Where we’ve come from and where we are headed
Real estate crowdfunders have disrupted the status quo of residential real estate investing with online platforms that put new opportunities — once the domain of the wealthy — into the hands of Main Street America.
The growth of real estate crowdfunding into a billion-dollar industry has been nothing short of phenomenal, and the sector has a bright future. Already, it has brought real estate investing to the masses while changing the way people and businesses invest and borrow. To be sure, real estate crowdfunding’s fast growth has resulted in both opportunities and challenges.
Historically, U.S. real estate lending and investing have worked within a fragmented industry where lenders have been slow to adopt technology. These lenders often had a myopic focus on the owner-occupant. In the real estate investment area, only those with deep pockets — mainly wealthy individuals and institutional investors — had the wherewithal to invest in a significant way.
There were limited options for non-owner occupants from Main Street America who wanted the financing to establish a real estate portfolio, or who wanted to invest in the deals of bigger players. This dynamic began to change in the wake of the housing crisis. Alternative lenders emerged to meet the needs of real estate investors who saw opportunities to rebuild the nation’s residential real estate market after the 2008/2009 financial crisis, but who were stymied by limited financing options.
Entrepreneurs who recognized the opportunity developed innovative technological solutions to address some of the problems facing the housing finance market. They developed online lending and crowdfunding platforms to provide efficiencies, speed, 24/7 access, transparency, national reach, and lower costs to the investor/borrower.
Literally hundreds of real estate crowdfunding platforms have formed in recent years. However, most haven’t overcome the very basic challenge that faces crowdfunding startups: If you don’t have investors, how do you get projects on your platform? If you don’t have projects, how do you get investors?
Real estate crowdfunding, a subsector of a wider arena of crowdfunding platforms, has only been around a few years. A couple years after these organizations began forming, venture capitalists and private equity firms began to strategically invest in a few of these platforms. Today, about a dozen real estate crowdfunding platforms have reached significant size in terms of revenue, deal flow, and participation by borrowers and investors. Institutional involvement is raising the sector’s profile and its ability to fund larger deals.
Growing volume and influence
A joint study by the University of Cambridge and the University of Chicago suggests the sector “hit its stride” last year. “The 2017 Americas Alternative Finance Industry Report” has some interesting statistics:
- Total market volume for alternative finance was $35.2 billion in 2016, up 23% over the prior year. (The data covers the United States, Canada, Latin America and the Caribbean with the majority of the volume, $34.5 billion, in the U.S.)
- Marketplace, or peer-to-peer, lending makes up the bulk of the alternative finance volume, about 60%, while real estate crowdfunding accounts for 2.3% of the volume.
- Real estate crowdfunding is on a fast-growth trajectory, increasing its volume by 70% to $821 million in 2016 from $483.8 million in 2015.
The report notes that the number of new entrants into alternative financing is slowing and some entrants have exited. However, it also reports on new emerging Regulation Crowdfunding (Reg CF) platforms that began to emerge last year. In the United States, Reg CF, part of the JOBS Act, turned 1-year-old in May. The regulation has been successful in providing startups with capital while opening up new investment opportunities for smaller, non-accredited investors.
Since Reg CF took effect, 119 companies have raised $36.6 million under Reg CF, according to statistics from WeFunder. With these funds, investors are funding a wide variety of businesses from breweries to tech startups.
In a few short years, it’s become evident that real estate crowdfunding has entered the mainstream.
Addressing the sector’s challenges
With its fast-paced growth, come challenges. The challenges facing the industry are varied and sometimes complex. They include the following:
1. Strength during economic distress. Most real estate crowdfunders are less than seven years old, and some have just barely spread their wings. They have yet to be tested in recessionary times
2. Cyber attacks. The frequency of cyber attacks on financial institutions is a growing problem and recent global attacks on traditional banks as well as large retailers have heightened the concern. Cyber threats are among the most critical challenges facing the financial services industry, including alternative lenders. U.S. banks have been among those who have been victims of cyber attacks from ransomware to denial-of-service attacks. Crowdfunders aren’t immune. A popular crowdfunding site, Kickstarter, was a victim in 2014 of a hack that involved the theft of customer data. Patreon, a crowdfunder for creatives, was attacked in 2015 and had customer data stolen as well. Although there hasn’t been a headline concerning crowdfunding customers who have lost funds due to a hack, it’s imperative for crowdfunding platforms to keep constant vigilance and continue to develop sophisticated front-end defenses. Still, some in the cybersecurity industry believe it may become a matter of how a company deals with an attack, not whether they will be attacked.
3. Building scale under current regulations. Much crowdfunding to date has been equity crowdfunding on individual deals, which makes it challenging for a platform to build a scalable solution. For this reason, growth in real estate crowdfunding is largely occurring on the debt side. However, platforms that do lending don’t meet current Reg CF limitations for arms-length transactions. Thus are prohibited from unaccredited investor crowdfunding. There is some growth in e-REITs, a natural progression of investing for unaccredited investors under Title IV Regulation A+ although the limitation on e-REITs — about $50 million over a 12-month period — is too small for larger platforms with significant scale. Crowdfunders applaud Congress’s passage of the JOBS Act, and Reg CF, which has opened up investment opportunities to the public at large, but believe there are still more regulatory improvements that can be made.
Looking toward the future
There’s plenty of good news in the sector and more good news to come. The retail investor can now participate, fractionally, alongside sophisticated high-volume investors on their same terms, which hasn’t been possible before. Real estate investing has long been a lucrative asset class with a high barrier to entry. Those barriers are coming down. In the past, people who wanted to get into real estate investing had to have a lot of capital. Before the advent of real estate crowdfunding, no one really cared about an investor’s $5,000 or even $50,000 infusion. They often wanted to see $500,000 or more. This left small, unaccredited investors mostly out of the game.
Now Wall Street, which was initially skeptical, has embraced the crowd and, as a result, more opportunities are opening up for smaller investors. The playing field is being leveled. For example, an institutional fund may opt to invest $250,000 in a million-dollar real estate project, leaving $750,000 for smaller real estate investors to come in and invest the remainder at much smaller amounts. Currently, these retail investors may not know that they are investing alongside an institutional investor. But the sector is moving toward providing that type of visibility — which will lead to added credibility — going forward.
As real estate crowdfunding grows, it’s likely the sector will see more opportunities for these smaller investors to participate alongside sophisticated institutional investors. In other words, someone could potentially invest $1,000 in a deal alongside an institution that is investing $1 million in the same project. As institutional investor acceptance of real estate crowdfunding grows, it will naturally lead to growth in the size and scale of projects brought to the crowd.
While there are challenges for the industry, there remains plenty of opportunity on the horizon. Real estate crowdfunding remains a small share of the overall alternative lending marketplace, but it is growing fast. As it gains acceptance, it will be able to tap into an enormous amount of available capital, from 401(k)s to IRAs, and put that capital to work in new and exciting ways. The future looks bright.
ABOUT THE AUTHOR
Jason Fritton is Co-Founder & Executive Chairman of Patch of Land, responsible for setting its vision and leading the team's efforts to accomplish the company's mission of building wealth and growing communities. Fritton launched Patch of Land when the SEC implemented Title II of the JOBS Act in 2013 based on his vision to evolve real estate financing to be tech-enabled, data-decisioned, and easily accessible to a marketplace of borrowers and investors. Prior to Patch of Land, Fritton founded and developed a telecommunications design and procurement firm active in the public sector. Previously he served as Director of Digital Marketing for a national retailer. Additionally he founded several technology-based startups including Startingline Networks, Tech@Cost, and Virtual Realities. Frittion studied biology at Cornell College.
This contributed article originally found on: Private Lender.