While investment crowdfunding rules initially were targeted at early-stage ventures in need of growth capita,l the new rules have fueled the rise of investment platforms for another asset class: real estate investment opportunities.
Early-stage ventures, from seed rounds to later-stage venture rounds, tend to include a high degree of risk. Most startups fail. That’s a fact. But expected returns on the firms that succeed tend to drive higher rates of returns for early investors.
But without the innovation cycle of emerging new firms seeking to beat incumbent services and products, economies would stagnate and falter. Markets must have risk-taking entrepreneurs and individuals, as well as entities willing to provide needed funds, to drive economic prosperity.
The advent of online capital formation, or crowdfunding, has helped to boost this access to capital and encourage entrepreneurship. This is a net positive for all parties involved. But these same rules have created a legion of marketplaces providing access to real estate investments that were markets that were previously very difficult to access.
Today, in the US and elsewhere around the world, multiple platforms have emerged enabling smaller investors to participate in both debt and equity offerings for commercial and residential property investments. These types of investments typically hold a lower risk profile than startups or early-stage firms. Yet these same investment opportunities can generate income or capital gains far and above more traditional asset classes.
In the US, several platforms exist that cater to non-accredited investors (IE Groundfloor, Small Change & Fundrise are examples) but most continue to offer securities under Reg D – only available to accredited investors.
The Securities and Exchange Commission (SEC) intends on modernizing the definition of an accredited investor to reflect the obvious shortcomings in the current rule – changes that will open up private investments to a wider audience.
Currently, the definition of an accredited investor requires an individual to earn over $200,000 a year or have a net worth of $1 million (beyond one’s primary residence). Thus, much of the population has been excluded from private market offerings – including real estate investments.
A democratized definition of an accredited investor could potentially provide greater access to real estate investment opportunities as opposed to the current exclusionary rules.
Last December, Brew Johnson, co-founder and CEO of PeerStreet, a leading real estate crowdfunding platform, authored an op-ed highlighting the outdated definition of an accredited investor and arguing against the idea that more wealth means greater investor sophistication.
Johnson stated at that time:
“At our company, the goal is to make the unique asset of real estate debt available to everyone through our two-sided marketplace in which investors can access a diversified group of secured real estate loans, funded by private lenders and backed by data analytics, due diligence, and internal underwriting processes. Our motto spells it out plainly: We want to level the playing field between Wall Street and Main Street. Unfortunately, our goal of bringing democracy to real estate investing is, so far, only partially realized. Government regulations today are not inclusive for small individual investors. The accredited investor definition effectively categorizes the vast majority of American citizens as less than equal, shut out from many investment opportunities, including platforms like ours.”
The SEC appears to have realized that access to opportunity should not be defined by the size of an individual’s bank account. The past exclusionary definition, one that has disenfranchised a generation of investors, is in need of an update. A proposal to add a sophistication qualification is on the table now and accepting comments from interested individuals. The proposed changes could end up being a very big deal.
Recently, Crowdfund Insider reached out to PeerStreet for a comment on the proposed update to the definition of an accredited investor. Brett Crosby, co-founder and Chief Operating Officer of PeerStreet had this to say:
“It’s very encouraging to see the SEC making moves toward amending the accredited investor definition. What will be most critical are the parameters they end up agreeing on. This is certainly a step in the right direction, but our hope is that they produce a new definition that is representative of the informed modern investor. Many Fintechs like ourselves with the goal of leveling the playing field between Wall Street and Main Street can’t do it if the investors who will benefit the most from these additional options cannot access them.”
“When it comes to real estate, historically investors needed a large sum of money in order to invest and when they did, they weren’t able to easily diversify. Technology and innovation have changed that. Now, companies like PeerStreet are allowing investors to invest in real estate with very little minimums, and offering a higher level of transparency and control than was possible before. It’s time for regulation to catch up with today’s market and allow new investing opportunities to be accessed by modern investors.”
SEC Chairman Jay Clayton believes the current “binary approach” falls short and an update to the definition of an accredited investor is “long overdue.” If you are interested, you may add your opinion to the discussion on the final rules here. Change is coming to the definition but final details regarding the rule will be clarified following the comment period. The update will impact investors for many years to come.