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Crowdfunding's Next Hot Frontier: Real Estate Venture capital and angel investors are sinking money into startups that are innovating the way that buildings are bought.

By Catherine Clifford

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Crowdfunding has fundamentally disrupted the way that artists fund their creative projects and startups get capital to grow. Now, it's changing the way buildings are purchased.

Investors are eagerly backing a variety of new real-estate crowdfunding platforms, all of which aim to bring greater transparency, efficiency and access to the industry. Last week, Beverly Hills, Calif.-based Realty Mogul announced a $9 million funding round led by Canaan Partners, the same venture capital firm that has invested in peer-to-peer lending platform Lending Club and dating site Match.com. In the same week, Palo Alto, Calif.-based RealCrowd said it secured $1.6 million in a seed round from investors at Y Combinator, the Data Collective and a mix of real-estate developers. And two weeks ago, Atlanta-based Groundfloor announced it raised $300,000 from American Underground, Bandwidth Labs and a couple of angel investors in the region.

For the real estate market, Internet-based transactions represent a huge innovation. Historically, for a real-estate deal to close, lawyers would have to FedEx documents back and forth, says David Drake, chairman of VictoriaGlobal.co, a communications platform specializing in institutional investing and crowdfinancing. Not only is that slow, but it can also add up to tens of thousands of dollars in legal fees. Crowdfunding online side steps all of that, Drake says.

Related: Become a Crowdfunding Wizard: 8 Tips You've Probably Never Heard Before.

Real-estate crowdfunding puts more deals in front of more potential investors. "We have clients that say, 'We would have never ever found these investors without crowdfunding. Because we would never have known who to call -- in London! We have no idea who to call back in New York,'" says Drake. "You are expanding communication through the Internet."

Another reason venture capital dollars are flowing into real-estate crowdfunding startups now: the public has warmed to the idea of making investments online. What was once a new concept has taken off in a big way these last few years, with the Securities and Exchange Commission even making regulatory changes to expand crowdfunding's potential. "People, over the past five years, have become more and more comfortable with the fact that they can participate in these crowdfunding sites," says Hrach Simonian, a partner at Canaan Partners, the venture capital firm that recently invested in Realty Mogul.

Related: This Startup Wants to Protect Your Startup From 'Bad Actors'

So, how do these three freshly-funded real-estate crowdfunding startups work? Here's a brief synopsis of each:

1. Company: Realty Mogul

Headquarters: Beverly Hills, Calif.

Money raised: $10.1 million, including $9 million announced last week

About the company: With Realty Mogul, accredited investors pool their resources and buy shares of investment properties. Accredited investors have to be making at least $200,000 a year or have net worth of more than $1 million, according to the SEC. Eligible investors browse through real estate investment options online and track their various investments with a Realty Mogul dashboard.

So far, almost $15 million has been invested on Realty Mogul in 58 properties through 14 states.

Investing with Realty Mogul is an alternative to investing through what are called REITs, or real estate investment trusts. REITs are also pooled real-estate investments. Some REITs are publicly traded, meaning fluctuations on Wall Street affect the value of an investor's holding. The difference between buying a portion of a REIT and investing with the Realty Mogul crowdfunding platform is that an investor knows exactly which buildings he or she is investing in. This means that an investor has more control in his or her real estate investment decisions. Typical investments on Realty Mogul are apartment buildings, office buildings, retail shopping centers, self-storage facilities and pools of single family homes. An investor with Realty Mogul purchases a portion of an LLC managed by Realty Mogul or a portion of a real-estate-backed loan owned by Realty Mogul.

Another reason an investor would want to invest in real estate with Realty Mogul as opposed to through a REIT is because of a tax benefit. In a REIT, any deduction in assets is absorbed by the REIT. With a Realty Mogul investment, an individual investor is eligible to claim real estate depreciations on his or her taxes, decreasing the bill to Uncle Sam, points out Simonian of Canaan Partners.

Canaan Partners likes the idea of niche crowdfunding startups, having recently invested in Realty Mogul as well as Circle Up, a crowdfunding platform that helps consumer product entrepreneurs raise money to grow their businesses. Entrepreneurs running niche crowdfunding sites become treasure troves of information on the players in the space, which Canaan Partners considers beneficial. "You can really build knowledge and you can use the data to predict better performing assets over bad ones," says Simonian. "You can get smarter and better at predicting defaults, things that go belly-up."

How it makes money: Realty Mogul charges a 1 to 2-percent annual fee for administrative services such as reporting, cash flow distributions and tax documentation.

Related: Your Crowdfunding Cheat Sheet (Infographic)

2. Company: RealCrowd

Headquarters: Palo Alto, Calif.

Money raised, when: $1.6 million, announced last week

About the company: RealCrowd gives accredited investors access to the sort of investment options that are typically only available to real-estate managing companies. On the company's FAQ page, the one-word summary of why investors would need to use RealCrowd is "access." These are deals that, without the Internet services provided by real-estate crowdfunding, most investors would very likely never know about.

That access is exactly the appeal to the investors who are backing RealCrowd. "There's the potential for great returns, sure, but ultimately it's new access to a new investment that makes up a section of a healthy, diverse portfolio," says Alexis Ohanian, the co-founder of reddit and an investor in RealCrowd.

The number of real-estate-based crowdfunding platforms has accelerated in recent years because of the development in technology and increased public acceptance, but also because of recent regulatory changes, says RealCrowd co-founder Adam Hooper. In September, the SEC formally lifted the decades-long ban on general solicitation. Prior to the rule change, an entrepreneur could not try to raise money from an investor that he or she didn't have an existing relationship with. "Investment opportunities were held within this bubble of investors, these small networks of investors, and nobody outside of that network could ever participate," says Hooper. With entrepreneurs now able to publicize their efforts to raise money, there has been a "massive reallocation of how people can access these opportunities," he says.

Properties on the RealCrowd platform are geographically diverse, running from San Francisco to D.C. to Arizona and Alabama, says Hooper. "It really opens up access to people who would never even have the ability to really even know that these offers even existed." Real estate investments on RealCrowd are generally worth more than $10 million and are office buildings or apartment portfolio complexes.

When the SEC finalizes rules for equity crowdfunding among non-accredited investors, demand for sites like RealCrowd is expected to increase. "As we see more legislation to open up crowd-investing to a larger market, there could come a time when citizens aren't just figuratively invested in their communities, but literally as well," says Ohanian.

How it makes money: Real-estate managing companies pay a fee to RealCrowd when they are connected with investors. Investors pay nothing to RealCrowd.

Related: In Crowdfunding, Who is Responsible for Preventing Fraud?

3. Company: Groundfloor

Headquarters: Raleigh, N.C., with a subsidiary in Atlanta, Ga.

Money raised, when: $300,000, as of March 21

About the company: Groundfloor bills itself as a "peer-to-peer real estate lending marketplace." Unlike the previous two real-estate crowdfunding startups, non-accredited investors can participate on the platform. While investments on RealtyMogul and RealCrowd start at $5,000, investments with Groundfloor start at $100.

Until the SEC finalizes and formalizes the rules for equity crowdfunding, only accredited investors can participate in real-estate crowdfunding across state borders. That said, a handful of states, including Georgia, have passed laws legalizing equity crowdfunding inside their state. As such, Groundfloor solicits investments from all Georgia residents.

"Our investments are open to participation by everyone regardless of wealth or income," says Brian Dally, the co-founder and CEO of Groundfloor. "We believe financial opportunity should be equal and open to all. While there is nothing wrong with connecting wealthy investors with more opportunities for their money, that's not what gets us up in the morning. We see more challenge, more good to be created in the world and more market opportunity creating a true mass market product available to all."

The first two properties that Groundfloor funded were an $82,000 single-family home fix-and-flip renovation and a $440,000 new construction of four townhome units for sale in the Atlanta suburb.

How it makes money: Groundfloor earns money from borrowers who pay fees based on the amount of money raised.

Related: As Comment Period Closes, Debate Over Equity Crowdfunding Rules Rages On

Catherine Clifford

Senior Entrepreneurship Writer at CNBC

Catherine Clifford is senior entrepreneurship writer at CNBC. She was formerly a senior writer at Entrepreneur.com, the small business reporter at CNNMoney and an assistant in the New York bureau for CNN. Clifford attended Columbia University where she earned a bachelor's degree. She lives in Brooklyn, N.Y. You can follow her on Twitter at @CatClifford.

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