Small investors: imagine owning a property by browsing a website and buying a piece of property that appeals to you - just as you buy a piece of clothing you find appealing online from one of your favourite brands.
Prospective entrepreneurs: imagine pitching a project or business through an online platform and raising funds from hundreds of interested investors without giving lengthy pitches to multiple investment banks or venture capitalists.
Crowdfunding, at its essence, is exactly that. It connects crowds with entrepreneurs where crowds invest in a project or business pitched by an entrepreneur through latter's crowdfunding platform. Crowdfunding has enabled a hassle-free way to find, research and support causes, projects and organisations, and contribute or invest directly without a middleman.
Crowdfunding may seem like a modern idea, but it has its roots going back to the early 18th century when the Irish Loan Fund was established by an Irish nationalist to provide loans to poor but creditworthy people in Dublin. The idea was so successful that it resulted in wave of imitations, as well as establishment of an official Loan Fund Board a century later.
However, the modern, online crowdfunding occurred in 1997 when a British rock band funded their reunion tour through online donations from fans who wanted the band to perform live in the United States. One of the band members emailed to his 1,000 person mailing list, telling them that the band would lose US$ 60,000 if they went on tour. This led to fans contributing the money to the band, with one fan volunteering to put the raised funds in escrow in his back account, to be returned if not enough was raised. The campaign ended up raising the money and the band went on tour. But the impact of this email resonated far beyond one band tour.
Inspired by this alternative means of financing, several crowdfunding platforms began to emerge across the globe. However, the focus of this article would be on crowdfunding where small investors contribute money to acquire real estate and crowdfunding operators manage such real estate by earning management fees from it - akin to fund managers managing a property collective investment fund and earning performance fees from the fund. This real estate crowdfunding model has gained popularity outside the UAE and is a potential opportunity for both the small investors and crowdfunding operators alike.
Regulatory framework for real estate crowdfunding in the UAE
In 2017, the UAE took the lead in GCC region when the Dubai Financial Services Authority (DFSA), the financial regulator in financial free zone of Dubai International Financial Centre (DIFC), introduced regulations for loan and investment based crowdfunding platform (and later property based crowdfunding), with the aim of protecting the rights and obligations of both the parties involved in crowdfunding: investors (i.e. the individuals interested in investing) and crowdfunding platform operators (i.e. the entrepreneurs intending to raise money for their project or otherwise seeking to earn income from business ideas pitched by them).
Setting up a real estate crowdfunding platform
Entrepreneurs desirous of operating a real estate crowdfunding platform would first be required to obtain a category 4 licence from the DFSA. Once a licence is granted, the crowdfunding operator may operate in and from DIFC to target investors intending to contribute their money to buy real estate under a crowdfunding structure.
The operational structure for a real estate crowdfunding broadly works as follows:
- the crowdfunding operator sets up a special purpose vehicle (SPV) for the purpose of purchasing a property from the funds raised from the investors (as per the requirements of Dubai Land Department such SPV may only be set up in DIFC); and
- the SPV to have a set share capital (e.g. 100,000 shares). By way of illustration, if a property is worth AED 1 million and each share in such SPV is worth AED10, then the investor will own 1,000 shares or 1% of the property if he decides to invest AED10,000.
The shares will always be the property of the investors and they remain the ultimate beneficial owners. The crowdfunding operator does not own any shares in the SPV, rather it serves to facilitate the entire process for the investors and earn performance fee.
A separate SPV is required to be set up for each of the properties and the title deed of each such property is issued in the name of a relevant SPV. The properties must only be residential properties and consist of an individual apartment, house or building with a single discrete title deed. It is possible for a property to be situated outside the UAE so long as it complies with the local law requirements of that jurisdiction.
Key takeaways for investors
- The investors get the opportunity to get involved in lucrative real estate sector of the UAE by investing only small sums of money. The investors can invest amount as less as AED 1,000.
- The investors build a portfolio in some of the most iconic properties situated in high-income neighborhoods of Dubai, diversifying investment risk as a result.
- The investors are not responsible for upkeep of a property. This is performed by a facilities management company appointed by a crowdfunding operator.
- The investors (being the shareholders in an SPV) receive returns in form of dividends proportionate to their shareholding in the SPV. The SPV's income is usually comprised of rental receivables. The investors may use such rental returns to supplement their monthly income.
- The investors may also meet at the end of the investment term and can vote in a shareholders' meeting to sell the property. A secondary platform may also be created online allowing investors to sell their shares in an SPV before the end of investment term.
Key takeaways for crowdfunding operators
- The crowdfunding operators get the opportunity to access largely untapped retail investors who are otherwise not able to invest large sums of money.
- The crowdfunding operators get to earn a subscription fee, administration fee, property management fee on the rental income, and exit fees.
- This model is suitable for those crowdfunding operators who are otherwise not able to set up and manage property collective investment funds due to more stringent regulatory requirements for fund managers.
Crowdfunding has the potential to become the future of real estate investing in the UAE (particularly in Dubai). Dubai still offers investors one of the most attractive rental yields in the world. Besides diversifying risk, real estate crowdfunding has other advantages: it is digitalised and allows access to real estate market that normally requires a large amount of capital. The investors who cannot afford investing huge amounts are able to take advantage by contributing through a crowdfunding platform, while the crowdfunding operators have the advantage of tapping a large segment of retail investors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.