Questions about Crowdfunding – What’s the Deal with Due Diligence?

Posted by | April 15, 2014 | Business, Real Estate | No Comments

Questions about Crowdfunding – What’s the Deal with Due Diligence?
By Tesse Hoekstra | National

The emergence of crowdfunding in the CRE business is a hot topic. A lot has been written recently about the opportunities and concerns associated with this new capital raising platform, and last week’s RealShare Los Angeles conference featured a dynamic discussion on the subject. With the CRE industry currently in what RealShare attendee Andrew McCulloch (Green Street Advisors) described as “a sweet spot, where demand is not strong, but strong enough in an environment with low supply and low interest rates”, opportunity for investment is abound. The rapid growth of real estate crowdfunding platforms is opening up new opportunities for funding such investments.

Shaping Policy around Crowdfunding
Crowdfunding – which is the aggregation of small amounts of capital from multiple individuals or companies, normally via an online platform – is quickly making a name for itself in the CRE world. Globe St’s recent poll that asked about the legitimacy and reliability of crowdfunding showed that 84% of respondents see value in, or potential for, crowdfunding initiatives in real estate transactions.

The concept is new to our industry, and policies and regulation are only starting to shape around it. It wasn’t until late 2013 that the Securities and Exchange Commission (SEC) lifted a ban on ‘general solicitations’ for investment in the real estate industry, and then issued proposed rules for the regulation of crowdfunding under the Jumpstart Our Business Startups (JOBS) Act. Now active discussions are taking place across the industry about what exactly constitutes an “accredited investor” or “reasonable steps” as mentioned in these rules.

Crowdfunding and Real Estate Due Diligence
Questions also remain about the decision making process in crowdfunded CRE deals. With so many stakeholders involved, who calls the shots about what assets are purchased? Whose risk tolerance is considered when determining the level and scope of due diligence to be implemented before and after the real estate transaction? Will a simple Transaction Screen Assessment and zoning report suffice, should an ALTA Survey or compliance audit be included, or are comprehensive industrial hygiene or remediation services required? Should these decisions be the sole responsibility of the crowdfunding platform, or do the individual investors play a role in the level of due diligence that is performed before an asset is bought, sold or developed?

The many CRE crowdfunding platforms that are popping up around the world have different business models, and varying approaches to due diligence. As an example, prominent real estate crowdfunding platform Realty Mogul has stated that the company conducts “due diligence on each transaction proposed by its investment partners and shares the results with its members. From there, the individual investor assumes all responsibility for their investment decision.” Other platforms seek greater involvement from investors in determining the appropriate level of transactional due diligence.

In this new industry, reputational concerns are leading many crowdfunding start-ups to focus on safe investments, opting for low-risk sites that will deliver slow and steady returns. A comprehensive due diligence program – which includes environmental, engineering and/or financial review – will help these companies understand and effectively mitigate risk associated with a deal.

CRE crowdfunding initiatives are expected to grow exponentially over the next 12-24 months, and I expect regulations and policies governing this industry to evolve accordingly. What the best approach is to due diligence, and who should set the standards or industry best practices remains to be seen. Regardless of the platform or its investors’ risk tolerance, with numerous stakeholders involved and a complex liability structure, crowdfunded deals require careful consideration of risk. As always, only a thorough due diligence program will help identify and mitigate issues to minimize risk on crowfunded investments.