Equity crowdfunding is still in its infancy, but the dollar amounts raised thus far are impressive- an estimated $150 million in 2014 for just real estate projects. Dozens of sites are offering accredited investors a slice of the real estate pie. By pledging as little as $1000, high net worth people can become property investors while avoiding the headaches of becoming property managers. There’s also the upside for landlords and developers, they bypass the bank and get funding from an alternative source within days of asking. But what about the tenants’ interest? What’s their risk in this new investment venture?
Old trend, new delivery mode
Pooling investors’ money to buy a property isn’t a new concept in real estate, but thanks to technology the scope of investors and their options have significantly broadened. Unlike REITs, investors have the control to pick how many and what properties they like best. Accredited investors, those making an annual single income of $200,000 and a net worth (minus primary residence) of $1 million can quickly become part of a single limited partner entity. Like many investments, there are potentials for pitfalls such as no return guarantee, mismanaged funding sources, and lack of accreditation.
Tenant Protections from the Crowd
Corporate tenants should become educated on the ramifications of entering into a lease where the landlord entity is a crowd-funded group of investors. There is a lot of discussion on the potential dangers of the investor side of the equation, but little attention thus far has been focused on the tenant’s risk in doing business with a large group of property investors. Entering into a lease with multiple investors who have no direct contact with the leased property can expose the corporate user to everything from minor annoyances such as unplowed, snowy parking lots to significant operational challenges that affect the tenant’s ability to conduct business at the leased location.
Another area of concern is whether the party acting on behalf of the landlord (local management company) has authority to make ordinary business decisions and bind the landlord. Tenants should rightly be nervous that a landlord backed by hundreds of investors may not respond quickly to basic tenant needs, such as a broken door or damaged roof. Therefore, tenants should require crowd-funded landlords to disclose to the tenants the provisions of the landlord Operating Agreement that grant the manager of the landlord the right to make ordinary business decisions, such as maintenance and repairs, without consulting investors, and to amend, sign, and renew leases, consent to subleases, and agree to almost all common real estate transactions. Including the Operating Agreement as an Exhibit to the lease contract as well as specifically addressing tenant’s rights and landlord’s obligations in specific lease clauses may mitigate some of the potential operational threats when dealing with an unresponsive landlord.
The investor’s personal involvement with the building may also increase the possibility of an upset investor protesting the tenant’s business or otherwise harming the tenant’s reputation. As a result, tenants should require landlords to represent and warrant that the landlord has authority to buy out an investor’s share if an investor threatens or damages the tenant’s business.
Is this the future?
It’s an interesting concept, albeit not a new one. It definitely feeds into the ongoing influence of technology in business. Just like most technology ideas, there are issues to flush out before it can become a mainstay. There are already several sites to address different real estate sectors and these will continue to expand. There’s also the governmental hurdles, such as the complex and not yet finalized SEC regulations. However, if Title III of the JOBS Act passes, then unaccredited investors may become the future of crowdfunding’s success. Commercial real estate isn’t a field where you can click a button and expect an immediate return, but there’s certainly a profit for those who invest wisely.