to fully understand the people you’re getting into bed with.”

Fieber also noted that it could potentially be difficult to raise a large real estate fund through crowdfunding because of the significantly smaller minimum investments – typically $5,000 to $10,000 – as compared with traditional real estate funds, where minimum investments generally are in the hundreds of thousands of dollars. Additionally, “crowdfunding also may dilute the brand a little bit, as it brings down the exclusivity of the actual fund,” he said. “It reduces the cachet.”

Very broadly speaking, crowdfunding appears best suited for smaller, less established property firms and existing managers that may be struggling to raise capital, although there are clearly exceptions to every rule. And in the case of crowdfunding, the rules – literally and figuratively – are still being written.