Disruptive innovations are those that help create new markets or value networks – and which eventually disrupt existing ones, often by displacing earlier technologies. In real estate crowdfunding, we could be witnessing another such disruptive mechanism.
Technological or other innovations are not always “disruptive” in the true sense; for that, a changing application of the technology is usually required. The automobile was a revolutionary technological innovation, but for decades it remained an expensive luxury item until the lower-priced Ford Model T debuted in 1908. The automobile by itself was not disruptive, but its mass production changed the entire transportation market.
Examples of disruptive innovations exist throughout history, but the recent technology-driven era has seen more than its fair share. E-mail has now largely replaced postal mail, because messages can be sent over vast geographic distances in mere milliseconds, without wasting paper or requiring expenditures for postage stamps. Downloadable digital media has now largely replaced CDs and DVDs, largely due to the iTunes Store and Amazon.com. Mainframe computers were eventually outgunned by personal computers, which themselves are now threatened by tablet computers and smartphones.
In each of these cases, however, larger market dynamics ultimately ended up mattering more than the technological innovation itself. Email didn’t become widely adopted until the internet allowed universal connectivity among computers. The illegal peer-to-peer file sharing technologies that eventually led to today’s downloadable media were first driven by the market need created when the music industry phased out the sales of singles. And mainframe computer manufacturers did not initially consider the minicomputers as threats to their market, since the value of distributed computing using less-powerful, individual machines was not immediately apparent to enterprises wedded to centralized, high-powered systems.
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Sometimes the market change defies even the established legal system. Markets for “gypsy” or other unlicensed taxi services have long existed, for example. But the ability of Uber, Lyft and others to make dependability and nicer cars available to anyone with a smartphone app has created such sizable market demand that local regulators often back away from enforcing their laws protecting medallion-bearing taxis when confronted with company-organized social media campaigns in favor of the ride-sharing services.
Now the world of real estate finance is experiencing the initial throes of what could be a similar disruptive innovation — crowdfunding. The finance world has often made room for smaller investors in markets such as mutual funds, commodities, individual stocks and bonds. The development of real estate investment trusts (“REITs”) in 1960 allowed for broader individual participation in commercial real estate – yet even then, most REITs are holders of “pools” of assets, and it hasn’t been easy for smaller investors to play a part in individual project syndications. Today’s communications technology, however, has enabled smaller investors to participate more broadly in specific real estate investments.
Through the online platform that I work with, Realty Mogul, accredited investors can now review real estate investment projects at their convenience, sitting with their laptop or tablet computer after dinner, for example. These projects were previously often limited to institutions or persons of very substantial wealth. Using these crowdfunding sites, vast numbers of smaller investors can now pool smaller individual contributions to invest in larger or higher-level real estate projects than previously weren’t accessible to them.
The ability of these crowdfunding sites to open up the real estate finance market to smaller investors with no previous industry connections, at smaller contribution amounts than were formerly practicable, could well prove to be a disruptive force in the industry. For now, the larger finance players remain focused on institutional and other big-money customers, and perhaps – like the mainframe computer makers in earlier days – they don’t yet consider the distributed sourcing of investor funds that is enabled by crowdfunding to be a threat to their market. They may not see crowdfunding as something that their mainstream customers want, or they may view the projected profit margins as insufficient to cover a big-company cost structure.
This may, however, be a short-sighted viewpoint. The development of the computer industry demonstrated that technology empowering individuals (rather than external hierarchies) tends to, over time, transfer influence and power to where it optimally belongs — at the individual level. The decentralized network of individual real estate investors may still be seen as unattractive to the larger players in the finance world. The history of disruptive technologies, however, should caution market observers to take crowdfunding seriously – and to watch whether its business model of taking existing technology and applying it to a different value network could in fact be the wave of the future in real estate finance.