Disrupting the disruptors — What is the value of a real estate crowdfunding platform?

Origin Capital, a private equity firm based out of Chicago, recently announced the launch of their own real estate crowdfunding portal. Earlier this year the firm tested the crowdfunding waters through RealCrowd. Despite their success with RealCrowd, the firm must have believed they could replicate the same process on their own platform. The concept of disintermediation, or removal of middlemen, is one of the main benefits of technology. Real estate crowdfunding doesn’t really remove the middleman from the capital raising process, it just does it in a more cost effective manner. Origin Capital, by going direct to the investor, will test the core value propositions of real estate crowdfunding platforms — their ability to curate quality investments and provide access to a captive pool of accredited investors.

Real estate crowdfunding and the concept of sustainable competitive advantage

“Marketplace” sites, such as RealCrowd, CrowdStreet and RealtySharesprovide a forum for sponsors to sell directly to the investor. The sponsors take responsibility for the securities issues, but the site provides automation of the communication, funding and information disbursements to investors. The more established ones tout their ability to curate opportunities, although with the inherent conflict of interest in their business model this selectivity is debatable.

“Fund Based” platforms such as Patch of Land, Realty Mogul and Fundrise invest their own money and/or underwrite deals on behalf of the crowd. Competitive advantages among these platforms center around their underwriting acumen, geographic or product expertise.

The Marketplace model demonstrates its value through its transactional innovation, which demonstrates immediate benefits to the client. In contrast, the Fund Base Model demonstrates its value to investors over time — Do their investments return as projected? Do the borrowers pay back their debt? It takes a long time (and some downcycles) to prove the efficacy of a platform’s expertise.

If the Marketplace model, which does not charge fees to the investor, eclipses the Fund Based model in terms of deal volume, what will that say to the value of their underwriting? Origin Capital goes even further by cutting out the marketplace platform, believing that a third party check on their deal sourcing process is neither necessary nor valued by the investment public. Since they have their own equity at risk (and their opportunities were already underwritten by their co-investing principals), the company’s interests are well aligned with the investors they are soliciting.

Investor Base and the costs of customer acquisition

Demonstrating value to a real estate sponsor through access to a sizable investor base is much easier than a platform’s more subjective benefits, such as process or underwriting acumen. The top crowdfunding websites, marketplace or otherwise, all enjoy a sizable registered base of accredited investors. Investor acquisition does not come cheap, judging by the latest promotions offered for referrals. If a platform is willing to pay out $150-$200 for an accredited investor referral, one has to assume the actual acquisition costs are considerably higher. In unit economic terms, if only 1/3 of these registered investors actually invest on the platform, they would need to invest $20K+ on average across three or more investments to break even on a Lifetime Value basis[1]. To achieve this, a platform either has to originate a sizable volume of opportunities (not easy if it is exclusive to one sponsor, such as Origin) or increase the average investment size by recruiting larger institutional investors. It is the latter strategy that many are electing to pursue. The displacement of individuals by institutional investors not only calls into question the benefits of crowdfunding, it challenges the value-add of a platform’s underwriting expertise. Many institutional investors already have real estate experts on staff — in many cases better than the platforms themselves — so ultimately they are paying for access, not curation.

Is it worth joining the fray?

If the 100+ real estate crowdfunding websites are any indication, it isn’t very hard to start a platform. The website isn’t difficult to build and there are many supportive services available to help one navigate the SEC regulations. The harder part is building, and engaging, a sufficient investor crowd necessary to fund an investment. There are clearly benefits from drawing from diverse sources of capital, so the desire of a sponsor to build their own platform is evident. Ultimately most will determine that the costs to build and maintain are best left to the experts.

[1] Assumes 2% fees earned by platform on capital placed

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