How is Crowdfunding regulated in Indian Real Estate?
Real estate investment is a dream for most Indians. People work hard to invest in at least one piece of land as it becomes a matter of pride to many. Capital appreciation, rental income, long-term financial security, etc. are some of the reasons why real estate is the most sought out investment option. However, investing in real estate can be a little expensive as it requires huge capital investment.
Real estate crowdfunding enables investors to invest in real estate property with a small investment amount. Crowdfunding is a method in which individuals pool in funds by making small investments for a specific real estate deal. The crowdfunding process is generally carried out through online platforms to reach potential investors. This method is also considered to be one of the most feasible alternatives to traditional ways of investing in a property.
Crowdfunding makes it easier for the investors to invest and become shareholders in properties they otherwise may not have acquired if they were investing through the traditional methods of investing.
Also Read: Crowdfunding in Real Estate
Important Roles in A crowdfunding process
There are three main roles played in a crowdfunding project and this include:
The sponsor is the person or entity which is responsible for finding the best investing opportunity, planning the acquisition process, inviting and finding potential investors through different crowdfunding platforms. He is also responsible to oversee the management and sales activities of the property. After finding the potential investors and bringing them on board, a Special Purpose Vehicle (SPV) is created. It is through this that the property is then purchased.
Just like the role of the sponsor, the role of a trustee is also important in crowdfunding. He is required to check and verify that the property qualifies all the statutory requirements and additionally provides services relating to corporate governance, holding securities for the lenders, etc. He is also required to carry out the management and advisory functions of the project.
The manager on the other hand is responsible to handle and manage all the assets and investments that are made on the property by the investors. He is responsible to carry out the operational activities on the real estate asset following the guidelines provided by the statutory body.
Distribution of Profits
The investors contribute towards the capital to earn a share in the profit. The division of the profits from real estate assets may vary according to the investment model that has been chosen by the investors. The two most prominent investment strategies include:
Equity-based distribution of income is a model in which you receive a return based on the rental income that is generated out of the property. In case the profit is generated on the sale of the property then, the profit is shared based on the percentage of investment under this model of investment. By investing through the equity-based model, you as an investor will earn maximum profit as the property value appreciates or the rental yield increases. By investing using this model you are opening a channel of income for about 5-10 years.
- Debt or lending based
In this model, the investment made by the investor in the property is treated as a debt or an amount which has been lend to the entity. According to this model, the investors will not have ownership shares in the property and they will receive fixed returns along with the interest rate on the amount he had lent to the entity.
In the case of a lending-based model, the investors are safer compared to the equity-based investors as in case the property goes into foreclosure, they are assured of the money they spend and will be paid first.
What is the best way for me to profit from a crowdfunded investment?
Real estate crowdfunding systems allow you to invest in a property and become a shareholder in the same way that you would with a stock. You can earn a part of any earnings created rather than purchasing the entire property and having claim to all possible profits (but also taking on all the labor and risk).
These revenues are often derived from rental income streams or any proceeds from the building’s sale. You may get distributions (also known as payments) on a monthly, quarterly, or yearly basis, depending on the company plan.
The risk profile of each trade also affects the amount of money you may make from your investment. The great risk is frequently connected with high gain, just as it is in the stock market. For example, development projects cannot yield rental revenue since there is nothing to rent–the sponsor is spending your money to construct the building. They can, however, attract a higher sale price if all goes according to plan a few years down the line.
Core transactions, on the other hand, are often fully leased, best-in-class buildings in large metropolitan areas. They’re more likely to produce a consistent revenue from day-to-day activities, but they’re unlikely to appreciate much over time. These transactions, on the other hand, are less likely to disappoint and produce more consistent returns.
Is crowdfunding permissible in India?
In India, crowdfunding is made permissible in three main ways namely Donation Crowdfunding, Peer-to-Peer lending, and Reward Crowdfunding. Thus a person raising funds using crowdfunding options must abide by the provisions of the Companies Act, 2013, Securities Exchange Board of India Act, 1992, Securities Contracts (Regulation) Act, 1956, and Depositories Act, 1996. The Securities and Exchange Board of India (SEBI), has however not authorized equity crowdfunding as those lacking experience in this field can get attracted to the high returns offered by it and this might end up being a little risky.
Rules regulating crowdfunding in India
One of the most prevalent exemptions used by real estate developers to secure crowdsourcing financing is Rule 506(c). The following are the most important components of this rule:
- The developer can reach out to the broader population and publicise their service widely.
- All of the investors must be accredited.
- The developer shall take reasonable precautions to ensure that the investors are qualified.
- The developer has the ability to raise an endless number of funds.
- The developer can raise funds from as many investors as he wants (as long as they’re certified).
This means that the developer can seek financing from the general public and even publicise their service. All they have to do now is make sure that everyone who participates in the initiative is a qualified investor.
Offerings under Rule 506(c) are frequently done using an online real estate crowdfunding platform. This allows the developer to accept more investments and streamline distribution payments and investor interactions.
Another popular exception is Rule 506(b). The key distinction between this regulation and Rule 506(c) is that the developer can seek cash from non-accredited investors, but they cannot solicit or publicise their offering to the general public. They can only take investments from persons with whom they already have a relationship. The following are the most important components of this rule:
- The developer is unable to publicise their offering or request public funding.
- Up to 35 non-accredited investors can contribute to the development.
- A non-accredited investor must have significant financial and business expertise and experience.
- Can accept investments from as many certified investors as they like.
- Investors must have a prior relationship with the developer.
- The developer has the ability to raise an endless number of funds.
This sort of crowdfunding is most commonly utilized by developers who want to raise money from friends, relatives, and individuals with whom they currently conduct business.
Developers can publicise their offering and raise funds from accredited and non-accredited investors under Regulation A. This exemption also comes with a slew of additional regulatory requirements and up-front expenditures for the developer.
Tier I and Tier II are the two categories of Regulation A offers. Rule 506(b) and Rule 506(c) have extra disclosure requirements, and both require the developer to have their offering certified by the SEC. The following are the basic regulations for both types of Regulation A offerings:
- In a 12-month period, the developer can raise up to $20 million from approved and non-accredited investors.
- In the states where they propose to sell securities, the developer must file and get their offering qualified by state securities regulators.
- There are no continuing reporting obligations.
- In a 12-month period, the developer can raise up to $75 million from accredited and non-accredited investors.
- State securities regulators are not obligated to qualify an offering.
- Reporting obligations that must be submitted with the SEC on a regular basis.
- Regulation Offerings are usually made through a real estate crowdfunding platform, which is nearly required due to the additional regulatory requirements.
Advantages and disadvantages of crowdfunding
While making any investment decision it is important to evaluate it on its merit and demerit. Listed below are some of the advantages and disadvantages of investing through crowdfunding:
- By investing through crowdfunding you will be able to invest in large projects which you thought were impossible for you to invest individually. In other words, real estate crowdfunding has made it possible for investors to access properties that were otherwise accessible to high-end investors.
- You can diversify your portfolio and thus reduce your risk of investment.
- By engaging in real estate crowdfunding you can also diversify the geographies in which you are investing. This is an important merit as different markets can function differently in a given circumstance. By diversifying your investment geography you can reduce the risk of price reduction in a particular market.
- Crowdfunding can be a good option to earn passive income as well.
- By investing through a debt or lending model, you are assured of your investment amount even if the property runs into loss and goes into foreclosure. You are treated as a lender under this model of investment and thus will be compensated firstly.
- The returns are shared and thus you will not be able to make as much profit as you would have made in the case of traditional investment.
- Investment using crowdfunding may not be a liquid investment as it cannot be converted into cash immediately in case of need.
- By investing through an equity model, you stand at a risk of losing your rights on the property if the property runs into loss and goes into foreclosure.
- By investing through the debt model, you will not receive a share of the profit and will only receive the invested amount along with the interest.
Real Estate Crowdfunding FAQ's:
Yes, crowdfunding is a good way to invest. It enables you to invest in large projects with a limited fund to invest in. By investing with little money, you can also restrict your risk. By investing through crowdfunding you are treated like a shareholder in a company and given a share of the profit earned from the property and also capital appreciation.
Yes, you can make money by crowdfunding real estate assets. You are eligible for a certain percentage of the profit and capital appreciation. By investing using the debt model, you can get the money you invested in the property along with interest.
Real estate crowdfunding is legal and a person investing in crowdfunding should abide by the provisions of the Companies Act, 2013, Securities Exchange Board of India Act, 1992, Securities Contracts (Regulation) Act, 1956, and Depositories Act, 1996. SEBI has however unauthorized the equity model of investment as it is risky for investors that are unskilled and inexperienced.
Real estate crowdfunding is safe to the extent of your investment in the property. The risk also varies based on the model you chose to invest in. Inequity model, you may be at risk of losing a large part of your investment or whole of your investment while on the other hand, the investment made through debt model may not be at high risk as in case the property runs into risk and goes into foreclosure, you will be compensated along with the other lenders.