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Real Estate Crowdfunding: A Better Mousetrap?

You’ve probably heard the real estate crowdfunding buzz. Thanks to the JOBS act, accredited investors can now receive general solicitations, and the land grab to define and dominate a new niche within the real estate capital markets is well underway. Think Kickstarter for real estate, only now you own hard assets instead of receiving a free t-shirt for your investment.

The promise of the concept is clear. The real estate capital markets are not that efficient, both in terms of how capital is procured and the output of the invested dollar, there is plenty of room for improvement.

Attracting interest is often a challenge, because assets are unique and complex, and assessing risk requires considerable expertise and time. Industry participants’ bandwidth is quickly eaten up, and sooner or later they are overwhelmed. Their investment focus naturally skews to larger assets and they become very hard to reach. In short, investors are busy and deals complex. My mantra has long been: money moves when it is well informed. And it takes a lot of time to become informed enough to actually wire funds.

As for capital efficiency, imagine this: a teacher puts money into her pension fund; the fund engages fund advisors; the advisor selects an opportunity fund; the fund works with the brokerage community (which includes Fident) to secure a joint venture with the developer; developer does the deal with the teacher’s money and gets some of the profit. Perhaps 87 cents on the dollar invested by the teacher will get into the hands of the developer, and probably less than 50 cents of the profit earned by the developers’ deal will get to the teacher.

To say there is room for improvement is an understatement. This is a huge part of why the tech industry has the traditional model in its crosshairs. Reducing the cost of doing business by removing the middleman promises to be a positive disruption. With lower transaction costs, deals that are otherwise marginally unattractive may find buyers. Significant pools of capital can be freed to make new investments and realize growth.
It is worth noting that there are three main types of participants:

  • Portals that create a marketplace for investment (think ebay)
  • White label tech providers (like SAP) that enable you to be in this business
  • Partner platforms that manage a pool of investors from the crowd. They look a lot like a traditional JV partner, or lender, to the real estate operator. They’re more like one-off private equity funds where the manager gets a carried interest and fees.

 
So we get the excitement here, but there are real issues. The two biggest in my mind are securities law compliance and risk management.

Regardless of how they find the investors, a securities issuer is still a securities issuer. The SEC, FINRA, and others have a mandate – and onerous regulations – to protect investors. Sure, you can now put up a billboard with a big arrow pointing to the raw land: “$10MM development right here! Go to www.mydevelopment.com to invest!” but nothing changes with the regulatory burdens. (I believe many in the industry choose to ignore this, and I think we’ll see significant blowback from the regulators once a Madoff event unfolds.)

As much as we can all identify with the attraction of getting the teacher’s money directly to the developer, the teacher likely knows nothing about non-credit leases within grocery-anchored retail, for instance. There is real expertise and value in the process (friction) that gets the teacher’s money into the developer’s hand. Is there waste? Absolutely. But is our teacher ready to manage her own risk? Can she sidestep that costly chain of experts and select the proper opportunities?

Here we come to the second issue: risk. This is real estate. We cycle. The market is going to have downturns. Yes, this all sounds great, like an excellent way to make money. But how about losing money? Ever see a bank nose-dive that didn’t fail because of real estate? The mandate to the issuer is to provide transparency, to maintain investor relations, and to professionally manage deals even when they go sideways. Replace your three country club investors with 65 investors from the crowd and you now have 65 potential plaintiffs if your deal craters.

To me, crowdfunding is a better mousetrap. It’s a way to richly connect with thousands of global investors who can, on their own, elect to support an investment. Risk doesn’t go away, the regulatory environment doesn’t change, and the need to manage complex assets from cradle to grave perseveres. But, the tech vastly improves distribution efficiencies, and just the concept of broadcasting the opportunity to the world changes the very nature of content structure and texture for the better.

You can now legally put your marketing message in front of many, without knowing them or their financial profiles. Your broadcast is more than putting an ad in the NY Times or on Google, or making an infomercial. It is rich, technology-enabled content designed to empower do-it-yourself investors, whose job is to assess the risk for themselves, much like when you buy on eBay. Now that mass messaging is legal, these digital platforms will facilitate not only marketing, but also ongoing investor relations and reporting (think WellsFargo.com).

My sense? Be excited about crowdfunding—and be careful. As always, when you create value you’ll get paid.

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A few interesting participants in the space:
www.Realcrowd.com Portal to various offerings.
https://patchofland.com/ Partner platform focused on hard money. Fees and servicing to them, coupon to investor.
www.fundrise.com Partner platform for equity and debt.
www.realtymogul.com JV platform for equity and debt.
www.lendingclub.com An entirely different animal of peer to peer lending with $1B IPO pending. Part of the reason, I suspect, real estate is getting so much buzz.