Rethinking Real Estate Investment

I was fully intending to write something appropriate for the post-Thanksgiving consumption frenzy, it being Cyber Monday after all. Perhaps a piece on how mall design came out of traditional downtowns, which are now seeing a resurgence, but are looking more and more like malls… But I just cannot for the life of me focus on that because of this article from The Atlantic Cities on a new model of real estate investment that is hopping around excitedly in my brain. What these real estate developers are doing in DC is really phenomenally amazing and simple: developing real estate with funds from groups of people who are interested in the specific property, neighborhood or building, perhaps because they live or work there.

The history of modern financial investment has been the story of people and their money moving farther apart into abstraction, to the point where most of us don’t know where our investments (if we have any) have gone. But shorten the distance between those two points, and things start to change. Put your money into a building you can see in your neighborhood, and suddenly you might care more about the quality of the tenant, or the energy efficiency of the design, or the aesthetics of the architecture.

The investment model described in the article does not happen often due to investment regulations which are designed to protect the uneducated investor. This limits the option for regular people who are not rich, affiliated with a non-profit development organization or connected with real estate developers to invest in local projects.

Many a year ago I took a class on producing films. This was the first time the odd rules regarding approaching potential investors for non-publicly traded ventures were introduced to me. The teacher of the class was not very clear on why one could only ask a certain number of people for money (I think he said the max was 20), only that that was the rule. Later I learned that this was due to Regulation D which requires that there be no “general solicitation.” This and other rather confusing SEC regulations limit the ability of small businesses to ask for money from the general populace.

Note that even investment clubs are required to register with the SEC if they make a public offering and/or they exceed 100 members. Conversely, ordinary people buying stock in a large real estate development company are not likely to influence the decisions of that company or even know for sure what projects they will fund ahead of time. Large companies might be more interested in the monetary return of a project, and thus would be inclined to sacrifice qualities of a building that local residents find to be necessary in exchange for maximum floor area and investment return.

Most of the small scale non-residential development that occurs is from small private companies or individuals. Large real estate developers, CDCs or other groups with specialized interests (usually affordable housing or community facilities) do not appear to be interested in [re]developing small commercial or industrial properties in a heavily residential driven real estate market like New York City. And those that would, might not be interested in adding additional expenses on these lower-yield investments by incorporating local preferences into the architecture or betting on new local businesses as tenants.

All of this does not leave much room for someone to ask for money from the general public to fund a small-scale project. So what Ben and Dan Miller (the folk highlighted in the article) eventually decided to do when they used the lesser known Regulation A to develop a small infill commercial property was really quite different:

The SEC does, however, have a little-used mechanism – Regulation A – that permits small offerings to unaccredited investors in exchange for time-consuming and financially costly scrutiny by both federal and state regulators. In 2011, 19 such offerings were filed with the SEC. Only one was eventually qualified: a revival of the Broadway musical Godspell. This is the arcane regulation on which the Millers set their sights. Their proposal seemed wholly unrelated to Broadway, but in fact what bound together Godspell’s investors – mostly musical enthusiasts – was a personal stake in a local, tangible project.

Recent changes by Congress are making Regulation A more flexible. This can potentially fill a gap for funding small scale industrial development in NYC (and other older industrial areas with smaller lots), especially those neighborhoods that have residents and industry in close proximity. I for one am really excited about this potential new investment model for real estate and hope that some cool new projects come out of this. Fingers crossed, but having local interested investors may even be a way to help develop a better use mix in areas which are suffering from quality of life or mixed-use conflicts.

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