Thursday, January 23, 2014

Crowdfunding: Changes and Impact on CRE

Crowdfunding is the collection of funds from multiple parties to finance a particular project or venture. I concluded by stating that technological and social pressures gradually rendered the regulatory regime from the 1930s obsolete and impractical. This forced the SEC to relax its once black-and-white advertising restrictions and turn them into a gray mess of guidance.
In 2012, Congress recognized this problem and finally put an end to the old advertising restrictions for private deals and created a regime for “crowdfunding.” The new regulatory framework would empower market participants on both sides of the equation, thereby providing much-needed relief to startups and smaller investors alike, removing some of the old barriers to entry and access to capital.
So, what precisely did the JOBS Act do? Here is an overview of the changes that are most likely to affect private real estate fundraising:
1. Gimme an “A”! New Reg.  “A+,” which was proposed by the SEC last December, would expand the scope of the seldom-used Reg. A and allow sponsors to raise up to $50 million in capital (currently capped at $5M) with a simplified registration process. Unlike current Reg. A, this new exemption would preempt state securities laws. This means sponsors would advertise and sell their deals in all 50 states without having to look up each state’s securities laws. The price to pay: registration and reporting with the SEC, investment limits (10% of investor’s net worth or income), and audited financials. The impact of this new rule on real estate will be highly dependent on the amount one hopes to raise. For smaller deals, it could be unworkable due to legal and audit costs.
2. For the ballers. Rule 144A offerings, which are limited to qualified institutional buyers (“QIBs,” which include financial institutions and other big players), can now be generally advertised. Perhaps market conventions will change, but don’t expect these sophisticated institutional markets to change radically anytime soon.
3. For the lesser ballers. Rule 506 offerings can now be marketed to the general public. The price to pay: issuers lose the ability to sell to anyone other than accredited investors ($200K in income or $1M+ in net worth) and have to verify that investors are in fact accredited. Bingo: as I will explain in future articles, this one is already changing market dynamics and is destined for glory.
4. For everyone else. Proposed crowdfunding regulations are exhaustive and cumbersome. For now, let’s just say that the impact of these regulations on real estate will likely be minimal due to the overwhelming complications that they bring (e.g. requirement to use a registered intermediary, yearly $1M limits per sponsor, audit requirements for offerings larger than $500K, and ongoing reporting requirements).
Stay tuned! I will expand on these new rules in future articles and explain how I see them affecting real estate fundraising in the years to come.

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