Crain’s New York Business | Crowdfunding Reshapes Real Estate Finance

October 2, 2015

When Cayuga Capital Management wanted to raise about $7 million for a 24-unit, four-building rehab of a mixed-use commercial building in Bushwick, Brooklyn recently, it turned to the real estate crowdfunding site Fundrise. The developer raised $1.5 million in preferred equity, in addition to raising financing from other sources, such as a bank loan for $4 million.

The deal was one of 10 done recently in New York City through Fundrise, based in Washington, D.C. Dan Miller, co-founder and president of Fundrise, which raises money from both high-net-worth, accredited investors and non-accredited investors, said the speed of fundraising on the site keeps picking up.

“On our first project, it took us about three months to raise $325,000,” said Mr. Miller. “Now, we can raise a few million dollars in a few hours. You launch the deal, market it and there are transactions flying through the site–and the funding all comes in.”

Mr. Miller has got plenty of competition for deals in New York City. When Fundrise started out in 2012, he was not aware of anyone else doing real estate crowdfunding. “Now there are over 100 groups who claim to be doing real estate crowdfunding,” he said.

In crowdfunding, business people who want to raise money turn to large numbers of people, usually through online sites. One reason that the once novel fundraising method has taken hold, say industry experts, is its effectiveness. “The crowdfunding industry has demonstrated it is pretty versatile and has adapted quickly to marketplace demand,” said attorney Gregg Lubier, a partner at Alston & Bird LLP, which has an office in New York City and a real estate practice.

That observation has held true as more sites have shifted from selling equity to helping developers borrow. “They can close loans in a week,” Mr. Lubier said. “That’s really fast. Their whole model is to respond very quickly and get the deal done.”

To be sure, crowdfunding has some drawbacks. There are questions the market has yet to resolve about what to do if a borrower defaults or a crowdfunding portal goes under, said Mr. Lubier. And from the point of view of developers, it may be difficult to source additional capital from crowdfunded investors if it is needed.

“The crowdfunding investors will probably not have an obligation to put in additional collateral,” Mr. Lubier said.

Some sites have tried to allay such concerns. At Fundrise, for instance, Mr. Miller said, “We’ve tried to structure the deals to eliminate part of the risk. We have the rights to step in and restructure the deal and take over the assets if we need to. If the borrower defaults, we have an agreement with the senior lender to step in and take over the transaction. I think through a downturn that will be incredibly valuable.”

Even with the kinks still being worked out, crowdfunding shows no signs of slowing down. One reason is that crowdfunding sites fill a gap in the marketplace, often facilitating smaller deals. For instance, Fundrise’s sweet spot encompasses deals in the $10 million to $30 million range, said Mr. Miller. “They are normally overlooked by institutional investors,” he said.

And crowdfunding lends itself to a customized approach. Mark Callazzo, a partner at Alpha Funding Solutions in Lakehurst, N.J., which provides bridge loans to developers and other clients, said his company, which does deals in the New York City metropolitan area, runs a private site, aimed at investors such as hedge funds. “We have a little internal site where they look for loans they want to buy,” said Mr. Callazzo. Although the deals may be viewed by more than one investor, they are typically funded by only one, he said. The firm’s minimum loan size is $100,000 but goes up to several million.

RealtyMogul.com, a crowdfunding site based in Los Angeles that works exclusively with accredited investors, has funded transactions in Brooklyn and New York City suburbs, such as Hempstead and North Baldwin on Long Island, said Jilliene Helman, who co-founded the site two and one-half years ago.

One recent deal was a multi-family apartment building in Bushwick. “It was a property that was 100% occupied,” she said. “The intent was to start renovating the units as they came up and, as they got renovated, to ideally release them at a higher price.”

With the real estate market booming, investors eager to get high returns are likely to provide a steady stream of capital for crowdfunding sites. At Fundrise, Mr. Miller said that investors in the Bushwick project earned 12% returns, and on most deals they earn 12% to 16%. Ms. Helman at RealityMogul said that annualized returns on her firm’s debt platform have been 11%. For equity deals, she said, ‘it is too early to tell.” For both sites, it is possible to find deals where one can invest as little as $5,000—a feature attractive to investors who lack the deep pockets to buy and renovate a building in a pricey borough like Manhattan or Brooklyn. “This is about the true democratization of investments,” said Mr. Miller.

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