Many investors are looking at real estate crowdfunding. At the same time, they don’t always understand the risks of this kind of venture. Is it a viable option for you, or just another foolish get-rich-quick scheme? Here’s what you need to know about this new way to invest.
What Is It?
Crowdfunding differs from traditional investing and lending in many respects. The first of which is that, for investors, it represents a direct channel into an investment, bypassing Wall Street. Equity crowdfunding, which wasn’t allowed until 2012, gives investors unprecedented control and access to companies without the need for lawyers and specialized contracts.
It gives real estate investors the ability to fund the building of new properties – all without having to spend ungodly sums of money negotiating with property builders.
For the financial industry, it represents a major threat to “business as usual.” Banks no longer have a monopoly on lending. When companies can go directly to investors for funds, it cuts out the middleman.
Real estate companies, like abbotts.co.uk can sell properties to clients, while those clients raise money through investors. Everyone wins, except lending institutions.
For crowdfunding to work, there needs to be a platform where investors can go to invest in good ideas. The platform facilitates the collection and investment of money. Investors are assured that money will be handled appropriately. But, as with all investments, there is risk. And, with crowdfunding, there can be considerable risk.
Challenges You Face
One of the biggest risks in crowdfunding is underwriting. Specifically, the underwriting of risks. Usually, risk-analysis is done by professionals. But, with crowdfunding, you are left to do that yourself. Traditionally, an underwriter or analyst does the due diligence for an investor, verifying the investment, how the company intends to make money, its prospects for growth, and so on.
Everyone wants money for their project, but not everyone deserves it. An underwriter is the gatekeeper that stands between investors and people or companies who want investment capital.
Best Practices That Are Missed By Amateurs
Many amateurs aren’t good at understanding risks. They miss best practices like a LexisNexis background check or a “Bad Boy” guarantee. And, they may forego professional legal counsel, title insurance, and crowdfunding platforms may not have a system in place to share underwriting discoveries.
A LexisNexis check means that you’re checking as to whether anyone you’re investing with has a criminal background. As an investor, you might automatically assume that anyone asking for money is clean. Criminals are never bold enough to ask for millions of dollars, right? Wrong.
A surprising number of sponsors do indeed have criminal records. Just because someone has developed a few buildings, or even a dozen or more, doesn’t means that there’s no trouble in their background.
A “Bad Boy” guarantee means that there’s a personal guarantee, but it’s only triggered by bad acts on the part of management.
Usually, this means fraud, or gross negligence, malfeasance, or some kind of other criminal activity. If a developer embezzled money, for example, they will be personally liable.
You should always seek legal counsel for an investment you’re undertaking yourself, especially when it’s not part of established financial markets. No one likes paying a lawyer’s fee, but at the same time not doing so can be very expensive.
Finally, if you do uncover something, share it with the community, and encourage other investors on the platform to do the same. This is one of the major benefits of crowdfunding. Think of it as “open source underwriting.” But, it only works when the community is transparent and willing to share anything they uncover.
The Potential Rewards
It’s not all dark clouds though. In an industry where many startups are valued by the money that’s originated through venture capital, entrepreneurs have become addicted to growth. In fact, it’s a “growth at any cost” mentality that often takes over in many industries.
The problems is that, for many business, there’s only one sure-fire way to guarantee unchecked growth: reduce quality.
Equity and real estate crowdfunding isn’t unlike a lot of other industries in that respect. Due diligence often means turning down most potential investment ideas because most ideas are bad. A great investment crowdfunding platform helps investors sort through all of those bad ideas and culls the good ones to the top.
Poor underwriting standards is the main threat in this model. But, for those who do succeed, real estate crowdfunding will take on the financial industry like Amazon took on retail bookstores, Twitter took on newspapers, Kayak took on the entrenched travel industry, and Uber took on the taxis.