It’s almost every week now that someone asks me about my thoughts on crowdfunding, and how it relates to commercial real estate and the revitalization of communities. Crowdfunding, for those that don’t know, is the practice of funding projects and ventures by raising monetary contributions from a large group of people, for smaller amounts than typically syndicators accept. This is typically done via the internet, but more and more crowdfunding companies are relying on a group of investors that they have already vetted.
A typical real estate crowdfunding model works very similar to a typical syndication of real estate. There is typically an independent sponsor that brings the deal to a crowdfunder, who then disseminates the deal and if anticipated returns are acceptable, will then take the project out to individuals and groups who then commit to the investment.
Since 2013 the overall crowdfunding industry has grown to over $5.1 billion worldwide last year (and projected to be over $10 billion this year) quickly becoming a viable model for investment. The major benefit of crowdfunding is that it allows developers new ways to finance projects, as well as smaller investors a way into a passive real estate investment, typically while supporting the communities they live and work in.
Developers can target their investors and attract ones from either a specific demographic or investment ideology, or investors whom often invest for reasons other than just the expected return. Some of these investors are willing to trade one or two points of an investment return for the possibility of doing greater good in the neighborhood, or just enjoy telling their friends that they own part of that building.
Many crowdfunding models try to incorporate a social aspect into their investments, putting together like minded investors to accomplish a goal, with the ultimate goal being to do well, by doing good. These goals can range from revitalization of a neighborhood (getting local neighbors to each invest a little to refurbish a rundown building), or to engage a social investment (either promoting educational, environmental, consumer protection, or diversity). Ultimately though, for these platforms to succeed, the core investment must still do well.
As a broker, private investor, and syndicator of deals, I do have some insight in how to project returns for investments. I am also acutely aware of how a sponsor, by slightly changing one metric, can exponentially increase the expected returns on a project. This is where I see the largest pitfall for crowdfunding. As a relatively young venue for investment, and with typical real estate investment horizons of 5 to 7 years (and sometimes as much as 10) many of the new crowdfunding companies are as yet untested. Also, from personal experience dealing with some crowdfunding companies, many of the executives seem to have very little real estate experience, with many primarily focus on banking, trusting the sponsor’s underwriting model which may at times be aggressive, or based upon an exit strategy that relies heavily on appreciation (realized in 5-7 years).
To minimize potential risks and downsides, many of these firms only deal with Accredited Investors as defined by the SEC (persons that make an income of $200,000 or more for the previous two years, or have $1,000,000 in assets, not including a primary residence). This effectively neutralizes one of the main benefits of crowdfunding – the ability for everyday people to invest in a project that they are passionate about and believe in.
I am not one for regulation, just for the sake of regulation. However, in an investment world that is ripe with fraud (or where a potato salad party can raise over $50,000) it is obvious that many of these investors are not necessarily doing the due diligence prior to making an investment. This is further complicated, by many of the real estate investment models (especially for those based on acquisition / Rehabilitation) being very complicated for the average person without a math degree to understand. I truly believe in the free market model, but I do believe that for the real estate crowdfunding model to truly gain steam and become a long term venue for everyday people to invest in, there needs to be more governmental regulation in how the deals are promoted, disseminated and invested in.
Either way, like the Wild West of yore, crowdfunding is here and offers unique opportunities for investors. However like the Wild West, if there isn’t a sheriff in town, you may want to make sure you check out the town, before blindly walking in, or investing.