CREFW-Summer2015

29 / 72

CRE Finance World Summer 2015
27
placed on both the amount that may be offered for investment
and the amount that may be invested seem to demonstrate this
underlying intent. In addition, several states have already begun to
regulate Crowdfunding utilizing provisions similar to the Crowdfunding
Proposed Rules. 9 This leads to the next question: how will these new
regulations potentially impact crowdfunding when applied to CRE?
It is highly likely that regulators would view crowdfunding of CRE
very carefully and perhaps with greater scrutiny. Traditionally, CRE
for both lenders and investors has been an area where only those
with the requisite capital and investing experience have entered.
Moreover, the regulations do not adequately provide enough capital
to fund most CRE projects of any appreciable size. The length of
the investment period permitted under Section 4(a)(6) does not
provide a long enough period of time for traditional borrowers or
investors of CRE that would otherwise seek out traditional lending.
Therefore, in and of itself, crowdfunding does not pose a threat
to traditional lending for the “trophy properties” that often fill the
CRE lending space. In addition, given the nature of CRE and the
nature of the investment, there would likely be little liquidity for a
crowdfunding investor to dispose of the investment.
Another potential concern related to crowdfunding revolves around
lender consent issues — especially in the context of workouts
and/or defaulted loan disposition. A group of investors (even if
they waive their rights to vote in any plan of disposition and/or
workout) will likely have a very difficult time achieving a workout
of a CRE loan that has crowdfunding. The situation is analogous
to the highly leveraged CRE loans made prior to 2008. It has been
very difficult for investors to exercise their rights on such loans
given the complex nature of the debt stacks and the diametrically
opposed interests that the holder of those debt stacks often have.
It is not inconceivable that in a crowdfunding scenario the situation
will be even worse given the possibly unsophisticated nature of the
investors in crowdfunding. Even if they were to waive their rights
to participate as an active voice in a workout, it is conceivable
that litigation would arise amongst the investors for any workout
or disposition strategy that goes awry, or even if such workout or
strategy were to perform reasonably well, litigation would likely
arise as a result of one or more of the investors being dissatisfied.
The SEC has not yet taken a stance on the Crowdfunding Proposed
Rules. One scholar suggests this is a result of the SEC’s concern
over fraud and/or loss in crowdfunding investments.10 Complex
CRE (or CRE of a substantial nature) might involve the very risks
that the SEC may have concern over. It would not take much to
invite the SEC in to harshly scrutinize CRE investments utilizing
crowdfunding were investors to suffer heavy losses. Potentially,
this might make CRE borrowers wary of seeking this type of
financing and push them toward traditional lending. How any of
this unfolds remains to be seen. Suffice it to say that the regulatory
mechanics involving crowdfunding are far from finalized, and if they
were to invite heightened regulatory scrutiny, it may not be appealing
for institutions currently engaged and (relatively) comfortable with
traditional lending.
In light of the above, regulators would likely take a heightened level
of scrutiny for arrangers attempting to use crowdfunding to fund a
large, complex and/or highly syndicated CRE loan. Despite these
obstacles, it does not mean that crowdfunding cannot fill other
liquidity requirements needed in CRE.
Crowdfunding: Who Needs a Crowd Anyway?
While crowdfunding may not have great utility for long-term CRE
finance and/or complex leveraged lending structures, crowdfunding
in CRE may offer unique liquidity solutions for smaller balance
loans short-term in nature. A CRE borrower looking for short-term
financing at a low cost of funds, with minimal upfront origination
fees, may find a crowdfunding solution very attractive. Indeed,
origination fees currently range from a low of 0% to a high of 4%.
Also, the speed at which a project can be funded and the loan
closed may be quicker than the time necessary for a traditional
CRE lender to fund a loan. Moreover, the loans tend not to feature
asset management fees and/or other costs of borrower type fees.
The lack of fees and costs, coupled with very favorable interest
rates, may make crowdfunding-backed CRE loans very attractive
to small, non-institutional borrowers looking for capital to develop
their CRE projects. If this were the case, it arguably aligns well
with legislative intent both at the federal and state levels for
permitting crowdfunding.
In addition, crowdfunding can (and is) being used to attract investors
that would be “accredited investors” for purposes of Section 501
and Section 506 of Regulation D to the 33 Act.11 Under Section
506, unlimited numbers of investors, as long as they qualify under
Section 501 as accredited investors and are given the notices and
materials required under Section 506, may participate and/or have
materials directed to them for an offering, and that offering will not
be subject to registration under the 33 Act. Access to investing on
a crowdfunding website could potentially be restricted to individuals
that are accredited investors via password protection and other
security procedures. Some CRE crowdfunding websites do limit
themselves to participation by only accredited investors, and such
investors are required to certify that they meet the requirements of
Section 501. With this new phenomenon on the rise, the reactions
of traditional lenders in the traditional lending space to crowdfunding
are of great interest.
Crowdfunding: The Future of Commercial Real Estate Lending or Just a Voice Lost in the Crowd?