The answer is all three.
Real estate crowdfunding and the venture capital pouring into the industry recall the mania of 2000 when all mortgage transactions were heading to the interwebs. Do these headlines sound familiar?
“FDIC Selects Pedestal For Live Internet Auction Of Mortgage Assets Pilot to Start October 25”
“Major banks put $20 million in Ultraprise”
“MortgageRamp Lines Up $50 Mln of Capital From Outside Investors”
These names may not be familiar to everyone reading this but they were all well known within commercial lending industry in 2000. During tech bubble 1.0, Pedestal.com raised more than $15mm and Ultraprise more than $20mm from very smart investors including Battery Ventures, Freedman, Billings and Ramsey, Walker Investment Fund, First Union, Citi, GE Capital, Capital Z and others. Despite the wave of investment and positive press, these mortgage startups did not redefine the industry the way many people expected but rather merely absorbed into it. Loantrader merged with Ultraprise and, ultimately, Ultraprise was absorbed into a mortgage technology firm attracted to its XML data organization technology to help a notoriously (and still) inefficient data process. Pedestal and MortgageRamp suffered a similar fate. Many many others simply failed.
Today, as we sit atop of a wave of startups achieving eye-popping valuations as they disrupt entrenched industries (Uber, Airbnb , Kickstarter as examples), real estate crowdfund platforms seem to be everywhere making the same claim…but will it really be a profound game-changer for how real estate sponsors raise equity and debt? Will it disrupt the entrenched real estate paradigm or just become another tool in the established fundraising ecosystem? What will and what makes it different this time?
Ultraprise basically went out of business in less than three years, according to an employee, because “…despite having a substantial number of loans posted in the system…we couldn’t sell the loans.” Immense supply but no demand. Therein lies the threshold issue and the opportunity that crowdfunding presents – can demand finally meet the pent up supply?
The game changer in the real estate crowdfunding space will not be the technology in and of itself, but rather be the broad adoption by the sponsors and investors alike AND actual transactions being repetitively funded through this non-traditional financing mechanism. There are only three outcomes for Real Estate Crowdfunding companies (and the new industry in general): (a) gamechanger, (b) advanced tool or (c) death.
A. Game Changer / True Disruptor:
- Possess real estate knowledge, expertise and most importantly, experience
- Intermediate directly between tens of thousands of individual and institutional accredited investors and a national network of real estate sponsors
- Develop a meaningful, trusted, repeat connection with those accredited investors
- Replace traditional sponsor equity fundraising mechanisms
- Replace or dramatically improve upon the traditional professional / banker / broker / administrator fundraising ecosystem (fundraising, legal, financial advisory,,fund administration reporting returns, accounting firm providing K-1, etc.)
- Provide best-in-class technology
Outcome: The outcome for the crowdfunding platform that is a true disruptor will be:
- A dramatic shift in the landscape of the how sponsors and investors communicate
- Replacing the hegemon of traditional banks and brokerages
- Either a large value exit through an acquisition by an entity interested in capitalizing on the customer relationships and transaction data.
- Consolidation in the industry by another similar firm to generate scale
- Its continued interest through a public markets exit
B. Tool Company will/may:
- Exist as a tool to help mortgage / equity brokers technologize their process
- Intermediate between institutional investors and real estate sponsors
- Provide differing levels of professional / banker / broker disintermediation
- Provide best-in-class technology
Outcome: The outcome for the crowdfunding platform that doesn’t strive to be more than a tool will be:
- Attractive technology to help facilitate capital raising for Sponsors
- One of many new investment channels for investors
- A tool company’s exit will ultimately be a smaller value exit or absorption into a larger firm
C. Companies poised for failure will/may:
- Possess limited real estate expertise, relying on the “its all about technology” fallacy
- Utilize metrics like “deals posted” or “investor views” versus transactions closed to measure progress
- Provide non-differentiating technology
Outcome: Claims, bills, accusations
According to the Huffington Post, Times Realty News “tracks 100+ sites in realty crowdfunding worldwide, with the bulk of these sites operating mainly in the US.” History tells us that after most of these initiatives die, the vast majority of the survivors will become tool companies. This is because they will end up intermediating between institutional investors and real estate sponsors, an excellent business model but one that isn’t a game changer. This is because the law of large numbers will take over.
Another way to evaluate the opportunity is by market transaction volume. According to Real Capital Analytics, there were $423 billion of transactions over $2.5mm in 2014. Assume that 10% to 20% of that amount consists of of true equity (versus structured institutional financing). At a 5% commission, the aggregate industry revenue model is $2.1 billion to $4.2 billion. Even if you reduce that figure by almost half for 2011 aggregate transaction volume of $234 billion, there is a substantial revenue stream to disrupt and the established fundraising ecosystem will certainly try to disrupt the disrupters.
Only a game changer will lead the charge in creating a truly outstanding and landscape-altering company, with dedicated customers, closed transactions, a sustainable revenue model, and ancillary revenue streams and value components. To quote a famous real estate play and movie, for the others who come in second place? A set of steak knives. Third place? You’re fired.
Herald Mail: “Major Banks put $20 million in Ultraprise” by Dave McMillion. 1/11/00
Ode to Code: “The Software Cure For A Financial Meltdown” by K. Scott Allen. 1/22/09
Huffington Post: “Top 80 US Real Estate Crowdfunding Sites Open New Doors in 2015” by David Drake. 5/16/15