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Does Commercial Real Estate Crowdfunding Pose a Threat to REITs?
Online platforms that sell direct investments in commercial properties promise stable returns, but only a few players may survive.
Crowdfunding, the go-to money-raising strategy for food truck operators and app designers, has begun to make inroads into big-dollar U.S. commercial real estate deals.
The pitch: Affluent individual investors can take direct stakes in medical offices, shopping centers and other properties by putting up money online. Proponents predict that this new way of selling stakes in commercial buildings will one day elbow out established players such as real estate investment trusts.
Ken Klein, a retired certified public accountant in Boynton Beach, Florida, has invested in three projects through crowdfunding platform Acquire Real Estate. It enables the average Joe to have access to deals that would otherwise be unavailable to them, says Klein, who put between $5,000 and $50,000 each into an airport hotel in Dallas, a mall in suburban Chicago and a portfolio of hotels in Atlanta. In his view, these direct investments are less sensitive than REITs are to the whims of the markets.
Its not dissimilar to Uber, says Scott Picken, founder and chief executive of Wealth Migrate, a crowdfunding platform launched in 2009 thats based in Cape Town, South Africa, and operates in the U.S. from Alpharetta, Georgia. Were going to see a fundamental change in the way people invest, asserts Picken, who points out that non-U.S. regulators have been quicker to embrace crowdfunding. Its not going to happen overnight, but anywhere the Internet has come into an industry, it has led to disruption.
Dozens of real estate crowdfunding platforms have sprung up in the three years since President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act, which allows companies to sell equity investments online. Customers of so-called equity crowdfunding sites must be accredited investors with $1 million in assets or income of more than $200,000 a year.
For investors who have grown accustomed to managing their portfolios on the web, purchasing real estate there is an obvious step, according to Jilliene Helman, founder and CEO of Realty Mogul Co., a crowdfunding company based in Los Angeles. People have been buying stocks and bonds online for a decade now, but I dont think it occurred to them that they could buy their real estate investments online, notes Helman, whose platform launched in 2013 and says it has financed more than 300 properties with a total value of some $700 million.
Some are skeptical that crowdfunding presents a viable alternative to established strategies for investing in commercial real estate. I see crowdfunding as real estate lending without underwriting standards, or real estate investing without due diligence, says Thomas Springer, a professor of finance and real estate at Clemson University in Clemson, South Carolina. I dont think it will be a disruptive force.
Although each crowdfunding site takes a different twist, a deal marketed by New Yorkbased Acquire, which began operating in early 2015, gives a glimpse into how the concept works. Last March, Katz Properties of New York paid $46.8 million for Pompano Marketplace, a 239,000-square-foot shopping center in Pompano Beach, Florida. Acquire paid Katz $369,000 for a small stake in the property, then resold that share to more than 15 investors for $10,000 to $125,000 apiece, Acquire chief marketing officer Greg Shugar says.
Like owners of REIT shares, crowdfunding investors are attracted by the promise of quarterly dividend checks. Acquire told investors to expect returns of about 7.5 percent a year from Pompano Marketplaces cash flow.
If Katz sells the center, the crowdfunding investors will share in any profit or loss. Pompano Marketplace is fully leased, Shugar says; tenants include Walmart Neighborhood Market and Stein Mart. We feel comfortable Walmart is going to make their rent payment, he adds. Were not promising to make you rich. Were just promising to give you a nice return.
Acquire, which says it has raised $3 million so far, isnt the only crowdfunding platform to focus on stable properties that are creating cash flow. Wealth Migrate targets medical office buildings, whose tenants are unlikely to move as often as companies renting space in typical office complexes, says Picken.
Realty Mogul aims for projects with at least ten tenants, a strategy that reduces the risk posed by the failure of a single tenant, Helman says. All three crowdfunding companies say they avoid land deals and development projects risky endeavors that can reap big profits or losses.
Investors who want to play the real estate market can already choose from a plethora of REITs, so why not just buy shares in one of them? Crowdfunding players say their single-property approach holds a certain appeal, even if such investments are less liquid than REITs and offer none of the same diversification.
They have more control, Helman says of investors. We allow them to buy properties one by one. Theres more transparency into the individual property than they would have with a REIT.
Crowdfunding companies also say they can eliminate some costs, such as broker-dealer distribution fees. In a normal REIT there are numerous middlemen between shareholders and their investment, Wealth Migrates Picken explains.
Of course, crowdfunding platforms extract fees of their own. Acquire says it collects 2 percent of distribution payments that investors receive from Pompano Marketplace. If the shopping center sells at a profit, Acquire will take 5 percent of investors gains.
The mainstream real estate industry, for its part, has greeted crowdfunding mostly with a shrug. No one tracks crowdfunding in commercial real estate, so its tough to gauge how much money is being raised. Some experts told Institutional Investor that the concept is so new they have yet to form an opinion.
We dont think crowdfunding is going to replace REITs, says Ron Kuykendall, spokesman for the Washington-based National Association of Real Estate Investment Trusts. With a market capitalization totaling $939 billion as of October, U.S. REITs have a huge head start on crowdfunding platforms.
Even crowdfunding boosters expect a shakeout as the new business model finds its way. There are 150 real estate crowdfunding companies, Acquires Shugar says. Only a few are going to survive.
Jim Costello, senior vice president at Real Capital Analytics, a real estate data firm based in New York, also sees a reckoning ahead: This market is a little chaotic with the number of new entrants at this point.
Still, advocates contend that crowdfunding is poised to take off. The industry is still in its infancy, Helman says. But I dont think its inconceivable that youll see billions of dollars of capital raised this way.