When it comes to real estate investing, the Web has had a profound effect on the industry. However, although some see surfing the Internet as a means of locating and researching potential investment properties, the Web has also unleashed the power of crowdfunding, allowing ordinary people to invest in large properties that were once the domain of multimillionaires, large companies and big corporations.
What is real estate crowdfunding?
Crowdfunding is a relatively recent phenomenon. Although it is based on the old principle of collecting money from lots of small investors, the new spin makes all types of projects a reality. From producing useful products, games, and even financing movies and television series, crowdfunding has been used for myriad different projects.
In real estate, crowdfunding has been used to help raise significant capital to invest in all types of property.
Since 2012, this form of raising money has emerged on the scene as both viable and practical. Companies such as Reality Mogul, Fundrise and RealCrowd have benefited from the crowdfunding effort, managing to raise millions of dollars for different properties, which allowed ordinary investors a chance to own a piece of commercial real estate — even though this form of investing was intended to be for the purchase and sale of liquid securities.
In a sense, the current form of raising money for real estate purchases was established with the Real Estate Investment Trust (REIT) Act. Passed by Congress, REIT was created as a means to allow small investors to band together so they could invest in many large-scale, income-producing properties just like large companies, corporations and wealthy entrepreneurs had been doing for many decades.
Crowdfunding has offered another option, thanks to its unique ability to reach people around the world and allow them to participate in major fundraising goals. The effect has certainly been potent, but there have been some obstacles and roadblocks in this relatively new process.
Challenges of real estate crowdfunding
There are numerous challenges to crowdfunding typical of any new endeavor in which the full potential has yet to be reached. While crowdfunding has been used successfully when it comes to investing in all types of projects, there are still some obstacles when it comes to the real estate field:
Experience — Crowdfunding has yet to establish the long track record of success needed to be seen by most as a viable alternative form of real estate investment because it is relatively new. Given the overall track record of the real estate industry, this is to be expected, as many innovations take years to become standard practice.
Quality control — Due to the relative newness of real estate crowdfunding, there are no established controls or standards. The platforms that currently exist have enjoyed some measure of success, but there have not been enough examples for us to know whether the project decisions made with the platforms are reliable. It is not always clear how the process works, what parameters are tested and what criteria are considered when evaluating a project. Put simply, there are still no standards in the industry.
Lack of insurance or risk-hedging — Most investments have no guarantees that the project will pay off with the expected rates, but the issues with crowdfunding are more severe in nature because the platforms currently in use have not been fully time-tested. So, getting good, reliable advice is difficult; there is simply not enough evidence for most investors to rely upon. However, there is a method that is available in this system. With hundreds or even thousands of individual investors, they can insure each other through the platform; that might cut down on the individual return rate, but it will also cut the risk down considerably, too.
Regulations — The 2012 Jumpstart Our Business Startups Act (JOBS) legalized equity crowdfunding; companies could raise a considerable amount of money from investors who are accredited or have demonstrated that they have a net worth of at least $1 million or an annual income of at least $200,000. By law, crowdfunding sites must register with the United States Securities and Exchange Commission (SEC), either as investment brokers or funding portals for this type of investment.
Despite the new regulations leading to all types of crowdfunding platforms, only about 3 percent of Americans participate. Plus, the SEC is discussing tougher regulations, which may mean that fewer investors will be able to use these platforms in the future.
Relevance — There are some websites that allow investments as small as $100, which allows virtually anyone to participate, but since most accredited investors prefer to put in considerably more money, those sites are not nearly as relevant to an accredited investor. The accredited investor may be far less likely to look at crowdfunding options as a first choice, depending on the circumstances.
Liquidity — There is currently no secondary market for crowdfunding investment, which means that the project will have to come to completion before the investor can liquidate. This is a big advantage that REITs have over crowdfunding platforms; however, new or existing platforms could seize the opportunity to create a secondary market.
In the end, real estate platforms for crowdfunding offers many advantages for investors, especially those who do not want to risk a significant amount of their funds, which could jeopardize their portfolio. Crowdfunding is still relatively new, though, and it’s still somewhat obscure to many real estate investors, who may have heard of crowdfunding and even used it to invest in other types of projects but have never made the connection with real estate.
Although still facing challenges and growing pains, real estate crowdfunding is a powerful tool and a fantastic idea that will only keep growing in the foreseeable future. In fact, this form of crowdfunding (when perfected) will become a meaningful part of the industry as a whole.
Omri Barzilay is the CEO at Propcy. You can follow him on his blog or Twitter.