Could crowdfunding be the new frontier for real estate investing? Crowdfunding is an emerging industry alternative to property investment trusts for modern investors looking to gain exposure to real estate.
Crowdfunding is a growing phenomenon, based off of collecting funds from groups of individual investors to make a great variety of projects a reality with the funds raised.
So far, crowdfunding has been a significant capital-raising tool, and the World Bank predicts that in a few years the crowdfunding industry as a whole will be worth an estimated $93 billion. In the US alone, crowdfunding has grown by nearly 145%, with real estate making up a significant amount of that number.
However, despite this promise of capital appreciation, there are still significant challenges for this budding industry to overcome before it can reach its full potential as an investment space. Below, we examine some of these challenges and opportunities that crowdfunding will face in 2020.
Challenge: Lack of Track Record
Crowdfunding is still a young industry, and as such, it needs to be established more definitively to be considered a viable alternative to currently established real estate investment solutions. Typically, the innovation needed to transform an entire industry can take several years. With a new field like crowdfunding, the lack of track record raises other questions for investors, for example, what happens if the crowdfunding platform shuts down? The reality is that many of these platforms are not cash flow positive, and investors will naturally have questions about the risk surrounding their investments (as they should).
Generally, should a crowdfunding platform suddenly close down, investors would want some measure of investment protection or surety. Nobody likes to lose access to their hard-earned capital, especially in an unexpected manner. This is a complicated challenge, but not one without a solution. Crowdfunders should have a solid balance sheet, and appoint a receiver or a trust that would take over in cases of insolvency.
Challenge: Industry Standards
Because real estate crowdfunding is still a largely unestablished space, there are only a few industry standards or control measures that have been put into place thus far. As such, while existing crowdfunding platforms have shown some early signs of success, there have not been enough cases to show successful long-term outcomes as a consistent result.
There is also the issue of how these real estate projects are valued by crowdfunding platforms, based on which criteria, without clear industry standards put into place. Valuing real estate is arguably one of the most important factors in the success of such investments and will dictate potential performance. Without some clarity as to how these properties are selected by crowdfunding platforms, there is the potential that they could have been overvalued, and the returns won’t be as high as expected.
In order to achieve these standards, there is still some work that needs to be done. Things like introducing transparent regulatory frameworks, clear and uniform valuation methodologies and other consistencies in order to allow investors to have a deeper look at these very important vectors of their investment.
Challenge: Little Independent Investment Advice
The majority of investments do not offer guarantees of success, and the same applies to real estate crowdfunding. Therefore, finding reliable investment advice for this fledgeling industry is difficult. In more traditional areas such as stocks, people can visit an investment advisor or wealth manager for recommendations and ideas, or check out places like Morningstar to get performance ratings and other investment management services.
At present, no such advisory services are available to crowdfunding investors, which is an important challenge the industry will have to overcome. Without such guidelines from more-experienced professionals, newer investors may be too intimidated to make more significantly-sized investments because they don’t know how to maximize their returns or select the projects with the highest potential to perform well. In such a new field of investing, it’s safe to bet that many investors will be hesitant to participate without clear guidelines in the form of precedents set by others, and it may be a while before crowdfunding is familiar enough to have them.
Some of the regulatory challenges involve supposed ‘investor protection’. Not too long ago, the JOBS Act was passed which opened up investments to non accredited investors under Reg CF. However, Regulation CF only allows for raising a maximum amount of just above $1 million, hardly enough to make a significant dent in real estate. The majority of crowdfunded real estate projects instead rely on Regulation D, which allows for the raising of unlimited amounts, but only from accredited investors. Further, crowdfunding platforms based in the US that want to use Reg CF have to register with the Securities and Exchange Commission in order to legally comply with raising regulations. While the intent of these regulations may be good, it limits options for both security issuers and investors as a whole.
There has recently been some pressure from the industry to increase the maximum amounts that can be legally raised under Reg CF to be $20m or more. This will allow many more later-stage companies to raise using these specific exemptions, and allow larger real estate deals to do the same. The regulators are currently looking at balancing these industry desires with strong investor protection in a more balanced approach.
The crowdfunding industry still has some significant challenges to overcome in its journey towards becoming a fully established investment alternative to the options already available in the real estate market right now.
It’s important to note this still doesn’t take away from the industry’s overall potential - by the year 2025, the crowdfunding sector is predicted to raise $300 billion USD and real estate likely will make up a large part of that number. The key to these challenges is that they are conquerable. Real estate is a great way to diversify a portfolio, and crowdfunding will put the tools of this diversification into the hands of the many.
About the Author:
Kirill Bensonoff is an immigrant, investor and a serial tech entrepreneur with multiple exits. He is an expert in enterprise IT, blockchain and fintech. Bensonoff currently serves as Chief Product Officer of New Silver, a fintech non-bank loan originator.
As a graduate of the EO Entrepreneurial Masters at MIT, he has served as both an advisor and angel investor to over 30 different companies. As a mentor at the MIT Enterprise Forum, Kirill has helped startups with scaling, product market fit and growth strategies. Kirill invests personally and via the Chain Reaction Boston group, as well as with the Blockchain+AI syndicate on Angel.co.
Kirill runs an entrepreneurship-focused podcast called The Exchange With KB, which has produced over 20 episodes to date. He has been published or quoted in national business and technology media, including Inc, CNN, The Street, Forbes, Huffington Post, Bitcoin Magazine and CoinTelegraph, and others. More information is available on kirillbensonoff.com.