Legality of Crowdfunding Real Estate

More and more investors are looking into crowdfunding real estate. After all, it presents them with a lot of opportunities to own attractive real estate. What is this setup? Basically, it’s like your usual crowdfunding initiative wherein an initiative is set up after an idea has been established. You then wait for investors to support your initiative until you reach the targeted funds. You’ll then use these funds to execute the idea. Simply put, it’s pooling your resources together with other people so you can buy real estate.

An Example of Crowdfunding Real Estate

Let’s say that one investor stumbles upon a real estate investment that’s a possible winner. Unfortunately for him, it’s way outside his price range at $100,000. This investor can then come up with an idea on how to make money out of this investment. Once that’s established, he can try to sell this idea on a real estate crowdfunding site by setting up an initiative. On this site, other investors can pool their resources together so they can buy the real estate.

As a simple math, 10 investors can invest $10,000 each so they can invest on the real estate. With this computation, it’s easy to see why it’s gaining a lot of traction in the industry.

But is it Legal?

This is a valid question because this setup is really very different from how investors have been investing in real estate for years. This is why a lot of people are wondering if this is a legal way of investing in real estate.

The short answer to that question is yes, it is legal. However, there are several legalities involved. If you’re looking to join or start an initiative, it’s important that you’re aware of these legalities.

Legalities of Real Estate Crowdfunding

Before, it’s illegal for developers to market their projects to the public. This means that these investment opportunities were only made available to private equity firms and investors with a high net worth. Now with the JOBS (Jumpstart Our Business Startups) Act, it’s a thing of the past.

This is a law implemented in the US to funnel funds to small businesses. This is encouraged by means of the facilitation of securities regulations. This initiative is designed to help two communities. In addition to the startup community, it’s also designed to help the crowdfunding community. In addition to facilitating the sale of securities, it also legalizes it. The sale of securities is used for crowdfunding.

With this law, developers can now market their projects to investors that are accredited. In order to be accredited, the investor should have a net worth of $1,000,000 or more (excluding the house) and a yearly income of $200,000 or more.

However, developers can also market their projects to investors that are not accredited, provided that they make an investment that’s within the limit. Here are the limits:

  • If both your net worth and income are less than $100,000:
  • You can invest $2,000 or,
  • 5% of either the net worth or annual income, whichever is higher.

An investor can invest the greater amount between the two options. Let’s say that an investor has an annual income of $50,000 and a net worth of $85,000. The investor can invest $2,000 or $4,250 (5% of the net worth since the net worth is higher than the annual income). With this, the investor can invest $4,250 since it’s higher than $2,000.

  • If your net worth or income is over $100,000, you can invest up to 10% of your net worth or income, whichever is higher. Let’s say that you have an annual income of $50,000 and a net worth of $200,000. You can invest up to $20,000, which is 10% of your net worth since it’s higher than your income.

The Initiative has to be Started and Completed Using a Registered Broker-Dealer or Portal

First of all, you can’t just set up a website and post your crowdfunding initiative there. Also, you can’t use just about any crowdfunding portal, even if it’s the highly-popular Kickstarter. You need to use a portal that is registered with FINRA or SEC and it has to be registered as a portal for crowdfunding real estate.

Speaking of FINRA, they’re expected to issue rules that will administer the registration and conduct of brokers-dealers and portals as far as crowdfunding real estate is concerned.

Rules for Registered Brokers-Dealers and Portals

In addition to the need for registration with the SEC or FINRA, brokers-dealers and portals should also follow these rules set by the JOBS Act:

  • Disclose all the potential risks as required by the SEC.
  • Guide investors to ensure that they complete the requirements set by the SEC when it comes to investor education.
  • Set up anti-fraud measures like doing background checks.
  • Ensure the privacy protection of investors.
  • Oversee the investors’ investments to make sure that they’re not investing over their limit.
  • They shouldn’t compensate anyone for bringing investors in.
  • Make sure that their own key people don’t invest in opportunities offered in their platform.

As real estate crowdfunding gains more traction, it’s expected that more rules will be implemented in the future.

File photo of the SEC seal in Washington

SEC Requires Previous and Fundamental Business Relationship Before an Investor Can Invest

The SEC has made it clear that interested investors need to have a previous business relationship that is substantive before he or she can make an investment. This will apply with something such as the customary rule 506 offering, wherein the one offering the investment presents an offering that doesn’t permit advertisements to the public.

What is a Previous and Fundamental Business Relationship?

This is a relationship between the one issuing the investment and the one potentially making the investment. This is a very important consideration before an investor can invest because the SEC is careful not to allow violations to the securities laws to happen. According to this Real Estate Crowdfunding Article, there is 2 main regulations – 506(b) and 506 (c).

What is the SEC looking for? They’re looking for public advertising that violated the aforementioned securities laws. They’re ramping up their efforts to pinpoint violations especially since they’re under heavy criticisms for combining several ideas into one as far as a previous relationship is concerned when it comes to the absence of public advertising.

What Makes the Relationship Substantive?

For the previous business relationship to be considered substantive, the relationship should be of importance. This means that the previous relationship should have meaning and consideration. This allows the SEC to have a firm basis as to whether there really is a previous business relationship.

All About Rule 506

This rule is the “Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering”. The SEC made a vote proposing changes to Regulation D under the Securities Act so they can add Rule 506(c). This rule makes offerings private placements that can only be offered to investors that are already accredited.

“Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering”

But under this new amendment, advertisements can be made on a wide scale basis. Advertisements can be done on popular media such as newspapers and TV. More importantly, advertisements can be made online as well.

SEC Clarifies Ways to Show the Lack of Solicitation

There’s confusion as to whether the presence of a previous business relationship is more than enough to show that no solicitation has been made. The SEC clarified that the presence of a previous business relationship is not enough to prove that no previous solicitation has been made. In fact, the SEC said that this previous relationship can be established by these two things:

  1. Utilizing an investor questionnaire before presenting any offer to an eligible and possible investor.
  2. Waiting for “enough time” to pass between the time when the questionnaire was returned and the investment is made.

Why do both parties have to wait? This is meant to protect potential investors. This way, an investor will have more than enough time to consider everything without feeling bullied by the one offering the investment. This time is meant to be a cooling-off period so that the investor will have the chance to take everything into consideration and look at the pros and cons of the investment without the “you have to invest right now” pressure often employed by overenthusiastic offerors.

How Much Time is Needed?

Regrettably, there is no clear idea on how many days are considered to be adequate for the cooling-off period.

According to one letter by the SEC, it was indicated that a 30 day period is enough.

According to one letter by the SEC, it was indicated that a 30 day period is enough.

However, it’s important to note that there are some instances wherein specific requirements are given. As an example, an offeror doing business in California must give a copy of “A Consumer’s Guide to Small Business Investments” to all probable investors 5 days at the very least before an investment can be made. Also, this is to avoid a state merit review. Unfortunately, most of the types of offering don’t have any precise requirements.

Best Practices in the Absence of a Prior Business Relationship

Just to summarize, here are the things that should happen in an ideal setup:

  • The offeror would wait for a 30 day period to lapse. This period will start as soon as the offeror receives the questionnaire completed by the potential investor. The investor should sign the subscription agreement after completing the questionnaire.
  • In areas wherein this is not practiced, the one offering the investment should exert all efforts to establish a good relationship among all potential investors.
  • It is also recommended to wait for 5 days after the potential investor receives the private placement memorandum or similar disclosure agreements until the investor signs the subscription agreement.
  • The offeror should give the investor time so the investor can study the private placement memorandum. Once the investor has had enough time, the offeror should send an email offering guidance just in case the investor has any questions. Both parties should save the email conversations.

When these practices are followed, the investor would be able to make a very educated decision on whether he or she should invest or not.

By Jake Collins

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A Complete Guide to Crowdfunding Real Estate

Crowdfunding is one of the latest trends online, and a lot of people are surprised that even one of the oldest industries around, which is real estate, is being crowdfunded as well. But before joining in on the bandwagon, it’s important that you know at least the basics about it so that you’ll know what you’re getting yourself into. At the very least, it will give you an idea as to whether it’s an opportunity that you should grab or not.

What is Real Estate Crowdfunding?

Basically, it’s putting together a group of investors and using their money in order to invest in real estate. Crowdfunding is a popular way of raising capital, and with the money that’s being made in real estate, it makes sense to start this practice in the real estate industry as well.

Crowdfunding is a popular way of raising capital

What Makes it Different from Normal Fundraising?

For countless of years, most real estate investors approach banks and/or investors so they can pitch their idea and get the funding necessary for them to execute their idea. So if an investor wants to invest in a prime piece of land, he would have to approach banks and/or investors and let them know what he’s planning to do with the land. Simply put, the investor needs to sell his idea on how he can make money out of the investment so he can pay back the loan.

On the other hand, the process becomes simpler and easier with real estate crowdfunding. It all starts with an idea. Once an investor has an idea for a real estate investment, he will set up a crowdfunding initiative. The goal of this initiative is to find like-minded individuals who believe in the idea of the one that started the initiative. Once the goal of the initiative has been reached, the funds will then be available so the idea can be executed.

Benefits of this Setup

Here are the benefits of real estate crowdfunding:

  • You can own a prime piece of real estate with just a little amount.

To give you an idea, an investor just needed to invest at least $10,000 to get a piece of the action for a shopping center.. This is very different when it comes to traditional real estate investing wherein you need to have at least $100,000 in funds to make a significant investment.

  • You get access to potential investments that normally wouldn’t be made available to you.

This applies to prime real estate that you wouldn’t have heard about without a crowdfunding initiative. If you’re not a traditional real estate investor, you wouldn’t even know about these opportunities. With this setup, you can simply browse through the available opportunities.

  • It’s very easy.

This is especially true if you use a trusted site. You’ll be given the tools needed to make an easy investment. It’s so easy that you’ll feel like you’re making an investment in stocks.

  • It’s very convenient.

Everything is done online – from the support generation to the funding. Even documentations are usually online. This is a huge thing considering the fact that real estate has always been behind when it comes to technological advancements.

  • You get to network with like-minded individuals with the same investment ideas.

Instead of looking for supporters for your ideas, with real estate crowdfunding, you just need to find ideas that you can support. Since investors will be funding an idea, you can be sure that you’re investing with like-minded individuals that share the same ideas with you as far as real estate investments are concerned.

In the traditional way of investing in real estate, networking is very hard, as investors are competing with one another to find the best investment opportunities.

With real estate crowdfunding, you actually get to team up with other investors.

What Type of Opportunities are Available?

As early as now when this setup is just gaining traction, a lot of opportunities have been made available already. You can invest on some of the best opportunities including the following:

  1. Retail locations
  2. Self-storage facilities
  3. Residential properties
  4. Mobile homes
  5. Hotels

Soon enough, more and more investment opportunities will be made available.

How Secure is this?

Real estate crowdfunding sites have measures in place to ensure the preservation of the integrity of real estate investing. Some sites and companies have a software wherein they run each and every investor through to ensure that they will be good investors. Interviews are also done over the phone with potential investors.

The Future

The future is bright for real estate crowdsourcing. With more and more investors coming in because more and more investment opportunities will be made available, one can expect to have better setups in the future.

Also, with the soon-to-be passed JOBS Act and the Crowdfunding Rules, one can expect a better industry as far as crowdfunding real estate is concerned.

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