[Editor’s Note: This is a guest post from Ray Sturm, the Co-Founder and CEO of AlphaFlow, which helps investors build and manage real estate portfolios across the crowdfunding industry. Prior to launching AlphaFlow, he co-founded RealtyShares. His early career in finance included investment banking at Bear Stearns, restructuring at Lazard Frères and private equity at CCMP Capital.]
Real estate crowdfunding has absolutely exploded since opening up to investors in 2013 (see Part 1 here). I see that growth – 150% per year the last 3 years! – continuing and with that comes amazing innovation and challenging consequences. I wanted to share 5 important things you’ll see come to real estate crowdfunding in the next year:
1. Automated Underwriting
A number of platforms raised enormous rounds of venture capital in 2015. Many of these rounds were much larger than their performance metrics might garner in other industries. Fintech is hot right now though, and P2P/crowdfunding is on fire. However, large rounds come with similarly big expectations. If real estate platforms are to hit hyper growth, as Lending Club did around 2010 and Prosper did soon after Aaron Vermut and Ron Suber took the helm in 2013, you’ll see one big change. Specifically, I think you’ll see many more companies adopt some form of automated underwriting that allows them to evaluate exponentially more applications without growing their headcount proportionally. PeerStreet is a leader here, utilizing sophisticated data analytics that co-founder Brett Crosby honed at Google. To truly demonstrate the “tech” in fintech and not simply build real estate companies with websites, more platforms will move towards automated underwriting.
While Lending Club and Prosper offer very different products than the real estate platforms, they are nevertheless the world leaders in P2P investing. As such, many of us studied them closely in our earliest days as we looked for the roadmap to success. Most investors on these platforms that I know – at least those not in the P2P industry – choose to use automated loan picking instead of pouring through thousands of loans themselves. As the real estate crowdfunding market has started to pick up and sites have increased volume, many have begun to launch their own versions. Actually executing this in real estate is proving to be much more difficult than many founders expected though. The real estate platforms are working with tiny statistical sample sizes and long feedback loops compared to the massive wave of loans Lending Club can pour through in developing its grading system. Add in a lack of standardized metrics between platforms, and it’s going to be a tremendous challenge. For those who pull it off though, it could produce an inflection point in the ability to quickly fund deals! I’ll think you’ll see many try in the coming year.
There’s a Pavlovian influence to growing up in a bull market, and many founders haven’t seen the ugliness of a true down cycle. Instead, they’ve been rewarded for taking risks over the last few years and felt most burned by the investments they did NOT make. The result is some platforms underwriting deals at risk levels (i.e. LTV) you’d never see experienced real estate lenders touch. At a certain point, even in a bull market, the law of numbers kicks in and defaults happen even in the best of circumstances. How the industry handles these will be key.
Experienced investors understand that not all deals go well. When deals fall behind or go into default on any of the industry’s major platforms, I tend to get the announcement forwarded to me from a number of our customers. Their reactions are typically tied to one very important item: transparency. Platforms who openly and continually communicate with their investors tend to earn patience. Letting investors know exactly what’s going on, why the situation came to be, and what the platform will do to maximize their recovery can go a long way to building loyalty.
Unfortunately, this hasn’t always been the case, as some platforms – even some of the more popular ones – have seen defaults pile up. Many of these defaults will help to sharpen underwriting in the industry. That said, in a venture-fueled environment where growth may be paramount to performance in the short-run at some platforms, I’m reminded of Upton Sinclair’s quote: “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”
4. New Distribution Channels
As we discussed in Part 1, there has been a proliferation of real estate crowdfunding platforms, with close to 230 in the world today! I’m hearing about customer acquisition costs at platforms moving north of $5,000. Ridiculous numbers like that simply aren’t sustainable, and so platforms are looking to new distribution channels. With investors so fragmented, it wasn’t difficult to convince a number of top platforms to publish their deals on AlphaFlow, and today we have a healthy waitlist of those looking to connect.
You’re also finding new ways to invest. In November 2015, Fundrise launched a new investment vehicle – dubbed an eREIT – to invest in commercial real estate. Non-accredited investors can also participate, opening up an entirely new market of people who now have access. In February, AlphaFlow launched the industry’s first multi-platform fund, giving investors a way to passively build a portfolio of 75-100 deals with one investment. I think you’ll see a number of additional funds announced in the coming year as platforms work to expand beyond early adopters who were eager to actively invest, and tap into the majority of investors who prefer to participate passively.
5. Mobile Technology
Like everything in technology, you’re seeing real estate crowdfunding going mobile as well. In Q4, Access launched an app that they’re calling “Tinder for Investments.” In 2014, mobile overtook desktop usage. It’s moving slower in real estate crowdfunding though for two primary reasons: (1) the demographics of the investors today are skewed towards those still using desktops over mobile for actually transacting, and (2) given the size of these investments, they’re not often quick decisions made while sitting at a Starbucks or between meetings on your phone. I think mobile will start to make a dent, but it will come more in reporting and monitoring than in actually transacting.
As one of the early founders in the space, I can say that I couldn’t have imagined we’d get where we are as an industry this quickly. I continue to be impressed with the growth, innovation, and most of all, the people in the industry. I think you’ll see some growing pains this year, but real estate crowdfunding is ultimately poised to continue its meteoric rise. I’m excited for the day when we look back and wonder how real estate wasn’t in everyone’s portfolio, when crowdfunding makes it so easy!