Equity crowdfunding is a relatively new concept, and governmental regulation is struggling to keep pace with the rapidly changing crowdfunding landscape the world over. Crowdfunding for real estate is still in its early days in Canada. However, it has been making significant inroads in the US. In 2014 and 2015, there have been a number of large real estate projects in the US backed by crowdfunding campaigns (i.e. 17 John Street commercial real estate overhaul in Manhattan, $25M raised as of September 2014). In contrast to traditional investing through REITS (real estate investment trusts), crowdfunding portals provide investors the opportunity to choose exactly what building(s) or project(s) they want to invest in.
In the US in 2012, the JOBS Act was enacted allowing companies to solicit equity investments online, to crowdfund, up to $50M a year. However, until June 19, 2015, the type of investors were limited to accredited investors (i.e. (a) individuals making over $200,000 per year, (b) married couples making over $300,000 per year, or (c) individuals or couples with a net worth of over $1M). Now, the general American public will be able to invest in commercial real estate projects they would never have had access to before, with some limitation on the amount that can be invested (10% of the greater of their annual income or net worth) in these securities.
On December 6, 2013, Saskatchewan became the first Canadian province to implement rules that provide a prospectus exemption for equity crowdfunding for start-ups and small businesses.
On May 14, 2015, six provinces (including BC and Saskatchewan) announced the implementation of harmonized equity crowdfunding exemptions aimed at start-ups and early-stage businesses. These exemptions were discussed in detail by my colleagues in a previous blog post (see here).
The Ontario Securities Commission expects to publish its own crowdfunding rules in the fall of 2015. As opposed to the rules introduced in BC, Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia, these rules are anticipated to apply to both smaller and larger companies, non-reporting issuers and reporting issuers, and to allow companies to raise as much as $1.5M a year (a significant increase over the other provinces’ current $250,000 twice a year).
Neither Canadian, nor US, securities laws appear to differentiate between different uses of the funds raised through crowdfunding portals. The same laws appear to apply to crowdfunding for technology start-ups as to commercial real estate crowdfunding.
Equity vs. Debt:
Real estate crowdfunding falls into two sub-groups: debt and equity.
In debt crowdfunding the investors act as a lender for, rather than as, the owner of the property. Some crowdfunding portals act as arrangers (a) where the crowd acts as a direct lender to the borrower company, (b) where the commercial real estate loan is pre-funded and the crowd purchases interests in the loan, or (c) where the arranger creates a lending vehicle with funds collected from the crowd and then the vehicle lends funds to commercial borrowers and grants the crowd investors ownership interest in the lending vehicle itself. In such circumstances, the investment would be secured by the property and the investor would be entitled to monthly interest and a return of principal, but not to any benefit from property appreciation.
In equity crowdfunding, the investor becomes an indirect owner of the property by obtaining shares, limited partnership units, or other securities in the entity that owns the property/project. This form of investment carries inherently more risk, but also a potential greater return as a result of a direct interest in the property appreciation.
Risk and Disclosure:
US companies who are crowdfunding continue to have the duty to provide investors with a sufficient amount of information to allow them to make an informed decision. When dealing with real estate this duty to disclose will encompass anything that a person purchasing real estate though regular transactions would consider material, including zoning issues, leases, cost of renovations/construction, any issues with title, construction defects, etc.
Under the proposed Ontario crowdfunding exemption, reporting issuers would continue to be required to comply with their existing continuous disclosure obligations and non-reporting issuers would be required to provide disclosure of specific events, notice of how the proceeds are expended, and audited financial statements (when certain financial thresholds are met).
For BC and the other provinces who have implemented start-up crowdfunding rules, an offering document is required that includes basic information about the company, its management and the distribution, including how the business intends to use the funds, and the minimum offering amount. If, and when, these exemptions are utilized by commercial reals estate companies, the amount of information with respect to use of funds will need to be closely examined to ensure that the disclosure is sufficient for this particular type of investment. As the funding requirements of most commercial real estate companies will be significantly greater than $500,000 per year, it is unlikely that this exemption will be used to invest in/develop commercial real estate in BC. We will need to wait for a broader exemption, like that anticipated in Ontario, for commercial real estate crowdfunding to take off in BC.
Though securities regulations will provide consumers a certain level of protection by limiting each individual’s allowable investment amount and disclosure obligations, the rigorous consumer protection obligations we have become accustomed to for new real estate development projects, through legislation like the Real Estate Development and Marketing Act (BC) (“REDMA”), may not apply. Based on the current drafting of REDMA, and its related regulations and policy statements, I believe that such crowdfunded investments in real estate will fall outside of its regulatory purview as investors will not be obtaining a direct interest in the property. It will be interesting to see whether or not regulations evolve to meet the market, addressing the marketing of equities/securities to the public which are directly linked to specific real estate investments/developments.
Though crowdfunding will allow more people access to the commercial real estate market, for companies being able to solicit investments in projects from the general public online both greatly increases companies’ ability to raise the capital they need, from a greatly expanded pool of potential investors, but may also greatly increase the likelihood of lawsuit, especially if the investment performs poorly.
As commercial real estate crowdfunding, and crowdfunding in general, continues to gain traction and evolve both north and south of the 49th parallel, it will be interesting to see what changes in the commercial real estate financing industry occur and how legislators, regulators and the judiciary keep pace with this ever changing landscape.