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CRE Finance World Summer 2015
26
T
Crowdfunding: The Future of
Commercial Real Estate
Lending or Just a Voice
Lost in the Crowd?
Geoffrey Maibohm
Counsel, Finance Group
Alston & Bird
Stephen Denmark
Associate
Alston & Bird
Robert Sullivan
Partner, Co-Chair
Finance Group
Alston & Bird
he future of traditional lending has challenges ahead.
As technology advances and capital becomes more
readily available, traditional lenders are likely to see
increased pressures to lend and increased pressures on
profit margins from lending. Crowdfunding, assuming it
can withstand increased regulatory scrutiny, looks well suited to
fill a niche that traditional lending may not be able to fill. However,
traditional lending will likely not see any challenges posed by
crowdfunding for larger and/or more complex transactions. The
next several years will provide challenges and opportunities, and
entities that can overcome challenges and execute on opportunities
presented by technology and the widening availability of capital
will be well positioned to flourish. Less nimble entities are likely
to get trampled by the crowd.
Crowdfunding: What Is It and What Are Its Applications in
CRE Finance?
Crowdfunding has been described as, “[t]he practice of raising
funds from two or more people over the internet towards a common
service, project, product, investment, cause, and experience.”
1
In crowdfunding, various small investors serve as the source of
capital for the project. Applications of crowdfunding have been used
for a wide range of capital intensive projects over the last several
years, which include the production of major motion pictures and
video games.
2
In crowdfunding, a party seeking financing for
a project goes onto the internet to a website that arranges the
financing. The project is published on the website, and registered
users are given an opportunity to invest in the project in some
small increment. At the most basic level, crowdfunding is syndicated
investing/lending on a micro level. It is a global phenomenon
changing investing and lending.
3
Knowing what crowdfunding is
at its most basic level allows a look at its application and rise in
the world of CRE lending.
The principles of crowdfunding applied to CRE lending suggest
that potential CRE borrowers would go to a website dedicated to
crowdfunding to seek capital from the investors on that website that
have “signed up” or agreed to participate in the proposed project
through investing. There are already a number of crowdfunding
websites devoted to CRE investments featuring different risk
profiles for both assets and investors alike.
4
The role of the “crowd”
in crowdfunding for CRE is varied. Some crowdfunding websites,
acting as the arrangers, utilize crowdfunding structures where the
crowd acts as direct lender to the CRE borrower. Some arrangers
utilize a structure where the related CRE loan is prefunded, and
interests in the loan are sold to investors. Other crowdfunding
platforms utilize structures where the arrangers create a lending
vehicle with funds collateralized by the investors’ investments. The
vehicle then lends such funds to the related borrower(s), and the
investors are given ownership interests in the lending vehicle itself.
When structured in these ways, crowdfunding looks very much
like a microcosm of traditional lending. Yet, other crowdfunding
arrangements work where the arranger funds upfront and creates
a project note and the related crowd invests in that note. At its
core, crowdfunding is a blend of traditional lending strategies that
are being made available to the general small investor. In a market
that has been dominated by traditional large lending institutions
and large institutional real estate investors, this could signal a
major shift in CRE lending away from its traditional lending present
form. Nonetheless, the mechanics of crowdfunding and its ability
to service the needs of CRE borrowers must be considered. In this
regard, the rise of the crowd may just not be enough to replace
traditional lending.
Crowdfunding: Who is in the Crowd and Who Regulates It?
As mentioned earlier, investors/lenders in crowdfunding are not
traditional CRE lenders; they are the antithesis. They are individuals
interested in CRE finance. They may have no experience in CRE
investment, and generally are neither institutional investors nor
the wealthy individual investor that have otherwise dominated CRE
finance from its beginnings to present day. This raises questions and
concerns simultaneously. In particular, many wonder how regulatory
agencies will deal with the phenomenon that is crowdfunding.
Crowdfunding in the United States arises from the recently enacted
Jumpstart Our Business Startups Act (the Jobs Act).
5
According to
the legislative history of the Jobs Act, crowdfunding was designed to
improve liquidity and investment in small business.
6
Most notably, the
Jobs Act amended Section 4 of the Securities Act of 1933 (the 33
Act) to include provisions that permit crowdfunding in new Section
4(a)(6), yet limit the amount that may be invested by each investor
within any given 12-month period.
7
On October 23, 2013, the Securities and Exchange Commission
(SEC) proposed implementing rules related to the newly amended
Section 4(a)(6) of the 33 Act and crowdfunding (Crowdfunding
Proposed Rules).
8
While the Crowdfunding Proposed Rules have
not yet been adopted by the SEC, they contain several key points
for discussion that are beyond the scope of this article. Relevant
for purpose of this article, however, is discerning the legislative
intent. The text of Section 4(a)(6), as amended by the Jobs Act,
and the Crowdfunding Proposed Rules arguably demonstrate the
legislative intent of Congress and the SEC. Congress and the SEC
want to grant small business easier access to capital markets, but
at the same time, protect small and/or unsophisticated investors
from overreaching. The limitations that Congress and the SEC have
Crowded Trades: Crowdfunding Enters Commercial Real Estate