Denzity on Real Estate Crowdfunding (Part 1 of 3) [#tb] [from https://www.denzity.io/blog/]
Here at Denzity, we are passionate about effecting change in an asset class and primary tool for capital appreciation and wealth preservation maintained through generations. Real Estate Crowdfunding (“RECF”) utilizes technology as a medium by which property ownership can be spread and diversified among a wide demographic of investors from different places.
Real estate has traditionally been an asset class that only available to wealthy individuals. Real estate platforms, such as private equity funds, have therefore only been able to seek investment from accredited investors. Accredited investors are individuals with USD $200,000 annual income or USD $1,000,000 net worth.
RECF is a new medium made possible since 2012 with the introduction of the Jumpstart Our Business Startups Act (also known as the JOBS Act). The JOBS Act means real estate platforms can access a wider demographic of potential investors. However, there are several key issues which arise as a result.
In this article, we will highlight the technical knowledge investors need before investing.
Real estate investment requires technical knowledge. This is why Platforms hire real estate and investment professionals to perform due diligence and benchmarking before making an investment. As an investor, you will usually be provided with an information package, primarily containing an investment memorandum (“IM”) and a limited partnership agreement (“LPA”).
The investor would read the IM, which contains details on the real estate property and its market (geographic and type), along with cash flow projections based on the platform's forecasts. Platforms will explain what capital expenditures are needed to improve the building’s marketability and the tenancy schedule to achieve a certain return to investors — one of the key metrics used by investors to decide on investment opportunities.
As an investor, you would need to understand the terms and conditions of the LPA, a document which details the legal manner by which you participate in the project. An investor who subscribes for shares in an investment fund, the vehicle used to hold the project, would be subject to certain rights and obligations under the LPA. These obligations can present itself in the form of a legal and commercial obligation.
The point is that understanding these documents require specific knowledge predominantly held by investment professionals who are typically employed by investment funds. These investment professionals accumulated their specific knowledge and skillset having worked in the finance (e.g. banker) and/or legal (e.g. lawyer) fields.
For example, a real estate project purchased for USD $10,000,000 obtains a USD $6,000,000 loan from a bank. The bank provides the loan subject to a facility agreement (“FA”). The FA is a legal document which defines the project’s legal obligations, which are primarily to (i) pay interest to the bank, (ii) repay principal ($6,000,000) to the bank, and (iii) maintain certain metrics referred to as covenants, such as a specified loan-to-value (“LTV”).
As an investor, you should understand the FA which highlights one of the key risks associated with the project and your investment. In the event, the project is unable to satisfy the covenants (e.g. unable to repay the bank loan principal), the project would be in default and your investment would become at risk.
Therefore, investors without the technical knowledge stand at a disadvantage to investment funds that hire investment professionals. So what’s the good news?
Denzity is backed by a team of real estate and investment professionals here to guide you along the way of searching and filtering RECF investment opportunities, and here to help you understand the key metrics and provide insights.
We hope these articles provide you with insight into the real estate investment process and journey!
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