Crowdfunding IPO for mortgage REIT launches for non-accredited investors

IPO is the first of its kind and, with low fee, could attract investors away from nontraded REITs

Dec 3, 2015 @ 7:00 am

By Jeff Benjamin

Investment crowdfunding, which is already dominated by real estate-focused platforms, is now taking a swipe at the nontraded REIT market with the first-ever crowdfunded real estate investment trust for retail-class investors.

Fundrise, a real estate crowdfunding site that has raised $100 million through more than 75 offerings over the past 18 months, started selling shares of its Fundrise eREIT on Thursday.

The mortgage REIT, which has a $1,000 minimum investment and a 1% annual fee, is the first product of its kind to earn approval from the Securities and Exchange Commission for sale on a public crowdfunding platform to Main Street investors.

“This makes complete sense because a REIT is perfect for crowdfunding,” said Mark Roderick, an attorney specializing in crowdfunding regulations at the law firm of Flaster Greenberg.

“The REIT market is extremely inefficient, laden with middlemen, and infamous for being very expensive and non-transparent,” he added. “When you can directly connect buyers and sellers, and get rid of all the middlemen, who would pay a 10% load in addition to all the other fees when you get the same thing through crowdfunding for a 1% or 2% annual fee?”

FIRST OF ITS KIND

The Fundrise eREIT is the first such product to emerge as a result of the SEC's June 19 passage of a specific provision of the 2012 JOBS Act, which allows for crowdfunded public offerings of up to $50 million to non-accredited investors.

In October, the SEC approved an additional part of the JOBS Act that will take effect early next year and allow retail-class investors access to crowdfunding offerings capped at $1 million, and include less regulatory scrutiny.

“We filed our prospectus on the same day of the SEC's (June) decision, and we were cleared to move forward last week,” said Ben Miller, Fundrise co-founder and chief executive.

Similar to a nontraded REIT, the Fundrise REIT will not be traded on an exchange, and liquidity will be limited to quarterly, meaning investors will be able to sell their shares four times a year. The portfolio, which will be constructed as investor dollars come in, will include mortgage instruments that are already on the Fundrise platform as separate crowdfunding investments.

For at least the first two years, the REIT's 1% management fee will be waived if the fund doesn't meet a 15% annualized rate of return.

Citing quiet-period restrictions prior to Thursday's IPO, Mr. Miller would not comment on why the hurdle rate was set at such a high level, especially when the 10-year Treasury bond is yielding less than 2.2%.

MORE DEMAND THAN SUPPLY

“It's a new model, but our expectation is there will be more investment demand than supply of real estate,” Mr. Miller said.

It's a bold statement, but it is also supported by some strong momentum.

Of the 1,269 investment crowdfunding platforms worldwide, 300 are individual-property real estate investing platforms based in the United States.

“Real estate is one of the targeted asset classes that will benefit from crowdfunding, because people can relate to the asset class,” said Oscar Jofre, founder and president of KoreConX Corp., which helps companies navigate the regulatory and due diligence process of listing on crowdfunding platforms.

After real estate, Mr. Jofre said the most popular crowdfunding investment categories are biotechnology and marijuana.

Globally, he said, $65 billion was raised on crowdfunding platforms last year, including $18 billion in United States, which is behind Europe because crowdfunding has only been approved for investing purposes in the U.S. since 2013.

Momentum notwithstanding, financial advisers are likely to take a wait-and-see approach before rushing into a crowdfunded REIT.

“Real estate is interesting because it is an investment that many people feel they understand better than stocks or bonds, but when it comes to real estate crowdfunding, it's still early days,” said Chris Chen, a wealth strategist at Insight Financial Strategists.

Even though he recognizes the layers of fees and other challenges that come with nontraded REITs, Mr. Chen believes those fees also represent some kind of due diligence support.

MORE HISTORY REQUIRED

“The recent history of nontraded REITs is less than glorious, which reinforces the point that better due diligence is needed,” he added. “I think crowdfunded REITs do have promise, but more history is required.”

Further, Mr. Chen believes the low minimum investment for a crowdfunded REIT might lead investors to take an even more casual approach to the whole process.

“How much due diligence is somebody going to put into a $1,000 investment?” he said.

Tom Balcom, founder of Custom Wealth Management, called the concept of crowdfunded REIT “interesting, but not something I would bet the farm on, or advise my clients to put a chunk of money into.”

But as Mr. Roderick explained, the real estate asset class and the REIT structure represent the ideal marriage of a crowdfunding success story.

“A REIT is just a tax animal, it's a not a real estate or securities law animal, and crowdfunding is just using the Internet to raise capital,” he said. “The real question is whether you can find investors for a private REIT using crowdfunding, as opposed to paying a lot more fees going through broker-dealers, and I think the answer is yes.”

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