Part 3 of 3: So Who can benefit from STOs in 2020 and How?
Once you have a holistic understanding of the commercial real estate industry, the private and public securities industry with its regulations and limitations, and the various participants including the investor’s needs wants and desires; it becomes fairly obvious why STOs failed to launch in 2019. They were trying to sell a digital square peg into an analog round hole. The visionaries were trying to persuade establishment investors, investing in establishment investments that the STO would bring value to them, but the establishment knew better.
What is needed are: commercial real estate visionaries and innovators!
The blockchain visionaries have been saying from the beginning that this technology will enable the “democratization of U.S. commercial real estate” and it certainly has the potential to do so. But in order for this to become a reality, there needs to be some real estate visionaries with a holistic understanding of the entire ecosystem, who can navigate the complex web of regulations and bring a properly structured product offering to new investors, who will actually benefit from the added value of an STO. Much in the same way that the introduction of the REIT structure in 1960, for the first time allowed small investors access to commercial real estate investments.
This is the key point. It is the primary benefit and objective of the STO marketplace, to provide small investors not only in the U.S. but from around the world, access to private market investment opportunities and over time to provide liquidity as well.
There are only a few ways to legally access small investors for U.S., Private placement issuers or sponsors.
Friends and Family
Reg D exemptions – “accredited” investors only (relatively small investors)
Reg A+ exemption – non accredited investors (does require SEC approval and audited books)
Reg S exemption – non U.S. investors (subject to home country rules)
Here are some of the key regulatory obstacles that need to be navigated:
- SEC prohibition against advertising (Reg D-506(b) only, unless prior existing relationship)
- IRS requirement to withhold 30% of income for non-U.S. investors with no U.S. tax ID. No one is talking about this.
- SEC filing requirement – if total investments of $10 million or more and 2000 investors or more.
- SEC required minimum holding period before private shares can be traded. Different for equity shares and for debt shares.
Here are some commercial real estate realities that need to be navigated:
- Value-add (or development) deals are more risky than fully leased stabilized deals.
- Stabilized property prices have peaked and have more or less leveled off for the foreseeable future – no Cap Rate compression or market growth in value can be reasonably anticipated over the next several years.
- Investor dividend income yields are lower than years ago (estimated between 4% – 6.5%).
- Interest rates are low and stable and not expected to rise in the near future.
- Single property investment deals are more risky than multi-property fund deals.
- Multi-property fund deals are by necessity blind pools.
Some small Investor expectations may need to be overcome:
- Investors need to understand the benefits of an STO.
- The tradeoff between risk and yield.
- Expectations of higher yield income from real estate investments.
- Global investors may want income deals, but will not want 30% withheld until a U.S. tax return is filed and pay Home country tax as well.
- The tradeoff between income and growth.
- STO liquidity is coming, but it is not really here yet.
Some Additional Considerations:
There are few if any experienced broker dealers or money finders in the U.S. who have experience raising money from foreign smaller individual investors. Global investors will have to be reached through advertising.
You will see many Wall Street articles about the many $ Billions of foreign investment annually into U.S. real estate. Realize that they are talking about foreign institutional money and that they already have their international lawyers and tax strategies in place. So, from the prospective of the STO marketplace, they are indistinguishable from U.S. institutional investors.
Real Estate issuers need to start thinking about structuring their private offerings as if they were going to be a public company. For example plan on being a perpetual company, plan on having more than 2,000 investors and being an SEC reporting company. If you really want to provide access to global small investors you must have an IRS tax compliance plan that will work for both U.S. and global investors alike.
I can assure everyone. It can be done!