Over recent decades , the growth of urban jobs and population over U.S. cities has outpaced residential development. Nationwide, the number of new homes surpassed the number of new households from 1974 through 2008. But the building of new homes has not dramatically exceeded the number of new households since 2009, and housing prices have typically risen more than incomes1.
Years of underproduction of housing are due to: restrictive zoning, community opposition, increasing building costs , high impact and linking government fees, and lack of contact between developers and communities.2 All of these factors have slowed down and stopped residential development, pushing up prices as demand exceeds supply.
Crowdfunding may theoretically help address this issue by promoting regional investment in affordable housing through reforms.
Today’s crowdfunding regulations under Regulation A+ and Regulation D permit Approved Investors online crowdfunding, without comprehensive public registration and traditional disclosures preceding initial public offerings. However, there are legal risks for developers and little incentive to solicit investment from local residents. Reforms may serve a useful role in supporting affordable housing development which is financed locally.
One way would open up a new source of affordable housing funding and promote investment by residents in their communities: the Securities Exchange Commission (“SEC”) could provide guidance and safe-harbors for Regulation D and Regulation A+, creating a new category of “Community Investors.” Public developers may then invest in modernizing or constructing eligible local residential projects that meet or exceed the criteria of local affordability.
My plan will allow projects sponsored by Community Investors to adhere to a tightly tailored mini-disclosure system, including “Type AH” (Affordable Housing).
Whether it continues under Regulation D, or Form 1-A if it occurs under Regulation A+, Form AH will possibly be additional to Form D.
Projects sponsored by Community Developers will also need to meet or exceed the criteria for affordable housing to satisfy the SEC. Without Community Investors, real estate will continue to be financed through less risky and established private placement models that occur through relationships and brokers, not generally subject to federal securities regulations, and that exclude local populations.
Existing crowdfunding templates for real estate
The JOBS Act of 2o12 updated Regulation A+ and Regulation D to exempt online real estate crowdfunding from registration and disclosures that would otherwise be applicable to online securities investments. Registration is costly and time consuming, with forced disclosure repeated. Registration also brings with it greater exposure to civil liability.
Regulation A+ provides for sales up to $ 50 million and includes a similar reporting in detail to the reporting of public corporations. Accredited investors (as specified in Regulation D) and unaccredited investors (up to a maximum of 10 percent of income or net value) can invest in offerings under Regulation A+. Under Regulation A+, businesses such as Fundrise, which operates 16 “eREITS” function. Fundrise provides only common shares of its eREITs to investors whose participation does not reach the threshold of 10 per cent.
Like other emerging investment platforms in real estate, Fundrise (i.e. Lex Markets and Cadre) does not encourage localized investment and does not specifically encourage affordable housing development.
Alternatively, crowdfunding could make use of Regulation D.
Rule 506 of Regulation D allows for the inclusion of up to 35 non-accredited investors in an bid under Rule 506. Those investors who are not accredited must have sufficient financial knowledge and acumen to evaluate the investment. Cadre uses 506(b) to permit an unlimited number of Approved Investors, including individuals with income over $200,000 or $300,000 in conjunction with a spouse, or a net worth over $1 million.5
Accredited investors are the preferred investors because fundraisers (issuers) are less responsible for ensuring the sophistication of the investors. There’s less room for insufficient disclosure allegations from non-accredited investors in accredited-only deals. Crowdfunding companies may get non-accredited investors to invest. Nonetheless, this move will make fundraising more practical and less costly from the non-accredited investor exposure.
Although Accredited Investor revenue caps have not been changed for decades (increasing the pool of Accredited Investors), many still consider real estate investment out of control.
The SEC introduced amendments in December 2019, and requested input to extend the concept of Accredited Investor. The proposal proposed widening the accredited category on the basis of “technical expertise , experience, or certifications. “6 The Group Investor Regulations comply with developments in order to lessen the strict definitions of accredited investors and compensate for the expertise of their respective communities and trends.
Expansion of Regulation D could guide existing crowdfunders and help better build communities through expanded funding opportunities for more transparent and community-linked development and housing stock.
System for Public investors & disclosure
A new SEC regulation could require Community investors to apply under Regulation 506 and Regulation A+ and to benefit from it. Local investors will need to provide evidence of jobs and income and fulfill a condition of 2 years of residency. Developers will have to complete more precisely focused, mandatory forms to include non-accredited investors and group investors7.
Congress granted Section 36 authority to the SEC to exempt any individual, transaction or class from any SEC rules where required or reasonable in the public interest and consistent with the security of investors. Various government programs have repeatedly considered development of affordable housing to be in the public interest. However if this Community Investor Regulation does not function explicitly under Section 36, it supports the spirit of Section 36 and is compatible with that.
Existing issuer disclosure regimes do not easily map digital asset offerings and blockchain technology well on crowdfunded. Likewise, types of crowdfunding are not well suited by non-reporting companies for real estate growth. Revised regulations will provide greater clarity, reduce the chances of litigation and promote broader fundraising.
Under the latest SEC Form AH, required filing (modeled after the full S-1 IPO and the mini-IPO systems A+) will be done.
Type AH will include: project summary and compliance with the criteria for feasibility and estimated construction costs, as well as rent rolls. The new Form AH will also include narratives that include all debt and equity participants with industry and local market data, risk factors, and histories.
Form AH will request specific developer details including: other owned properties, construction track record and pipeline, and a property-specific management plan. Form AH may require statements about expected economic and social impacts.
Finally, this property-specific report will include anticipated financial returns and investment exit options, and should state whether the return on the community’s equity varies significantly from the returns of other parties in the transaction.
The rules on disclosure should be designed to elicit brief responses to increase the chances of developers filling them out, particularly smaller developers who do not have sufficient resources to comply with comprehensive disclosure. Shorter forms also increase the chances that they will be fully read by Community investors. These forms would help to better inform voluntary disclosures already provided to Accredited Investors, as well as mandatory disclosures to non-accredited investors.
Most developers would be wary of subjecting themselves to the control of securities laws. Therefore, the rules on innocent and insignificant errors and related beliefs, which can prevent offers from losing immunity from Regulation D, will refer to these new regulations. Furthermore, certain laws of redemption should be applied more broadly.
Investor involvement in the Community
Residential developments are often blocked as a result of vocal opposition and a lack of local support aside from support from developers and trade groups. Rule 502(b)(2)(v) requires issuers to give an answer to questions to investors. 502(b)(2)(v) may be extended for initiatives sponsored by Community Members, including group meetings (including virtual meetings) with question and answer sessions.
This mechanism will help residential developments gain more community support in robust planning and entitlement processes, including for compelling deals with multiple investors vying to invest and not having crowdfunding. More accountability is provided by required meetings with Group Investors. This is different from the complexity and opacity that undermines coin offerings; this complexity increases the risk of fraud , misrepresentation and lawsuits. The rules regulating Community investors are a conduit for greater civic engagement and support.
The SEC may also offer tools and guidance materials for Community Investors to better assess investments, as well as forms AH itself. Materials should advise about industry standards and the value of verification by the third party.
Advertisement and resale of interest to Group investors
The SEC should consider relaxing resale restrictions as part of this reform to allow investors to sell to other qualifying Community investors.
Community investors should be expected to provide to secondary market Community investors all forms which they initially provided. Resale will only be authorized if there is notification of material changes from the initial disclosures. This will make the resale strategy of Regulation D more in line with Regulation A+.
Permissive resale will minimize the discount on liquidity, which decreases the value of securities that can not be resold freely. Requiring resale only through online third-party funding platforms will include an additional layer of project screening and publicity.
Funding sites now provide opportunities for location and community-centered crowdfunding. Startengine features Power2Peer which has fundraised under Regulation A+ (subject to rules on accredited and non-accredited investors) and Regulation CF. Power2Peer is creating a marketplace where users can support and purchase local renewable energy sources. A category of Community Investors would allow regional ventures to succeed by offering more freedom to seek fewer legal restrictions from their jurisdictions, while Form AH might provide appropriate reports.
Regulation D advertisement and solicitation laws do not need to be substantially altered by Group investor permits. Currently, 502(c) restricts general solicitation, such that broader advertising is allowed solely with Accredited Investors in 506 offerings. Such guidance will provide Community Investors with protections for ads, with recruitment only allowed in localized areas and community-controlled targeting.
Trial span not for profit
The SEC could potentially limit these permissions for community fundraising only to existing, affordable housing developers with no profit. Allowances only for affordable housing developers with a non-profit ethos will make non-profits more competitive in raising capital and increase their impact on cities. A non-profit trial period may show whether the rules of the Community Investor can be applied to organizations with a benefit.
Furthermore, a non-profit trial period may provide data to decide whether resale would only be allowed to other Group members, or to the general public.
The involvement of Community members in non-profit ventures using Form AH will provide proof of concept. Such trials will illustrate the benefits of community fundraising to well-established, adequately financed developers who are wary of triggering more regulations.
Shape AH can then be used by existing developers to gain community support that can assist with planning and zoning processes