Crowdfunding, through its rapid emergence as an investment vehicle, has broken down barriers hindering investors lacking major capital and connections, and increased development efficiencies. When initially exposed to the concept of crowdfunding in 2011, the concept was more tailored to young entrepreneurs and app developers looking for small amounts of capital to get themselves going on individual projects. Sites such as gofundme.com and gogobot.com seemed like useful tools, but people had yet to consider the range of possibilities of this concept. Fast-forward to present day, real estate crowdfunding is rapidly reshaping the way individuals find and invest in properties. While an exciting new concept, understanding why skepticism remains along with the differences between crowdfunding and traditional REIT funds, provide a more holistic understanding of what to expect as a real estate investor.
The Development of Crowdfunding
While the concept of crowdfunding is new, real estate investing has been a long-standing method for individuals looking to accumulate low-risk assets. Access to investment properties however were not wide-spread with major barriers present for those without a strong internal network. The Securities Act of 1933 emphasized this concept with its premise being that private properties could not be publicly marketed. This consequently gave rise to the idea of "country club" privilege in having access to individuals closely connected to real estate markets. This model led rise to a clear discrepancy in who was able to invest and created a market inefficiency with a lesser supply of investors fighting over a large supply of investment opportunities. This inefficiency has just started to develop pushback with President Obama signing in the 2012 JOBS act. This act was huge in allowing small businesses and start-ups to raise capital and advertise their offerings publicly. Doing so increased investor supply and rebalanced the equilibrium in real estate investment. Pushing to current day, we say that this act has also allowed crowdfunding to expand with "hundreds of millions of dollars" raised through crowdfunding in 2015.
REITs vs. Real Estate Crowdfunding:
REIT funds have developed into a $670B industry with investors using REITs as a way to diversify their portfolio with a supposed "low-risk, high return" outcome. This, up till 2012, has been investors only option without outright purchasing a property. Crowdfunding while a very similar alternative, possesses a few important differences worth discussing.
1. While a REIT fund focuses more on gaining return based on the overall performance of the fund, investing in crowdfunding bases its return on profitability of the individual property. The plus of investing in a REIT fund is that you a more protected strategy in case one of the properties falls through and so you are therefore able to hold various types of properties holding different magnitudes of risk. A crowdfunding firm, while holding more inherent risk, allows individuals more control to where their money is and allows them to more easily act on areas they see as being potentially profitable.
2. The second difference to note is fees. With REIT funds managing a conglomerate of different properties, management fees would be expectedly higher. This varies significantly with crowdfunding firms which allow more autonomy to investors and resultantly don't need as much capital to manage properties. Firms such as Crowdstreet and Fundrise, further emphasize this point by tailoring their marketing slogan around having fractional fees in comparison to traditional REIT funds.
Remaining Skepticism of Crowdfunding
Through the growth of this new investment vehicle, skepticism has remained behind the various challenges that crowdfunding firms face. Below, I have detailed the various concerns presently occupying this new investment strategy.
1. Uncertainty: Unlike REIT funds, crowdfunding has only been really present in the real estate market for 3 years. While this is not necessarily a problem and will pass with time, only "3% of Americans currently participate"
2. Risk Hedging: As mentioned above, one of the major differences between REITs and crowdfunding is that REITs hold a heavily diversified portfolio and are able to better counteract major valuation drop-offs in a particular property. This problem stems from the innate differences of the two strategies, and mitigation mainly comes from viewing real estate as only part of an overall portfolio and diversifying through purchasing of other asset classes.
3. Liquidity: With ownership in particular properties rather then just equity in a portfolio, the idea of liquidity comes into play with property being less liquid then securities. To mitigate this problem, congress is currently in the works to pass the "Main Street Growth Act', which would create "venture exchanges" - secondary markets where early investors in startups and small businesses could sell their shares, and new investors could buy in and trade these private stocks. While initially geared towards start-ups, this bill has pushed other companies to work towards mimicking the concept in real estate markets with companies like Acquire Real Estate creating a platform for individuals to buy and sell equity in real estate properties.
Having explored crowdfunding through these various dimensions, it is clear to see the promise behind crowdfunding and while various barrios stand present, being aware and understanding the pros and cons of this investment strategy will go a long way in deciding whether crowdfunding is a viable strategy for your investment portfolio.
Being a new writer also learning about these strategies, I would really appreciate your feedback and experiences relating to this article as it is best way for me to continue to learn about the industry.