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Crowdfunding Myths Debunked
As featured on Inman.com
- It’s often the size of the deal, not quality, that drives a sponsor’s decision to crowdfund.
- High deal volume is not necessarily an indicator of success.
- As with any product or service, some crowdfunding platforms are better than others.
Crowdfunding — using an online platform to “pool money from the crowd” to facilitate funding of new investment opportunities — has been a hot idea for years. Thanks to changes in regulation, developments in technology and the internet’s ability to connect people and information quickly and effectively, small businesses have the potential to raise capital like never before.
Likewise, investors can participate in previously inaccessible opportunities from their laptop or tablet, which makes the whole process fast, convenient and efficient.
By bringing together real estate companies with individual investors, real estate crowdfunding has certainly helped disrupt the way people find and invest in properties. According to Crowdsourcing.org, real estate crowdfunding is projected to reach $3.5 billion in 2016. As the industry evolves, all signs indicate real estate crowdfunding is here to stay and will continue to grow.
"Real estate crowdfunding is projected to reach $3.5 billion in 2016."
There are some real estate entrepreneurs and investors, however, who haven’t yet embraced these online platforms. For those who hesitate to join the crowd, here are six common crowdfunding myths and the truths that bust them:
Myth 1: Only bad deals end up on crowdfunding websites because their sponsors can’t get capital anywhere else.
Truth: Choosing to crowdfund has nothing to do with deal quality.
Often, it’s the size of the deal, not quality, that drives a sponsor’s decision to crowdfund. The small balance commercial market — say, loans or equity contributions that fall in the $1 million to $5 million range — have been largely underserved since the financial crisis, thanks to increasing bank regulatory costs.
Additionally, with crowdfunding, borrowers and sponsors skip the hassle of managing multiple investor relationships, distributions and tax reporting because online platforms do that for them. So, choosing to crowdfund can also be about convenience.
Finally, through crowdfunding, real estate companies get incredible access to a much larger network of investors, which makes it easier to raise capital as needed. So, a desire for access to more investors might also drive a decision to crowdfund.
Real estate investments carry risks, do not guarantee a return of any kind and can include the loss of your entire investment. But rest assured, a reputable platform will do its due diligence and thoroughly screen deals before placing them on the marketplace for investors to fund.
The platform’s very reputation and survival depends on it.
"Often it's the size of the deal, not quality, that drives a sponsor's decision to crowdfund."
Myth 2: Crowdfunding platforms are just marketing websites that present a third-party product with no diligence. Essentially, crowdfunding is ‘eBay for real estate.’
Truth: As with any product or service, some crowdfunding platforms are better than others.
Yes, as mentioned above, there are crowdfunding platforms that don’t do their due diligence. Others are meticulous about vetting deals and even fully underwrite every one they offer.
With real estate intermediaries, it’s important to have complete transparency. Are proformas available? Third-party reports? Market data? Track records of the sponsor so that you can review previous performance?
Good platforms make all these and more available to investors, so you can choose deals that align with your investment goals.
Myth 3: All crowdfunding platforms are the same.
Truth: Not even close. The product and the people behind a platform are everything.
Crowdfunding platforms can vary extensively, depending on the product and the team behind it. When choosing a platform, it’s important to recognize that the product is affected by the level of deal screening and the types of investment being offered.
For example, does the platform focus on deals offering cash flow, or does it concentrate on appreciation through land development? Does it fully underwrite each transaction on its platform? Does it perform site visits or trust third-parties only?
Some platforms boast a team of professionals who are best in the field of real estate, finance and technology; others are staffed by people who are less experienced and less credentialed.
When choosing a crowdfunding platform, put your trust where the product you want meets the team with the most collective knowledge, experience and integrity.
Myth 4: Platforms with more deals are better.
Truth: High deal volume is not necessarily an indicator of success.
Just because a platform offers more deals doesn’t mean those deals are good. Having high volume could mean the company does less screening and simply originates a lot of deals to boost numbers — a quantity-over-quality approach that doesn’t prioritize investor protection.
To identify better platforms, instead look for a stated commitment to vetting and underwriting deals, being transparent with information and otherwise protecting investors against risk.
"High deal volume is not necessarily an indicator of a crowdsourcing platform's success."
Myth 5: If a crowdfunding platform goes out of business, I’ll lose all my money.
Truth: Good platforms structure transactions in a way that protects investors in such event.
There’s cause for concern if a crowdfunding platform shuts its virtual doors — and a good deal of comfort to be had from a platform that is well-funded.
How do you mitigate any potential bankruptcy-related loss? By choosing a platform that structures its deals in a way that protects investors and that has a bankruptcy contingency plan in place.
Does the platform use Special Purpose Entities (SPEs), which create bankruptcy remoteness? Is there a reputable third party that will step in if the platform’s viability is at risk? Research these things before investing to minimize or even prevent your loss in the event of a platform’s demise; because remember, there are no guarantees when it comes to investing.
Myth 6: As an investor, I’m better off working directly with the sponsor.
Truth: Not necessarily. There are some advantages to investing indirectly.
First, as an investor, you get access to more sponsors and more deals if you join an online platform.
Secondly, the “power of the crowd,” by definition, can bring with it “the benefits of the many” — like specific voting and decision rights that might be unavailable if you invest as an individual on your own.
Finally, the expertise the platform provides, through its team of behind-the-scenes professionals, helps protect investors and ensure they have a consistently good user experience across all investments, regardless of origin.
At the end of the day, real estate crowdfunding seems more and more like the wave of the future — and the great evolving ride of the present.
Although to some it might still be the new kid on the block who comes with all sorts of risk and mystery, a bit of knowledge can help you recognize the better platforms out there — and start benefiting from this potentially profitable and growing trend in real estate financing and investment.