Imitation is Flattery: Reg A+ Innovations in eREITs & Beyond

The Thinker Rodin Duplication Immitation Art

The RECF (real estate crowdfunding) community has been keenly interested in finding creative ways to use the new Regulation A+ that came into effect earlier last year. However, not all filings have been successful or made much business sense. Last year, I wrote about Groundfloor’s Reg A+ filing which was the first A+ filing out the door, but made little business or strategy sense. Since then, Washington D.C.-based Fundrise began selling securities under its recently approved Regulation A+ filing, which they cleverly termed an e-REIT.

Before I go on about Fundrise’s filing and its impact on the industry, I should note that my intention is not to analyze the merits of their offering or whether it’s a worthy investment. My line of inquiry stems more from a legal and business perspective as to whether the filing shows creativity and innovativeness, and whether it may be a new, viable product for the crowdfunding industry. I’m not here to comment much on the actual details of the offering itself (RealDeal already did some of that). As always, investors should consult with their financial advisors as to whether the security itself fits within their personal investment parameters.

With all the disclaimers out of the way, an old adage comes to mind: Imitation is the most sincere form of flattery. I think the RECF industry will begin to see more filings structured similarly to that of Fundrise’s e-REIT, as platforms will likely adopt the Reg A+ model that makes most sense.

Why the eREIT Reg A+ Structure Works

Rules RegulationsThe beauty of the e-REIT is the way it’s structured. The Fundrise team clearly understood the bounds and limits of Regulation A+ and fashioned a new product accordingly. As such, the company crafted a side product to compliment the company’s current range of product offerings. Notably, the e-REIT filing is made by a subsidiary entity, rather than by Fundrise’s parent company, Rise Corporations. Because of this, Fundrise didn’t need to disclose details surrounding the parent company’s much-coveted financials. They also indicated that they didn’t expect to limit their entire business to Regulation A+, as Groundfloor did.

The e-REIT structure also works well logistically, allowing Fundrise to identify and invest in real estate opportunities over time, instead of needing to identify all the properties upfront. This method prevents the company from going back to the SEC via a delayed approval process every time they want to add an acquisition or mortgage to a list and ask, “Mother, may I?” The  offering therefore gives the company flexibility to act quickly and execute on better real estate deals, where time is of the essence. Despite a common need for speed in many real estate transactions, certain asset classes like commercial equity require more time for proper underwriting. And it is this larger, more complex type of deal that seems to be filling the e-REIT.

A Crowd of $100 Benjamin FranklinIn terms of transaction costs, the e-REIT structure boasts that its ongoing costs will be less than that of a traditional REIT. The cost of creating, advocating and filing the $50M e-REIT itself was negotiated to $312,500 per program for the first 10 programs (note to non-lawyers, this means they may have negotiated a long-term payment plan) with one of the top law firms (Goodwin Procter). Of course, that means they’re locked into Goodwin for the next 10 projects, but it’s still not a bad deal, compared with Groundfloor’s $500,000 up front legal fees paid to a small firm (likely with lower hourly fees) and required re-filing or amending the offering throughout the year in order to fund more properties. In the vein of public sharing and standardization of innovative legal structures in the RECF industry, companies imitating the e-REIT structure might consider sending Fundrise a nice gift basket for developing and paying for this new product (just throwing that out there).

That said, the e-REIT structure is not without its drawbacks. Earlier this year, Fundrise had to publicly announce the termination of its CFO pursuant to reporting requirements under Reg A+. Because of this, some platforms might consider filing for a $20M e-REIT under Tier I instead of Tier II, exchanging a longer approval process for lesser reporting requirements. Regardless, platforms should make sure that they are able to support the e-REIT from an administrative, operational, and resource perspective.

Going Forward

With all the JOBS Act regulations now out (and almost all effective), the ultimate question is whether we have achieved the hopes and dreams of real estate crowdfunding.

JOBS Act Title IV Regulation A+Fundrise’s e-REIT is not the only way a platform can take advantage of Reg A+. I hope and believe that it is the first  of many innovative models that will emerge over the next few years, which platforms will be able to offer as an additional product for investors. There will likely be many e-REIT imitators, but I hope companies don’t stop experimenting with possible new, innovative, legal structures for real estate just because they know the e-REIT works.

Which brings us to the ultimate question–is there a better way? If so, what other solutions can we, as innovators in law and technology, bring to the table? Reg A+, in whichever form it may take, may be the ultimate solution if a real estate platform decides it only wants to raise $50M from the crowd each year and no more. And perhaps that’s the fate we’re relegated to, though $50M is not small change for any operator. However, many still aspire for more–a way to offer Regulation A +real estate investments a la carte to the crowd in a continuous way (in the style of Prosper or Lending Club). I can’t speak as to whether such an investment structure would be the golden ticket in real estate crowdfunding.

I don’t think we’ve reached the answer yet. There’s still more room for innovation. We’ll just have to be very creative and quite convincing with regulators, to find a way to the end goal. But Fundrise’s Reg A+ offering is a good step in the right direction.


 

Amy WanAmy Wan, Esq., CIPP/US is Principal at The Law Office of Amy Wan, Esq., where she advises on startup and crowdfunding law. Formerly, she was General Counsel at Patch of Land, a real estate marketplace lending platform. While there, Amy pioneered the industry’s first payment dependent note that is secured pursuant to an indenture trustee and designed to be bankruptcy remote, and advised the company on its $20.4M Series A funding round. She was recognized as a Finalist for the Corporate Counsel of the Year Award 2015 by LA Business Journal. Amy also brings extensive experience in legal innovation and rethinking the delivery of legal services. She is the founder and co-organized of Legal Hackers LA, and was named one of the one of ten women to watch in legal technology by the American Bar Association Journal in 2014. Prior to joining Patch of Land, Amy worked in enforcement and compliance at the U.S. Department of Commerce, where she represented the United States at the WTO and participated in free trade agreement negotiations on regulatory coherence and technical barriers to trade. Amy also spent time at the U.S. Department of State and U.S. Department of Transportation as a Presidential Management Fellow. She holds an LL.M. in Public International Law from the London School of Economics and Political Science, a JD from the University of Southern California Gould School of Law, and a BA in Biological Sciences from the University of Southern California.

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  • Mav

    A new way to peddle fraudulent investments with less scrutiny and oversight…brilliant! Vanguard REIT ETFs offer absolute liquidity, lower fees, better diversification, proven track records, and experienced/capable management teams. You’d have to be an idiot or a masochist to invest in this garbage.