Why real estate crowdfunding hasn’t worked

And how it might work in the future

This coming Friday, October 30th, the SEC will vote on the Final Rules for Title III of the JOBS Act. Title III will allow non-accredited investors to invest in early-stage companies, which will create a new class of investors and a new capital market. Chance Barnett from Crowdfunder.com does a great job explaining this vote and the implications for fundraisers and investors.

I’ve spent a majority of my career in the “crowdfunding” space, first for venture-backed private companies and later for multiple alternative assets such as real estate deals and hedge funds. 

The idea seems great in theory, but in concept I found some major issues preventing it from getting traction across most asset classes. The main outlier here is AngelList, likely because of a different, much more patient approach.

Some of the issues with crowdfunding:

Adverse selection = crappy deals and/or crappy terms

Many people call this “quality control”, but that sounds like weasel words to me. There are a ton of bad actors and idiots out there who are all looking to get paid. Most of them see crowdfunding as cheaper, easier, dumber money. 

Poor time vs. capital invested ratio

When a company goes public, a lot of people have signed off on it?—?the SEC, the accounting firm, the investment bank, and even the CEO and CFO. For most private deals, caveat emptor. The way this seems to work in real estate is that people create close, trusting relationships over time and understand who is good and who is not so good at following through. For a $5,000–25,000 investment, this is not a good use of most people’s time. Multiply that by hundreds of deals needing to be sifted through, there is too low of an ROI.

Tucker Max wrote a great piece on this about why he stopped angel investing and how it was a poor use of his time.

Additional capital likely required

In startups and real estate deals, there is often a need for additional capital to be raised (as part of the plan or an unforeseen hiccup) and trying to get a little money from a bunch of individuals (sometimes multiple times) can be very difficult, especially when there are tight time constraints or personal financial issues with some of the investors. If the capital isn’t there, the deal either falls apart or the small investors get washed out. This is why, for the most part, most big real estate deals are done by institutions or a small group of high-net worth individuals.

Regulatory pain in the ass

Despite best intentions by the regulators, the “protections” required in order to allow smaller investors to participate in investment opportunities are incredibly cost-prohibitive and time-consuming. So much so, that it is basically a non-starter for quality fundraisers to go down this route.

Where I see real estate crowdfunding going:

• Definitely institutional: Just like how peer-to-peer lending platforms (LendingClub and Prosper) went from small person-to-person loans to a place where institutions (hedge funds and family offices) could find out-sized returns, I see institutions providing a majority of the capital to these real estate platforms as a discovery tool for smaller, emerging managers and developers. I wouldn’t be surprised if the commercial real estate brokerage firms launched their own platforms.
• Probably high-net worth investors: Real estate is the most common alternative asset class high-net worth investors invest in. Couple that with the desire from most registered investment advisors (RIAs) and family offices to get access to more alternative product and you have a large and active group of sub-institutional investors.
• Unlikely non-accredited: Unless major changes in regulatory requirements and liability change, real estate operators voluntarily elected to be more transparent with their valuable and proprietary information, and there was a good solution for the warped due diligence to capital invested ratio, this is not a space non-accredited investors will be able to play in (successfully or impact-fully). Most likely their exposure to real estate will come from home-ownership and Public REITs.
• Marriage of Technology + People: I don’t see technology removing the broker from the equation?—?they are necessary to tell the story and generate demand. I do see tools and data coming to the investing space to allow smaller investors similar information to make investment decisions. Technology will allow for quicker dissemination of information, better tracking of investor interest and demand, and easier tools to effectively value and compare investment opportunities.

How do you think the real estate crowdfunding space will evolve?

Posted here first.