Crowdfunding carves out legitimate niche
03 AUGUST 2015 7:50 AM
Thanks to the power of the Internet and changes in securities regulations, the nascent crowdfunding platform could become a factor in the financing of hotels.
REPORT FROM THE U.S.—Changes in regulations by the United States Securities and Exchange Commission and the power of the Internet have opened up the possibility of crowdfunding as a financing source for all kinds of commercial real estate, including hotels. While few hotel owners have yet to use this platform, sources said it could become a significant piece of hotel financing.
“Real estate in general, including hotels, and debt and equity specifically, is exploding with these kinds of peer-to-peer lending platforms,” said Jonathan Bloch, a partner in the Los Angeles law firm Jeffer Mangels Butler & Mitchell. “Right now, the deals are pretty small, routinely in the $2-million-to-$4-million range. But the numbers are taking off and how long there is before a $40-million real estate offering is done on a peer-to-peer platform I don’t know.”
According to one analysis, last year about $1 billion was raised through crowdfunding for real estate projects. That was up from $396 million in 2013. This year, crowdfunded financing for real estate is forecast to top $2.5 billion worldwide, with $1.4 billion executed in North America.
The concept of crowdfunding is another form of syndication financing that has been used by real estate owners and developers for decades.
“It’s really the same idea,” Bloch said, “but the big change that has fueled interest in (crowdfunding) is technology. If you had $100,000 to invest in real estate, your financial advisor would tell you to spread it out geographically and perhaps over time and through multiple deals. But to go into four or five real estate deals with $20,000 or $25,000 each and spread it around the U.S. would be difficult to do. Now, with an Internet platform, the investor can easily diversify by geography and by real estate type.”
In general, these crowdfunding investments are not part of new hotel development packages, said Ted Farnsworth, chairman of iCrowdHotels, a company that matches investors and projects using crowdfunding.
“So far, most of the people who want to crowdfund are looking for operating hotels to invest in; they want cash-flowing hotels,” Farnsworth said. “Right now, there is little interest in the development side of the business, and it will take a little longer for that to pick up.”
There are exceptions to that trend. Prodigy Networks partnered with Korman Communities to develop the 140-unit AKA Wall Street extended-stay hotel in New York City’s financial district. The property opens later this year. Prodigy, the majority partner in the deal, raised some of the capital through crowdfunding sources, said CEO Rodrigo Niño.
Last year, the partnership purchased the 95-unit AKA United Nations for $68.5 million, of which $10 million was raised through crowdfunding. The hotel is closed for renovations with opening scheduled in September.
According to Niño, crowdfunding works as a real estate capital-raising tool because it can redefine the dynamic between guest and owner.
“The (hotel) business is all driven by loyalty and reward programs, and we believe ownership is the ultimate reward program because it changes the nature of the relationship between the owner and the guest by making them partner from an equity standpoint,” he said. “In addition, crowdfunding provides access to smaller investors for projects that were only available to larger institutional investors before.”
Not all crowdfunding efforts have been successful. In Detroit, a collaborative community project has been attempting to build a 45-room boutique hotel constructed of shipping containers. Following an initial fundraising effort, financing for the project is now in limbo, said Shel Kimen, founder and executive director of the Collision Works project.
She’s hopeful the project will attain additional financing that will enable the hotel to open sometime next year or in 2017. Despite the setback, Kimen believes in the power of crowdfunding.
“This project is community-based, and when the community has a stake in its success, it’s more colorful and creates more meaning for the people who participate in and eventually visit the hotel,” she said. “From the pilot project, the people who were involved in the Kickstarter campaign were extremely invested in the project. There were people who traveled very far from Detroit to see what they had participated in. That’s powerful.”
What’s driving it?
Several factors—the power of the Internet and passage by Congress of the Jumpstart Our Business Startups Act, and subsequent rulemaking by the SEC—provided the catalyst for the nascent crowdfunding industry.
The so-called JOBS Act allowed for the first time the general solicitation of private placement offerings, Bloch said.
“Previously, if you were a broker-dealer, you had to know your investor personally,” he said. “Now they can solicit generally through advertising or the Internet, although there is still an obligation for them to conduct due diligence about the investors. But if you have a list of 100 doctors from around the country, you can do a general solicitation to them.”
The term crowdfunding might be a little misleading, said Tim Edgar, president of Hotel Innvestor, a California-based hotel investment banking firm.
“We’re not actually crowdfunding because you have to be what’s called an accredited investor to put money in one of these offerings,” he said. “An accredited investor is an SEC designation that essentially equates to being a millionaire. (The investor) either needs to have $1-million net worth, exclusive of their primary residence, or have made $200,000 as an individual or $300,000 as a couple for the last two years with a reasonable expectation to continue to make that level of revenue.”
The SEC is slated to issue additional rules this year that will lower the net-worth threshold for potential crowdfunding investors.
While the SEC was the catalyst for mass-market real estate crowdfunding in the U.S., global investors can participate in the platform.
“Crowdfunders can’t take money directly from outside the U.S., and funds must come through a U.S. bank,” Edgar said. “However, someone outside of the country can move money into a U.S. bank and into a (crowdfunding) investment. They don’t need to be a U.S. citizen, but they can only invest U.S. dollars.”
The health of the hotel industry and relative low returns from other investment vehicles also are driving investors to crowdfunding.
“It’s a combination of a much better economy and the opportunity for people to invest in a different medium,” said John Balboni, partner in Boston law firm Sullivan & Worcester. “Investors want to be involved in real estate as some part of their allocation, and if you have some spare cash and want to make it part of your allocation, this fits into that model.”
Importance of due diligence
Hotel owners looking to tap into a crowdfunding source need to conduct due diligence on the matchmaking platform and on the investors involved, Bloch said.
“A developer needs to be careful, just as they would when they go to any financing source, to see who they are dealing with, what is their track record,” he said. “It’s a highly regulated world, but you still need to do your due diligence.”
Balboni is convinced crowdfunding will continue to grow as a financing technique in the hotel industry.
“It’s the democratization of capital, and everyone from Main Street to Wall Street can invest with this product and through this product,” he said. “There are some limitations now because the dollar sizes are a bit small, but as the industry grows, and as more people get comfortable investing through the Internet, you’ll see more best-in-class hotel operators coming to the market.”