This article was written by Ben Berkin who is an editor of Crowdtrader/
By now everyone is aware of the growing investment crowdfunding industry. This new model for financing businesses and real estate projects is supposed to disrupt the traditional ways of raising capital, the same way that Lending Club and Prosper rewrote the consumer lending industry.
Crowdfunding platforms promised the small time investor the opportunity to invest in large commercial real estate investments and hot start-ups which were previously out of reach for them. The realization of this promise has progressed and platforms such as realtyshares , Fundrise and CircleUp, leaders in the industry, have worked to try and bring great opportunities to the retail investor. Still bogged down by unclear SEC regulations, the passing of Regulation A+ and more recently Title III of the JOBS Act have definitely moved us one step closer to seeing the dream come true.
Nevertheless we have observed an interesting trend that should make us all pause for a moment to consider whether this is really going to be a viable business model moving forward.
The most recent development in the real estate crowdfunding sector has been the establishment of the eREIT launched by Fundrise.com. The eReit aims to exploit inefficiencies in the traditional model by streamlining the processing online and with cutting edge technology which will allow the REIT to cut operating costs, and to pursue smaller higher yielding investments that traditional REITs would otherwise not be able to invest in. This sounds great but we must ask, why is Fundrise pursuing this new instrument? Is it an indication that the initial model is not sustainable?
Real Estate crowdfunding platforms have been touting their model as a better alternative than a traditional REIT in that it allows investors to pick and choose the best investments for their portfolio with total control and transparency in the investments. With the launch of the eReit this completely negates the previously touted advantages offered through crowdfunding.
According to Fundrise though, its original offering for the eREIT was oversubscribed by 500% which makes it seem like there is a ton of interest nonetheless. What is more concerning is if you look at the current offerings on Fundrise.com (since it is the leading platform in the niche, we look to its site to identify overall trends), the site doesn’t have any single offerings, it only offers two different real estate investment funds which group together a bunch of different offerings that are brought to the site.
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Investors on Fundrise have expressed concern about these offerings wondering if Fundrise is trying to bundle together different assets in order to get some of the less desirable offers funded along with the more desirable ones. This helps its deals flow and keeps its status as a top destination for sponsors to get funding but the question remains, is this being done totally in the best interest of its investors?
When we asked Brandon Jenkins COO of Fundrise about the lack of single offerings on its platform he said it was in response to investors’ requests for better diversification at lower investment minimums. Whether this is the real reason or not remains to be seen as it is possible that Fundrise has realized it just isn’t profitable to offer single asset investments. If you look at RealtyShares.com or RealCrowd.com though you will still see a large mix of single asset investments that they are currently funding.
Although the advantages of pooling these investments together in the real estate industry may raise some concerns I don’t think the eReit indicates an overall trend for the industry. The reason for this is simple, the eReit was offered under Regulation A+ which was passed earlier this year and basically created a legal way to offer crowdfunded investments to non-accredited investors.
This offering took Fundrise lots of time and money to get off the ground and is truly “cutting edge” in the crowdfunding industry. I would assume this is much more of a tool to gauge how much investment interest future offerings will garner from non-accredited investors (which according to its claims of being oversubscribed by 500%, it seems like the interest is there).
In fact with this offering I wouldn’t be surprised if Fundrise will lose lots of money, but it is a great way for it to test the market and keep non-accredited investors engaged with its platform. This will give it market insight to help navigate the new Title III legislation which went into effect January 2016 and should finally open up the crowdfunding investment industry to all investors.
In contrast, start-up crowdfunding platforms such as CircleUp, run by CEO Ryan Caldelback, which focuses on the consumer goods sector recently launched its own “index fund” which aims to spread investors’ funds over 150+ companies fundraising on its platform.
For the start-up niche though this is a welcome addition as this offers investors a much needed tool to diversify in order to minimize the risk in investing in start-ups. Start-up investments have a much higher risk factor and an investor can expect that close to 80%+ of investments in these companies will totally fail. The small percentage that make it though can offer their investors huge returns. This index fund model therefore makes tons of sense in their niche allowing investors to experience the excitement and rewards of investing (even if it is only a very small part) in a hot new start-up. Hopefully the few companies that really make it will help make up for the losses on all the others offering investors a great risk-adjusted return.
Stay tuned to see how the crowdfunding industry develops in 2016 with the implementation of Title III. Then we will truly see if this is the future of traditional financing or a big flop.