Crowdfunding is coming of age in private real estate

Crowdfunding has revolutionized the financing of many small-scale enterprises. However, the platforms which allow boutique brands and community projects to raise capital are of increasing interest to real estate investment managers.

Perhaps the best-known crowdfunding site is Kickstarter, which at the time of writing hosts more than 46,000 projects, ranging from cookware to clothing, and has taken $5.4 billion of pledged investment. Following a 2012 change in US legislation allowing crowdfunding platforms to raise up to $1 million in funds annually from high-net-worth individuals and accredited investors, US platform Fundrise was the first to launch a real estate investment.

Since then, hundreds of specialist real estate crowdfunding platforms have been launched, allowing retail investors access to property deals around the world. Fundrise investors have committed nearly $5 billion in capital.

Jan Vecerka, founder of European crowdfunding platform aggregator BrikkApp, notes: “The real estate crowdfunding market is pretty fragmented, with more than 150 platforms in Europe alone and more than 250 worldwide.”

Estimates of the total market size vary widely, but Judge Business School estimates that in 2018, real estate crowdfunding platforms pulled in a total of $20 billion. However, only $3 billion was for equity investments in both commercial and residential real estate, the rest lending.

Most real estate crowdfunding platforms deal in small numbers, with transactions of only a few million dollars and small sums invested by individuals using the platform. Vecerka says: “The minimum investment may be as low as €50 to €200; we estimate each investor allocates an average of €2,000 for a deal.”

Such platforms might be of interest to a developer having trouble getting bank finance, but is there much to attract the interest of investment managers used to dealing in billions? Vecerka notes that real estate crowdfunding platforms have investors who have committed €100,000-€200,000, making them of interest, in aggregate, to larger investment managers.

David Genn, chief executive of alternative finance platform Goji Investments, says: “Crowdfunding was formed with this idea of democratizing access to assets, both for the investors, but also for the borrowers or the property developers, by automating credit decisions and the way they can access finance.”

He continues: “What is very interesting is that as the sector has evolved, more traditional investment managers are seeing the benefit of opening their doors to high-net-worth and sophisticated investors as well. I suspect that we will see a blurring of the boundaries between institutional and private investors.”

Genn identifies high-net-worth investors as the fastest-growing capital pool on the planet. Looking at illiquid asset managers across the spectrum, whether private equity or real estate, he believes they are all looking at how they can adjust their product suite to make it more accessible to high-net-worth investors.

“The crowdfunding movement was led by technology companies,” he says. “But now, as more traditional asset managers look to take advantage of this evolution within the market, they’re going to either have to develop that capability in-house – and that’s not one of their key competencies – or they’re going to look to acquire or partner with other providers out there.”

Joining the crowd

In 2019, German fund manager Commerz Real took a 24.9 percent stake in Bergfürst, a German platform which raises mezzanine finance for real estate investors. In 2020, two real estate investment managers have acquired crowdfunding platforms.

In February, Patrizia bought UK-based real estate crowdfunding platform Brickvest out of administration in order to run it as an independent business line.

Meanwhile in May, ARA Asset Management bought Singaporean platform Minterest. In both cases, the platforms focus on accredited and high-net-worth investors rather than small-scale retail investors, and on relatively larger transactions.

Since being acquired by ARA, Minterest has raised S$43 million ($31 million; €27 million) from Singaporean investors across three transactions. The largest of these was a 4.25 percent, 12-month fixed income backed by a portfolio of 24 properties across Asia-Pacific. Minterest raised S$30 million from accredited investors, high-net-worth individuals and family offices plus a further S$5 million retail tranche. The company is focusing its real estate fundraising on Singaporean investors and on projects from the ARA network of companies and countries where the investment manager has a presence.

Minterest chief commercial officer Janice Koh says: “Over the next few years, we aim to grow our digital marketplace with volume between S$150 million to S$200 million and a fivefold increase in our investor base. We expect crowdfunding to complement real estate investment developers’ and managers’ businesses in the future. The technology-enabled innovation of real estate crowdfunding enables real estate owners to raise capital from investors in an automated and efficient way online. This means they can reach out to investors globally, 24/7.”

Knowing the risks

The attraction of a low-cost platform which can raise capital while the real estate investment manager sleeps is obvious, however there are risks. Firstly, says Genn: “There is the regulatory risk of marketing the products to retail investors; that is where partnering with wealth managers and financial advisors is going to be key.

“The second risk is operational, because if you are going from dealing with a smaller number of institutional investors to a much larger number of private wealth clients, then you need to be able to serve those investors in a much more efficient manner. For this, technology is going to be key.

“Finally, there are risks around product structuring, making sure that the products work well for retail investors. For example, a traditional capital call structure to pull down capital would need more thought for it to work across hundreds of individual
investors.”

With so many new companies seeking investment dollars, there have been inevitable platform failures, disgruntled investors and some malpractice. Institutional involvement in crowdfunding already seems to have acquired its first casualty.

In February 2020, crowdfunding platform Yieldstreet announced that it was teaming up with investment manager BlackRock to launch a $1 billion fund, which would invest in real estate, as well as other illiquid sectors, such as art and legal finance. However, Yieldstreet subsequently came under fire from disgruntled investors and the much-touted relationship with BlackRock was terminated.

Concerns over liquidity and structuring explain why most real estate crowdfunding platforms focus on debt products. A 12-month, fixed interest loan is easy to explain and to promote; an equity investment in a single asset or a fund is far more complicated.

Minterest is preparing to launch a convertible note with “a distressed prime property” as the underlying asset, says Koh. “The unique structure of this product allows investors to invest into a fixed income instrument which generates annual dividend and includes the option to convert the debt into equity. The bond-like characteristic of convertibles provides downside price support, while the embedded equity option provides upside potential.”

Koh suggests blockchain technology could be the key to unlocking real estate equity crowdfunding. “We envision building our digital marketplace to become an efficient fundraising platform that is powered by blockchain technology to create new value through lower costs of raising capital and accessibility to a wide spectrum of investors globally.”

She continues: “Blockchain technologies can create an active secondary market for the trading of real estate and open up new pools of liquidity. Ultimately, with crowdfunding, blockchain technology and digitization of securities, with the right activation and execution, we can enable effective and cost-efficient methods for raising
capital.”

Joining forces with a “conventional” investment manager seems like an obvious way for a crowdfunding platform to gain scale, although Koh notes that some larger US crowdfunding platforms have evolved – logically – into banks. In the future, she suggests: “A successful crowdfunding platform will require the support of a strong sponsor that has access to quality, well-structured deals, as well as scalability of the platform, in terms of its range of product offerings and investor base.”

Crowdfunding: How does it work?

The key to crowdfunding is the automation of the investing and borrowing process, which saves both time and money.

The heart of each crowdfunding business is its platform, via which investors register and allocate capital to available transactions and where developers or asset owners can raise debt or equity finance.

Typically, investors go through a Know Your Customer (KYC) online verification process and once this is finalized they are free to invest in projects that are live on the platform. The platform will provide information about each deal, the asset or assets involved and the sponsor. Once invested, the investor can track the progress of each deal via a user dashboard.

The process for borrowers is rather more involved, with a loan approval process carried out via the platform. Automation is used to speed this process up and make approvals far quicker than applying for a bank loan. In each case, the platform garners a fee for hosting the deal.

Crowdfunding platforms do not offer guarantees. However, they may assist investors in recouping money due from borrowers. A high degree of trust needs to be built for platforms to succeed in the long run.