Property crowdfunding is an increasingly popular sector with obvious attractions; manageable risk, a democratic process and an accessible form of investment with a more predictable chance of rewards. The principle of property crowdfunding is that individual investors use a tech-based online platform to collectively pool funds towards a property development project, on the basis that their investment is rewarded by potential future returns, or definite returns, depending on the type of investment.

Ultimately, a property crowdfunding scheme offers benefits for both parties; the investor and the party offering the investment, but how is this controlled? The UK has been a forerunner in the crowdfunding sector and has been quick to develop regulations to protect the consumer, and this article is designed to offer an overview of the general legal framework of a property crowdfunding investment, and how property crowdfunding platforms must market their investments to protect the potential investors.

A property crowdfunding platform is essentially a mediator between the sponsors (the party offering an investment opportunity) and the potential investor. The platform introduces the two parties to each other and manages their relationship thereafter. So the platform has responsibilities towards both these parties, ie. for ensuring that the party offering the investment is being fully compliant in what it is offering, and that the potential investor is a capable and reliable investor in terms of criteria and credit history etc.

There are generally two types of property crowdfunding investment:

• Equity

Where multiple investors commit money towards a property development project and have partial ownership of the development based on their percentage investment. So if they invested £200 towards a £20,000 funding target, they would hold a 1% share, and if they invested £2000 they would have a 10% share. Once the development is completed, investors can expect possible returns based on rental income, or profits from the eventual sale of the property, or both. These returns would be commensurate with the percentage share they have in the investment, but of course there is no guarantee that the property will earn rental income or sell at a profit. Also, it is important to note that the investor is only liable for the percentage of their investment.

• Debt

With a debt investment, also known as peer-to-peer or P2P lending, individual investors effectively loan money to a property developer to fund a development project. Again, an individual can invest a percentage of the total funding target. The difference with debt investment is that the investor is guaranteed a return, because they receive a fixed monthly amount when the sponsor pays their money back with a pre-agreed amount of interest on top. So this may be less lucrative than the potential returns of equity investment, but debt investment at least guarantees some form of return, which is a known amount from the outset. From a legal point of view, this is a loan to the sponsor and so the sponsor is in debt to the investor.

Both of these types of investment follow the same kind of process:

• An investor registers their interest with the crowdfunding platform
• A minimum/maximum investment will be made clear, along with any fees required, by the platform
• The investor researches the information relating to the investment offering
• The investor chooses an investment and commits
• The platform provides information to enable investors to monitor progress with their investment
• The investor receives dividends depending on the type of investment and how it has performed.

Whether the investment is an equity or debt investment, the platform offering it must conform to standards set out by the UK’s Financial Conduct Authority (FCA). This ensures that a criteria for investors is set out, so that people investing have the means to do so and are not committing a dangerous level of their own financial assets. It also ensures that investors are made aware of the risks and have full transparency of the investment.

Because property crowdfunding is a three-way process involving property, finance and technology, it is a complex situation in terms of regulation and compliance. As a relatively new business model, there are natural concerns for potential investors, particularly as the sector is rapidly evolving.

However, there are controls in place which property crowdfunding platforms must comply with:

• Licensing

While there are variations to this depending on the local jurisdiction of different global markets, in the UK a property crowdfunding platform must go through an FCA authorisation process to obtain a licence to operate. This is to protect consumers and market competition, and involves a platform providing a business plan, along with evidence it has the knowledge and experience of the relevant financial regulations. There are various stipulations which come with this FCA licence, which we will look at in more detail shortly, but chiefly, the FCA needs a platform to confirm that investors are fully informed of and understand the various risks of an investment before they commit to it.

• Investor protection

A platform must carry out due diligence on an investment proposal to guard against fraud and misrepresentation.

• Disclosure

A platform must ensure investors receive all the information necessary on the property itself, the development plan and the potential risks, in order for them to make informed decisions before committing.

• Investment limits

A platform can apply restrictions for how much can be committed by an individual investor, and of course there are fixed goals for how much each project needs to raise. These controls seek to mitigate risk for an individual. The platform can also set criteria for investors based on high nett worth, or to restrict investment to people committing less than 10% of their net assets.

• Misleading information

A platform should not market an investment opportunity in a way that produces unrealistic optimism. The potential gains and associated risks need to be made very clear, and where comparison figures are used these should be represented correctly, for example, comparing interest rates on a debt investment with interest rates on a savings account.

• Data protection

With this being an online platform of course the personal data and financial data of all investors should be secured and protected at all times.

Investor protection and transparency is essential in property crowdfunding, because the success of a platform and its individual offerings hinges on a collective trust in the platform itself. Bear in mind that one of the key attractions of property crowdfunding is its accessibility to inexperienced investors. People are naturally wary of digital investments, so it is critical that a platform is open and transparent in how it markets an investment opportunity and how it subsequently performs.

• Proposal information

The initial offering needs to be detailed so that no investor can say they are going into it blind. There is no limit to how much information you can supply in terms of development plans, financial projections and property surveys. The platform should also demonstrate that it has carried out sufficient due diligence on the property and land etc, by providing information on property titles, surveys and feasibility studies carried out on the proposal itself. Realistically, no one is going to read everything, but the platform has a duty to provide everything, so the information is there and accessible for everyone at all times.

• Fees

A major element of being open and transparent is declaring all the relevant costs and fees upfront. Nobody likes nasty surprises, and it engenders mistrust if people think they are going to be hit with another charge any minute. Fees are required for various different things, but people generally expect this, and as long as there is clarity, nothing is hidden and all the necessary costs are declared upfront and given an explanation to justify them, this will help investors trust a platform.

• Performance reports

People are naturally inquisitive and anxious about an investment and will want progress reports even when there is nothing to report. The platform needs to make sure projections are updated to reflect market changes, and you can also report on costs such as maintenance and repairs, as this will potentially impact on investor returns. But when there is actually progress to report, the platform must be vigilant to inform its investors on project completion, rental income, occupancy rates or possible sales. Much like pre-commitment information about the proposal, there is no limit to what and how much information the platform should give people.

• Dashboard/communications

Following on from investors receiving progress reports, the platform should also provide an online portal through which it is always contactable and people can feel part of a community. This can be how investors receive their progress reports, in terms of real-time insight and analytics, but it is also how they communicate with the platform. Open communication is a big part of building up trust, so the platform needs to always be available and contactable, there should be a process for two-way communications, and investors should be able to raise comments, questions and feedback.

• Governance

While it is great to be part of an investment community, and there is an element of protection from being part of the crowd, there still needs to be governance and structure. A platform can generate trust by making its structure clear in terms of who makes decisions, how this is communicated and issues such as conflict resolution. People will accept that you can’t have a lawless and unruly structure and will feel safe and protected if they can see how the platform is governed and managed.

• Exit strategy

An essential element of any investment strategy is how you plan to get out of it. So this is defining what options you have for ending the investment whether it is going well or going badly. An investor wants to know how they can liquidate their investment, when this can happen and what it will cost them. The platform should make this very clear and provide a range of different scenarios in terms of how the investment ‘could’ perform, and what the investor can do in each case, with clear costs and risks explained.

In terms of having a legal recourse if an investment opportunity isn’t going well, a property crowdfunding platform needs to make itself available for communication. In the first instance, you want an investor to address the platform with any immediate concerns. After that, the platform should provide a facility whereby the investor has a 14-day cooling-off period, during which they can withdraw from the deal. This is a stipulation of the FCA licence.

Investors can get in touch with a financial ombudsman service if they wish to take a complaint further, but the impact of this can be mitigated if the platform has provided the correct information on the investment opportunity and done as much as it can to ensure the investor understands the risks of the proposal.

A platform safeguarding itself against legal challenges has a lot to consider, however. These include:

• Having the right legal structure for the investment proposal
• Providing correct and sufficient information on the due diligence of the investment opportunity and its potential rewards
• Controlling who is eligible to invest
• Verifying the identity of investors
• Cyberattacks and protecting data
• Controlling payment processing
• Marketing – where you can advertise a proposal and not misrepresenting a proposal

These are the key issues a property crowdfunding platform needs to consider, and these can largely be managed through how the FCA regulates the sector and how you must conform to the requirements. Essentially, if the platform carries out due diligence and provides sufficient information on the proposal, is clear and realistic about the risks/rewards, has a robust criteria controlling who can invest and is clear and vigilant on reporting progress, this should sufficiently protect the consumer and largely mitigate against damaging legal issues.