Crowdfunding platforms came on the scene shortly after the JOBS Act was passed in 2012. Intended to encourage small-business funding, the law provided opportunities for the public to participate in the early capital-raising activities of start-up and early-stage companies.
Prior to the passage of the Act, government regulations restricted private investments from being marketed publicly. Start-up companies and real estate private equity companies had to privately solicit funds through networking and relationship building with interested investors. As a result, commercial real estate investment sponsors typically raised funds for their projects by seeking large investments from a small number of private sources.
What Is a Real Estate Sponsor, and What Is Syndication?
The real estate sponsor, also known as the principal, is the owner of the asset and the party who raises the funds. The sponsor is the party that sources (finds) the deal and executes the purchase and operation of the property. Most importantly, the sponsor carries out the day-to-day operations of the asset and ensures that the business plan is executed.
Real estate syndication is the primary method by which real estate sponsors fund their real estate projects. At its core, a syndicated real estate transaction involves bringing a group of investors together to pool capital for investment in real estate (sometimes through crowdfunding). In exchange for their contributions, investors receive a membership or ownership interest in the company and expect to make a return on their investment.
How Crowdfunding Works In Real Estate Investing
After the JOBS Act passed, crowdfunding platforms created by technology specialists and real estate entrepreneurs became a new mechanism for real estate investment sponsors to get their deals exposed and funded by a huge population of online real estate investors. These online technology platforms created their own marketplace where real estate sponsors can post their opportunities and individual investors can easily invest a smaller amount as part of the crowd. Individual investors still must be accredited to invest directly with a sponsor or in an opportunity marketed on a crowdfunding site.
Crowdfunding sites operate on a fee-based model. Most charge both the sponsor and the investor fees to participate. The sponsor is charged a fee to post an opportunity and is charged a fee for every capital commitment made by investors on the platform. Individual investors are typically charged annual fees to be able to see investment opportunities being marketed on a site.
How Crowdfunding Platforms Became an Integral Part of Real Estate Investing
When the Act passed, every real estate company was allowed to broadly market their investment opportunities and solicit investment from the general public. Sponsors who had been raising capital from small networks of high net worth individuals suddenly had the opportunity to market opportunities more broadly to the general public.
Over a hundred crowdfunding companies have sprung up since 2012 and many failed in the first five years. Most were unable to build momentum and attract investors or sponsors to their platforms. Others had their reputations damaged by promoting sponsors and investment opportunities that were poorly vetted. Those crowdfunding companies that remain curate investments from a variety of sponsors and give individual investors that register with them an opportunity to invest smaller dollar amounts in each opportunity as part of the crowd.
Crowdfunding in Today’s World
Sponsors typically post their opportunities in crowdfunding marketplaces to try to augment their fundraising efforts. They rarely rely on any single crowdfunding platform to produce much more than 10-20% of the total capital raise.
There is nothing new about having a crowd of people pool their funds to make an investment in real estate. Real estate sponsors have been creating partnerships and syndicating investments this way forever. Crowdfunding platforms simply created marketplaces where crowds of accredited investors can see opportunities from multiple sponsors all in one place. Creating a marketplace for the promotion of real estate syndications is what the crowdfunding sites brought to the general public.
To learn more about real estate investing in today’s world, check out our blog.