What is the Difference Between Crowdfunding and Syndications?
Investing in commercial real estate has become more accessible to investors through the use of crowdfunding and syndications. These terms are sometimes used interchangeably, but they are not the same. Crowdfunding is a tactic of using mass advertising in the hopes of raising capital from a "crowd" outside of one's network; it is the means to attract and engage potential investors to syndicate a real estate opportunity. While crowdfunding advertisements are typically conducted online, it is not necessary to use this method. Crowdfunding has applications that extend beyond securities (think of a donation-based application like GoFundMe), and its use in syndications has grown since the JOBS Act of 2012 legalized publicly advertised offerings.
Crowdfunding is a method of finding investors or funders, whereas syndication is the grouping of these investors into a (real estate) transaction. In a syndicated real estate transaction, the syndicator (hereinafter referred to as "sponsor") sells to investors membership interest in a special purpose entity, typically an LLC, that will own and manage the asset. The sponsor may consist of multiple partners working as the management team and pooling capital from investors. The sponsor contributes the "intellectual capital" and is responsible for all the decision making and work involved with delivering the forecasted investment return to the investors. Because the investors have no responsibility to manage the details of the investment, the investors' involvement is "passive." Investing in a syndication can provide passive investors with several benefits:
- ⦿ Benefit from the sponsor's efforts to produce the investment opportunity
- ⦿ Ability to invest with others and pool capital to invest in more significant transactions
- ⦿ Pursue greater investment returns due to larger transaction size
- ⦿ Benefit from having a passive role in the opportunity
The membership interests that are sold to passive investors are classified as securities and subject to regulations governed by the U.S. Securities and Exchange Commission (SEC). Sponsors can legally sell their securities without having a broker-dealer license (also known as the "owner exemption"). Registration is a lengthy and expensive process that is utilized only when taking the offering to the general public. Otherwise, most sponsors choose to qualify their offering under one of two primary SEC exemptions under Regulation D, Rule 506(b) and Rule 506(c).*
- ⦿Rule 506(b) allows up to 35 "sophisticated" investors, but public advertisement of the opportunity is not permitted; the sponsor must have a substantive, pre-existing relationship with the investor prior to the deal. There is no limit on the number of "accredited" investors that may invest.
- ⦿ Rule 506(c), created under the JOBS Act of 2012, allows public advertisement of the opportunity, but all the investors must meet the income or wealth requirements of being "accredited."
Even with the addition of 506(c) to spur capital formation, it is estimated that over 90% of new real estate syndications are done under 506(b). This demonstrates the strong relationship and trust-based environment of these opportunities.
*This is a simplified overview of crowdfunding and syndications and is neither intended to be comprehensive nor legal advice. Check with www.sec.gov for specific criteria of accredited and sophisticated investors. Please consult with a securities attorney prior to engaging in a syndicated opportunity either as a sponsor or passive investor.