Real estate crowd-funding: Simulating the banking industry’s methodology to provide affordable affordable housing & bridge housing deficit in Nigeria

In paragraphs of few lines, in this article:

• How real estate investors can emulate or draw a parallel with the commercial banks’ strategy of reducing high cost of funds
• Real Estate Investment Trust (REITs) and crowd-funding
• Retail banking: Using Pareto’s 80/20 Principle to explain crowd-funding
• Pareto’s 80/20 Principle: Using the ‘pot-hole and well’ theory to explain crowd-funding
• Crowd-funding: Using Pareto’s 80/20 Principle to explain the real estate portfolio myth
• Ways by which crowd-funding reduces cost of funds
• Sustainable solutions to Nigeria’s housing challenges: Using retail banking to explain the potentials of crowd-funding in real estate

 If banks, particularly the commercial ones, are dumping high-cost funds for low cost funds at the retail end of its market, why can’t real estate investors give priority to low cost funds at the ‘retail end’ of the property market as against high cost fund?

Accordingly, commercial banks are dumping their high risk assets, especially pension funds, for low-cost deposits at the retail end of its market. Wema Bank’s Executive Director, Mrs. Folake Sanu, said there has been a decline in commercial banks’ deposit because of their deliberate effort to change the structure of deposit by giving priority to low cost funds as against costly/huge term and time deposits. 

The commercial banks' methodology

The logic here is simple: instead of a bank, seeking for say a billion naira, to accept a hundred million naira each from 10 high net-worth customers who will demand for 20-22% interest, the bank rather would accept N10, 000 from 100,000 customers who will demand as low as 4% interest. Bearing in mind that funds are the major assets of the banking industry; if banks are borrowing at over 20-22% interest from their high net-worth customers, at what percent interest would they lend to their customers who have approached them for loan? The cost or interest rate at which banks secure funds is an underlying fundamental that determines the monetary policies that concerns the lowering or upping of interest rates as it is the single largest determinant of the interest rate at which it will lend-out such funds to borrowers who might require the fund for the financing of an investment project or business. In turn, the price at which a borrower will put its completed investment or project in the market is a function of the high cost of capital which, in this context, is the cost or interest rate at which he borrowed the loan from bank.

The tale and fate of Nigeria's real estate industry: What happens when real estate investors borrow at high interest rate?

Assuming a real estate investor is the borrower of the loan and has used it to build an investment property, the price at which he will put the property up for sale or let, will be that which will allow him pay back; the loan, the high interest rate and also his profit. Usually, this price is very high, higher than that which the property market can support. In other words, the high price doesn’t enable the closing of whether sales or letting deals. By implication, due to unaffordability, the property is inevitably sieged with a lot voids thereby causing strain or loss on the investment whilst we yet have a growing housing deficit in the nation. Consequently, the investors are forced by the market situation to sell or let a price below that which it cost them, thus a bubble is created in the property market. That is, investors cannot even break even as there is a downward pressure on the price that is reasonable to make their investments viable ones. Conversely, in the event where the investors don't bend to the market dictates, that is when they have refused to lower their sales or letting price to that which is realistic in market because of their speculation to close deals when the market experiences a boom, they keep contributing to huge housing deficit in the country even as clog the property market - and yet, consequently strain the investments they have made in properties.

Real estate crowd-funding: Simulating the banking industry’s methodology

Given the above described situation of the property market, it has become impelling to emulate commercial banks’ strategy of reducing high cost of funds and focusing on low cost that will encourage property transactions. What do i mean? Rather than real estate investors get funds by borrowing a lump sum from banks at high percentage interest that increasingly makes property investment un-viable or makes it very unaffordable for the people, they can raise funds by borrowing bit sums from various entities that are willing to be a part of real estate investment project. Let’s assume a property investor is in need of five hundred million naira for an investment project in real estate; the investor can accept N5, 000 from 100,000 customers who will demand as low as 6% interest as against five hundred million naira from banks who will demand higher than 20-22% interest.

However, unlike the banking sector, the various technology-driven financial platforms where investors seeking crowd-sourced funds can meet the large number of people -who are willing to part with their small amount of money at a low interest rate in exchange for returns from a real estate project - is still very scarce and undeveloped globally, particular in developing economies of African countries like Nigeria.

Background to study on Real Estate Investment Trust (REITS) and Crowd-funding

Financially speaking, the practice of funding a project or venture by raising many small (could be large) amounts of money from a large number of people is called crowd funding. However, once upon a time, before the advent of crowd-funding, the major way by which large number of people with small amount of money could invest in, or contribute to the capital of, real estate investments is via Real Estate Investment Trusts (REITs) who in fact are specialized companies that let investors get real estate or real estate related asset exposure into their stock portfolio. REITs are real estate investment companies that own – and typically operate - income producing real estate or real estate-related asset with the aim of providing a means or structure for its individual investors to earn a share of the income produced from their portfolio of real estate assets. Comparatively, REITs allows people to centrally invest in the general portfolio of a real investment company through the purchase of shares of publicly quoted real estate investment companies. Some REITs are not publicly traded and are known as non-exchange traded REITs or Private REITs as they raise money for their portfolio by finding individual investors. Crowd-funding, unlike REITs, isn’t designed to allow people via their small fund (could be large) to plug-in directly into a particular investment project in the real estate industry that is being hosted by a real estate investment company. Thus, if that particular real estate investment project makes a gain or loss, the crowd-fund holders directly make a gain or loss. This is unlike REITs where an investor’s loss or gain is tied to a portfolio or shares of numerous properties- thus; a fall in the value or income a property doesn’t necessarily equate to fall in REITs holder’s income. These days, through what is known as REITs-IPO, REITs are progressively entering into the grounds of the IPO market which is consequently advancing the difference of REITs from crowd-funding. 

Retail banking: Using Pareto’s 80/20 Principle to explain Crowd-funding

Using a business as a case study, for example, Pareto’s 80/20 rule is generally of the opinion that 80% of an effect in the business (whether growth or fall) is generally caused by 20% of its customers, whilst 20% of the effect is caused by the remaining 80%. The principle states that, for many events, 80% of the effects come from 20% of the causes. These 20% of the causes that are accountable of 80% of an effect in events are known as the ‘vital few’.

Correlating Pareto’s 80/20 Principle with the banking industry: the norm before banks started dumping high-cost funds for low cost funds at the retail end of the market is in similitude with Pareto’s 80/20 Principle. To get funds, they would turn to 20% of their high net worth customers with billions in their accounts and distant from 80% low-net worth customers with few tens of thousands in their accounts. But, with the new move of banks to re-structure deposits in order to give priority to the low cost retail end of the market, there is an invalidation of Pareto’s 80/20 principle. As it stands, contrary to Pareto’s principle, the 80% who don’t belong to the vital few (as they are not high-net worth customers), will now be accountable for 80% of the funds banks get to raise , whilst 20% of the funds can be gotten from 20% of its vital few or high net customers. In the same way, crowd-funding in real estate, allows 80% of the funds for a project to be raised by 80% of the small-funds contributors- 80/80 principle- and 20% of the funds to be raised for 20% high net-worth individuals -20/20 principle.

Pareto’s 80/20 Principle: Using the ‘pot-hole and well’ theory to explain crowd-funding

The ‘pot-hole and well’ theory emphasizes on the result of digging multiple holes on the same spot as against digging multiples holes on different spots. Continuous digging on the same spot will eventually result into a well - which you can draw water from. Contrarily, multiple holes on the different spots will eventually result into potholes where you cannot possibly draw water from. However, as far as crowd-funding is concerned, the digging of multiple holes on the different spots, pot holes, can give water though in small amount. Illustrating with Pareto’s 80/20 principle, the well represents 20% of the high net worth individuals whilst the pot holes represents the 80%. However, discrediting Pareto’s principle, 80% of the funds can be got from 80% of the pot holes and 20% from the well.

Crowd-funding: Using Pareto’s 80/20 Principle to explain the real estate portfolio myth

In the real estate industry, the belief that 80% of income made from a real estate portfolio is usually from the 20% of high net-worth properties -which are usually commercial or high-end residential properties located in the eye brow areas – is a myth. The volatility of the market of high rent-commanding real estate puts the receivable income from them at a high risk. However, 80% of properties that don’t command very high rent like the aforementioned categories of properties are now responsible for 80% of rental income generated from a real estate portfolio, as their market is quite stable and streams of income from them are steady.

Ways by which crowd-funding reduces cost of funds

It is important that crowd-funding is progressed because it is the solution to reduce cost of funds. It has the potential to reduce cost of funds in various ways;

Through its inherent characteristic: In the finance parlance at large, interest rate is traditionally a function of two factors; amount invested (principal) and time. Usually, the huger the principal and the longer the term, the higher the interest rate. Since crowd-fund holders invest small amount of money, and for short term, it is inevitable for their interest rate (cost of funds) to be low.

By reducing demands for loans real estate investors from commercial banks: Crowd-funding will reduce the demand for loans from commercial banks by real estate investors since they can now source funds directly from the crowd. Given the capital intensiveness of most real estate ventures, real estate investors are a major client of commercials when it comes to borrowing loans. Since they are now turning their back on the banks and turning their faces to the crowd for loans, consequently there is be a reduction in the demand for loans which will inadvertently spur the reduction of the cost/price at which banks will lend out funds to other prospective seekers.

By reducing demands for loans by commercial banks from Central Bank of Nigeria (CBN): Demand of funds by commercial banks from the Central Bank of Nigeria (CBN) will drop. Going by the law of demand and supply, when demand drops, price (interest rates) consequently drops. In other words, it will bring down the interest rates at which Central Bank of Nigeria (CBN) lend to commercial banks since the commercial banks won't have to depend as much on the central bank for funds they need for their trading activities like lending to their customers (borrowers) to get paid at an interest that makes up their profit as an enterprise. Already, the Central Bank of Nigeria (CBN) Governor, Godwin Emefiele, recently hinted on possibility of lowering interest rate in the New Year. Whilst he attached the possibility of lowering interest rate on an underlying fundamental which is drop in inflation, there is no gain-saying that the consequence of the deliberate efforts by commercial banks to change their structure of deposit by giving priority to low cost funds at the retail end of its market would trigger the CBN to lower its interest rates. The monetary policy stance by the CBN would be poised and energized to change in 2018 as two principal underlying fundamentals which are low cost funds (driven at the retail market of commercial banks) and drop in inflation becomes more favorable for the apex bank to reduce its interest rate which the real estate sector will indirectly benefit from.

Through the elimination of commercial banks as middlemen between funds at the retail end of market and investors – in this case, real estate investors: Illustratively, rather than a bank who is wanting to raise a billion naira to accept N10, 000 from 100,000 customers and in-turn lends out the money to a real estate investors at ridiculous rates, real estate investor through crowd-funding can directly collect N10, 000 from 100,000 customers for a real estate project.

Through technology: crowd-funding is typically or traditionally via the internet just as the modernized banks in Nigeria. Given the huge number of persons involved in crowd-funding, the use of technology- particularly financial technology- is inevitable. Technology, whilst further saving time and cost of funds, serves the crowd by driving sign-up of individuals and the collection of the small amount of funds conveniently from the multitude of interested persons in a real estate project. Through mobile and browsing devices, various individuals can be part of the raising of funds for real estate investment projects.

Sustainable solutions: Using retail banking to explain the potentials of crowd-funding in real estate

Whist retail banking is a traditional way bank raise funds, crowd-funding is regarded as a form of alternative finance. It is in fact a creative and innovative finance system or structure. In other words, crowd-funding is a ‘new school’ finance style and hasn’t been properly integrated into the financing systems of most economies, particularly developing economies. However, in order to optimize its potential in the Nigerian economy, crowd-funding need not be seen or treated as alternative finance but as traditional financing - just as retail is to the banks.

As banks have identified retail as the future, and are increasing going for funds at the retail end of their market, so should real estate go to crowd-funding as the future of real estate financing and go after clients who are willing to part with their small amount of money in exchange for part-ownership of an income generating real estate project or investment. As a matter of fact, the number of people that are being denied owning a real estate, in the form of shares in real estate project or portfolio of real estate, is very much greater than the number of unbanked individuals in the country. This goes to say there are more of untapped potentials in the real estate crowd-funding programs than in retail banking.

In an economy where the funds is readily available and its cost to investors is low, entrepreneurship is boosted which will spur economic growth at an accelerated rate. More importantly, in an economy where the funds are readily available and its cost to real estate investors is low, housing deficit in the nation will be bridged even as housing affordability is increased. Given that over 80% of Nigeria’s housing problem is directly tied to cost or finance- according to real estate academic and industry practitioners, there is no gain-saying that crowd-funding is the innovative/creative financing and sustainable solution that holds the potentials to deal with the challenges of high cost of funds and its multiplier negative effects on housing deficit and affordability in the country.