Crowd-sourced financing meets urbanism

Crowd-sourced real estate financing has grown to a $200-million-plus business in just three years in the US. The industry is poised for even more growth next spring when new rules are expected to allow middle-class investors to take part.

This new industry combines technology created for websites like Kickstarter with financial returns for investors. It began with the JOBS Act (Jumpstart Our Business Startups) of 2012, which modified securities laws that dated to the Great Depression. Real estate development—historically an opaque, back-room business—can benefit from the openness of crowd-sourced financing. This concept allows an investor to place a small amount of money toward specific buildings in neighborhoods they like—and do it in a way that is similar to buying a mutual fund.

About 100 web-based firms have sprung up for this purpose, and some have experienced rapid growth. Few of these firms have a social “mission.” Small Change, a Pittsburgh-based startup by infill developer Eve Picker, is an exception in that its goal is to revitalize urban neighborhoods.

Small Change launched in October and has one project in the works—a tiny house in the Garfield neighborhood of Pittsburgh—and two more listed as “coming”—the redevelopment of a defunct brewery in Rochester, PA, and three infill townhouses in Pittsburgh.

The Brewery in Rochester, PA

Although the early projects are located in Western Pennsylvania, the goal is to operate nationwide. Picker points to patchofland.com, which took months to raise their first $100,000—but has grown to a $65 million business since 2013—as an example. “I hope we can do a small fraction of that,” says Picker, an architect and urban designer who refurbishes historic loft buildings. Her resume also includes a city planner job in Pittsburgh.

 “I like to develop real estate in a way that that does more than puts a building up, but also makes a change in the neighborhood,” she says. “I really believe good architecture and good design can be transformative—and cities deserve the best buildings they can get.”

To focus investments, Small Change created the "Change Index," a number from zero to 10 that assesses a project’s impact on revitalization and urban form. Walk Score, proximity to non-automotive transportation, adaptive reuse, location within a principal city, and “activating the street” account for about half of the index. The rest focuses on affordable housing, green building practices, job creation, and other measures. The index is well suited to infill New Urbanism. It is designed to incentivize developers to improve their projects and allow investors to assess their social impact. Each Small Change project will be assigned a Change Index score, which is fairly easy for developers to document.

The Change Index could help investors to do well as they do good—especially since high Walk Scores are associated with good financial outcomes and lower foreclosure rates, according to academic research. “There’s an incredible passion that people have for their city and to see their city succeed,” says Picker. Many people, especially Millennials, are interested in investing in something they believe in, she says. “It makes them happy if they can get a return while also making a social impact. I don’t want to invest in a mobile home park fund in California—I have got to assume there are lots of people like me.”

The kinds of projects that Small Change features are difficult to finance through conventional banks, Picker notes. The 350 square foot Tiny House is an example. “We can’t get an appraisal—we couldn’t find a similar house in Pennsylvania,” Picker says. “But the neighborhood is taking off. Google offices are less than a mile away. A Whole Foods is a half-mile away. Someone will buy it—and even if they don’t buy it, someone will live in it and pay rent.” Picker’s CityLAB is the developer.

The Tiny House

Picker also cites historic rehabilitations, which are often complicated public-private deals. A six-story vacant building in East Liberty, Pittsburgh, cost $2 million for Picker to fix up, but the bank would only finance $400,000. It’s now worth $4 million in a neighborhood that is rapidly revitalizing. Many mixed-use development projects don’t meet criteria for secondary markets—and banks shy away from them or charge high interest rates. 

The Small Change projects will have a pro-forma prepared to bank financing standards. “We will not host something on the site that we are not convinced will do well,” she says. “That involves a pretty hefty due diligence. It proves the project is real and the developer has wherewithal to do project.”

The minimum amount to be invested is a thousand dollars. The agreement spells out exactly how the investor will be paid. In the case of the Tiny House, the return is 7.5 percent annual. If the house sells within a year, the full 7.5 percent will be paid. Deals can be structured in many ways, and some may offer a percentage of returns over a period of years, she says. 

Currently, only “accredited” investors are allowed to take part in crowd-sourced financing, and that means affluent people. You must have either a net worth (excluding your home) of at least a million dollars, or income over several years of at least $200,000. But Title III of the JOBS Act was approved in early November, setting the stage for non-accredited investors—basically anybody—to invest in projects starting as early as next spring. Small Change was conceived with these investors in mind.

Investment amounts are strictly limited, based on income and net worth. Yet the deals are potentially more lucrative than keeping money in a bank and less volatile than the stock market. If an investor is familiar with a neighborhood and has confidence that values will be sustained, putting a limited amount of money into such projects could be attractive to a lot of people. Opening up this tool to non-accredited investors “could greatly boost the volume of deals and capital raised for companies, while allowing investors to directly access annual returns of 7 to 12 percent, industry executives say,” Reuters recently reported. 

A growing number of new urbanists have been focusing on small projects of 1 to 10 units built in a way that contributes to a whole neighborhood. Crowdfunding, particularly with a tool like the Change Index, is well-suited to that concept, notes Ben Schulman, the Communications Director for Small Change. “Absolutely, this is the type of financing tool that can help incremental development,” he says. 

Robert Steuteville is editor and executive director of Better Cities & Towns.