Concerned about Real Estate Crowdfunding

Why I’m Concerned About Real Estate Crowdfunding

Joe Stampone Featured, Innovation/Technology 25 Comments

Real estate crowdfunding is disrupting real estate finance by moving real estate capital raising online and making it open to everyone, thus disintermediating the middlemen. While I’m a huge advocate of real estate crowdfunding, (having said that) I’m really concerned about the space in the near-term.

Financial technology (fintech) start-ups are hot and it’s relatively easy to raise capital. However, we are in a high valuation environment for quick growth fintech companies due to the low interest rate environment, availability of capital, and the attractiveness of the fintech space. Real estate crowdfunding start-ups are valued based on top-line revenue and growth, so they have little incentive to focus on profitability. Therefore, most real estate crowdfunding start-ups are doing as many deals as possible, with little focus on underwriting standards. Compounding the issue, there are so many real estate crowdfunding companies competing with each other, VC’s are comparing who has the highest growth trend and assigning those firms with the highest valuations, creating a vicious feedback loop.

On the heel of big valuations for companies like Fundrise and RealtyShares, real estate crowdfunding companies will continue to pour into the space, raise capital, and do as many deals as possible in an attempt to boost their valuation.

The concern with this is that many deals/sponsors are being funded that probably shouldn’t and the retail investor, who often doesn’t understand the risk, will be in for a rude awakening when these deals go up in smoke. Further compounding this risk is the fact that we’ve been riding a hot real estate market, which has covered up a lot of bad deals/sponsors.

Deals will go bad, investors will lose money and unfortunately I think that’s needed to weed out the good real estate crowdfunding companies from the bad, and push the space forward.

There are some crowdfunding firms doing quality deals, however of the 140+ real estate crowdfunding companies, many are run by entrepreneurs who don’t understand real estate investment.

What aspect of real estate crowdfunding are you most concerned about?

  • BruceREFM

    Hi Joe, enjoyed this post. A lot in there to think about for sure.

    Some reactions:

    1. Have crowdfunders disintermediated the middlemen, or are they simply a new, technology-centric middleman with a fragmented source of capital? I would argue the latter.

    2. Yes, some deals will sour. This is precisely why the JOBS act is still only opening the door to accredited investors on the equity side. For debt-providing crowdfunding portals open to non-accredited investors, it’s harder for the capital providers to lose their money because it’s secured by the real estate, although not impossible.

    3. If a crowdfunding platform has a deal that goes south, that does not mean that it’s a bad platform. If they make a habit out of promoting deals that end up failing, then yes, they will eventually go out of business. But assuming that these platforms have the intent of being around for the long haul (which may or may not be the case for all), they will be forced to make smart bets again and again.

  • Hey @BruceREFM:disqus thanks for the comments. While I agree with everything you said, I think the bigger issue is there is a bubble forming in the valuation of high growth tech firms. The fact that VC’s value growth and top line revenue over profitability is leading to more RE crowdfunding sites and incentivizing them to do as many deals as possible. I have a feeling a disproportionate number of deals will go bad and I’m not quite sure how the retail investor will react.

  • BruceREFM

    I am not an expert on that, but my sense is that 95% of the real estate crowdfunding sites are not VC-backed, nor will they ever get VC backing. Nonetheless, they are startups, so they are desperate for business, thus the looser underwriting standards might in fact be an issue for concern. We shall see.

  • @BruceREFM:disqus agreed. I’m no expert either, but I think this is an external influence that impacts all stages of funding (angel, series A, B etc.). I hope I’m wrong, but it’s expensive to start a real estate crowdfunding site and it takes scale to become profitable. This timing mismatch forces start-ups to seek outside funding.

  • Sonia Savoulian

    Joe, I think you are spot on with your assessment. This pattern is very much like the flow of capital into real estate that led to the bubble in the 2000’s. Too much money made for bad decisions and bad deals. But that is the nature of real estate cycles. The downtown clears out those who are making decisions NOT based on real estate fundamentals. The aftermath provides the opportunity for committed real estate professionals to return to sound underwriting. Also to advance the industry based on the innovations and lessons learned from the prior cycle. Real estate crowd funding is just part of this process.

  • Hi @soniasavoulian:disqus well said, although I don’t see the space popping like a bubble typically does. However, as deals begin to go bad and investors lose money, regulation will come into play and companies will be forced to adapt. Thanks for reading!

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  • Crowdfunding is great when everything works smoothly but if it doesn’t, it opens a can of worms. I think right now lots of startups are launching same way during the dot-com era when computer startups are launching everywhere.

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  • There’s certainly no barrier to entry which is causing groups to flood the market.

  • Mark Kennedy

    Most of these crowdfaking sites make as much sense as some of the Uber inspired startups like Homejoy…remember them. 40M dollars later, and oops… I guess we can’t sustain a biz model that cleans houses for $19, but we have a really cool app. Wait I got an idea…what if Uber drivers also handed out PPMs for properties along their route. This has got to be worth a couple billion.

  • Haha, I can’t argue with that. Unfortunately, in this scenario, it’s the unsuspecting retail investors who are going to get burned.

  • Mark Kennedy

    Hey Joe, we’re told the deal flow is vetted and less than 10% of the deals get thru on the big sites (Fundrise and Realty Mogul). If that is the case where do the other 90% go??? Should we expect some new enterprising outfit pushing tAlt-A deals soon. To be honest, I would rather get local deals/with local sponsors with a little hair on them and some upside potential, vs the overbought NNN dollar stores in Tupelo with the 300bps spread.

  • Mark, the larger, more established groups, are going a great job vetting deals – Fundrise, Realty Mogul, and RealCrowd especially. I think the other 90% of deals either don’t get done or wind up one one of the other average crowdfunding sites.

    Great sponsors with access to great deals have no trouble raising money. So the question is, why are they crowdfunding this deal? I do think there are alternative benefits to crowdfunding which I’ve discussed before.

    For me, I’m investing first and foremost in the operational team, then the deal itself. Real estate deals are about buying at a good basis, formulating a strong business plan, and most importantly execution. Deals with a little hair usually are the best deals, when in the hands of great sponsors.

  • Mark Kennedy

    Thanks Joe-That is a very good point.

    I would be interested to get some data on the other 90%. Why are they turned away? Is it issues with sponsor, the economics, the presentation. My thinking is that there is gold in this scrap heap.

    After all, if crowd funding growth projections are on target, how are the CF sites going to keep up with demand. That said, can you see an opportunity to create a platform that takes the mildly defective deals and reworks the numbers, beef up the sponsors, bundles them according to food group, location, risk and sells them back to a CF site or PE, via an open source CF underwriting model.

    In other words, wouldn’t the CF sites, who are seeking to go national, be better off simply acting as a intermediary and outsourcing the deal origination and servicing to locals.

  • Mark Kennedy

    I guess this thing is going to be crowd-funded; a 500 million dollar Ferris wheel. Do we really need one that bad?

  • @disqus_Bj6wkIr6qu:disqus hahah, nope! But it’s one of those high-visibility, sexy deals that will get a lot of interest. That’s the thing about crowdfunding, it’s not the best investments that get the most attention it’s the ones with some sort of cache.

  • Pingback: 10 Telltale Signs You Should Avoid a Deal | A Student of the Real Estate Game()

  • Mark Kennedy

    Joe, what is your take on these guys or this type of crowdfunding format (platform that does not originate it’s own loans). Kind of a Wealthfront for RE. I am partial to this firm because they are based in my hometown Manhattan Beach CA – if you have never been there you need to go – awesome place; and a very Happy New Year to you and your very lovely new bride.

  • @disqus_Bj6wkIr6qu:disqus honestly I don’t know much about them, but I’m intrigued. I’m going to reach out to learn more. I’ll report back.

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  • @disqus_Bj6wkIr6qu:disqus if you haven’t already seen it, I did a recent post with PeerStreet co-founder Brett Crosby-

  • Pingback: My Thoughts on Real Estate Crowdfunding Part VIII [February 2017] - JRL Realty & Management()