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By Darren Powderly, CCIM, VP, Business Development & Co-Founder
Crowdfunding platforms continue to gain momentum as a viable means for investors to identify real estate investment opportunities, and for real estate firms to raise capital and manage investors online.
However, with this evolution has come greater differentiation between crowdfunding platforms concerning their fees, yields, risk and growth potential. This article takes a closer look at three business models that have emerged, and highlights some of the pros and cons of each:
- Direct investing
- Indirect investing
- Software-as-a-Service (SaaS)
1. Direct Investing
As its name suggests, the direct investing crowdfunding model allows accredited investors to invest in real estate directly with a real estate firm (“sponsor”). The crowdfunding firm acts as the intermediary that facilitates capital raising between real estate sponsors and investors. CrowdStreet and others in the industry, such as RealCrowd and EarlyShares, are among those firms that have adopted this model.
One of the key advantages of this model for investors is that investors co-invest in real estate opportunities alongside the sponsor. The investment risk, therefore, lies with the sponsor being able to meet the business plan for that particular property or fund. There is no risk associated with the long-term viability of the crowdfunding platform, which consists entirely of startup enterprises.
The benefit for sponsors using the direct model is that they not only gain access to capital, but they also establish a direct connection to new investors and can use the platform to expand their own investor network. Sponsors use the platform both to raise capital and to efficiently manage ongoing investor relations.
Once the crowdfunding firm has sourced the deal, investors review the detailed offering materials and may interact directly with the sponsor. The sponsor, in turn, knows who those investors are and can market future investment opportunities to those investors via the platform.
This model also offers lower fees for investors by cutting out the need for brokers in the middle, or the dreaded “double promote” fees. CrowdStreet, for example, does not charge fees to investors to join or invest via the CrowdStreet marketplace.
2. Indirect Investing
The indirect investing model is used by firms such as Fundrise, Realty Mogul and iFunding. Accredited investors participate via a Special Purpose Vehicle (SPV) created by the crowdfunding firm. The crowdfunding firm estimates how much capital they can contribute to the sponsor’s capital stack, and then attempts to fill that requirement by bringing investors into a SPV created specifically for that property.
In this model, the crowdfunding portal is akin to a single limited partner or lender that leverages crowdfunding to fund its position in a specific real estate project.
One advantage of the indirect model for sponsors is that they receive a single check and have one SPV to report to throughout the investment term.
However, the indirect platform model is a fairly standard source of capital, as sponsors are procuring a single new investor while the individual investors remain unknown to the sponsor. As a result, the sponsor does not gain a direct relationship with investors and, therefore, does not generally expand its pool of accredited investors to be leveraged in future offerings.
The downside to the indirect model for investors is that the SPV brings an added layer of risk based on the viability of the crowdfunding company. Since cash distributions and returns are paid to the investor not by the real estate sponsor but by the crowdfunding platform, there will be adverse consequences if that crowdfunding firm should fall on hard times or go out of business.
In that event, an investor’s capital may be lost or their returns diminished even if the underlying real estate asset continues to perform well. In short, the investor’s returns are impacted not only by the performance of the real estate asset, but also by the health of the crowdfunding platform used to manage the investment.
In addition, because the crowdfunding platform is acting as the investment manager of the SPV, it charges added fees to investors for this service. By contrast, direct crowdfunding platforms don’t charge acquisition, disposition or a share of profits and the investor and sponsor enjoy higher returns as a result. Similar to the way eBay’s marketplace operates, direct platforms connect investors and sponsors, and let the merits of the sponsor and their deals speak for themselves.
3. Software-as-a-Service
In the third crowdfunding option, sponsors integrate a “white label” Software-as-a-Service (SaaS) technology platform with their existing website. This enables online fundraising and investor management services under their own brand, to their own private network of investors as well as the public at large. CrowdStreet, CrowdEngine and Katipult are some of the firms that provide those solutions.
The benefit of this model is that a sponsor can use the technology platform to develop their own direct investing portal to enhance the value they provide to their existing investor network, while expanding their reach to new investors. It also allows sponsors to “tier” an offering by first promoting a new investment to their private investor network, and then sharing the opportunity with the public if additional funds are required.
There are a few crowdfunding firms, CrowdStreet included, that provide both a direct investing marketplace solution and a white label SaaS option. As the industry has evolved, CrowdStreet recognized the demand from sponsors to not only raise capital from a crowdfunding marketplace, but also to have their own private-label solution.
CrowdStreet Sponsor Direct allows sponsors to offer real estate fundraising and investor management capabilities on their own branded website and optionally promote their offering via the CrowdStreet marketplace.
The differences that set firms apart are likely to grow more pronounced as platforms become increasingly specialized in terms of property type, size and scope of opportunities—ranging from house flippers to those offering institutional quality real estate.
As the real estate crowdfunding industry continues to expand, it is important for investors and sponsors to take these different business models into consideration when evaluating the right solution provider for today and into the future.
