The Real Deal New York

Taming the crowd: What does Fundrise’s new REIT mean for crowdfunding?

Startup’s new venture applies JOBS act rules to traditional finance

November 24, 2015 02:20PM
By Konrad Putzier

Ben Miller

Ben Miller

What does it mean for the health of real estate crowdfunding if one of its pioneers is switching things up?

This month, Fundrise announced it is seeking up to $50 million to form a real estate investment trust. By tapping into eased-up regulations under the JOBS Act, the new venture is being billed as a cheaper and more accessible alternative to traditional REITs. But it also raises questions over the viability of traditional crowdfunding.

What the firm dubs an “e-REIT” appears to be essentially a conventional nonlisted mortgage REIT, albeit a very small one that allows investors to buy shares online. Investors can get in the game with as little as $1,000, but have no say over which properties the e-REIT invests in.

Fundrise declined to explain why it launched the new venture, citing a “quiet period” mandated by the Securities and Exchange Commission. But its publicly-available SEC filing offers some clues on why the startup thinks launching a tiny, illiquid online REIT is a good idea.

It bills its e-REIT as having the advantages of a conventional nonlisted REIT – stable returns free from the stock market’s whims – but at lower fees. Unlike traditional nonlisted REITs, the trust is filed under Regulation A of the JOBS Act, meaning Fundrise can sell shares through its website and openly advertise them without having to go through a registered broker-dealer. This, it claims, allows it to offer far lower fees than other REITs, an annualized management fee of one percent of the invested sum. But its real fees are higher, because the firm charges its mortgage borrowers a 3 percent fee, plus interest. That fee would otherwise go to investors, meaning they effectively pay upwards of four percent, adding on other smaller charges.

In essence, Fundrise is using legislation designed to help small businesses raise funds and turning it around to make the traditional nonlisted REIT structure cheaper for investors. It will be interesting to see if this idea catches on with other REIT sponsors.

“Today is a massively historic day for the Fundrise team — the result of over four years of work!” Ben Miller, co-founder and CEO, said in a statement when the news broke.

Despite the lofty language, the move could be another sign that real estate crowdfunding is becoming more and more like the traditional finance industry it set out to disrupt.

Consider the irony. Since September 2013, when real estate crowdfunding became legal in the U.S., its champions have talked it up by talking down REITs. The pitch: Why would you invest in a REIT, where the suits collect sky-high fees and you had little influence over which assets your investment goes into, when you could instead buy a stake online in a property of your choosing? Crowdfunding was advertised as the anti-REIT, and “democratizing investment” became its unofficial mantra. This is why Fundrise’s decision to launch one is so noteworthy.

As The Real Deal reported in July, crowdfunding startups have been been increasingly forced to compromise on their ideals of empowering the crowd. Raising small sums from hundreds of investors, it turns out, is a chore, and borrowers often don’t have the patience to wait for money to be raised online. As a result, a growing number of platforms have been raising money directly from institutions.

“Institutional money is already usurping the crowd,” Sherwood Neiss, principal at industry consultant Crowdfund Capital Advisors, which advises government and financial institutions on crowdfunding, said in June. “I think this is the general direction it will go in. Unless these are opportunities in small towns, I do believe that this will be mainly institutionally funded deals.”

If ditching small-time investors and going straight to institutions is an acknowledgement of crowdfunding’s limitations, launching a REIT may be another one. Both in terms of deals done and venture capital money raised, Fundrise has been one of the most successful U.S. real estate crowdfunding startups. In the filing, it claims to have “facilitated or originated approximately 56 real estate assets (…) with aggregate purchase prices of approximately $3.0 billion.” That figure, however is almost certainly inflated by Silverstein Properties’ $2.75 billion tower 3 World Trade Center. Fundrise bought $2 million in bonds for the project — less than 0.1 percent of its total value — on the secondary market in January, and offered them for re-sale to its investors.

That Fundrise has chosen to launch a more or less traditional investment vehicle should give crowdfunding’s cheerleaders something to think about. Not everyone, however, sees it that way.

“It seems like a logical next step,” said Douglas Ellenoff, a lawyer at Ellenoff Grossman & Schole LLP who has worked with several crowdfunding startups. “First, confirm that investors like the asset class and then manage a pool of investments rather than have them select individual investments,” he said. “Some investors will continue to invest directly themselves and want to maintain control and others are more interested in diversified returns.”

Rodrigo Nino, whose crowdfunding platform Prodigy Network claims to have raised more than $100 million for New York real estate projects, also dismissed the notion that crowdfunding’s potential has hit a ceiling. “Access through technology for smaller investors to opportunities that were privy to the larger investors before simply makes sense,” he said. “I believe they are exploring different avenues and this is not an indicator of where the industry is going.”