Daniel Calano, Prospectus, LLC

It seems that in real estate investing, as in many other parts of life, smaller is getting better. If not better, at least more common. Where people used to invest directly in buildings, recent history has produced many options: general syndications, limited partnerships, real estate investment trusts, and now crowdfunding.

You’ve heard of crowdfunding for companies, the most touted one being Kickstarter. But over the last few years it has moved into real estate. Not an obvious path to success, crowdfunding was fueled by the Jobs Act of 2012, created to foster the growth of smaller businesses. Without getting into the weeds, this act has been modified several times to promote various levels of investors to invest small positions in individual buildings. This process is becoming enormously popular, with investors growing faster than expected, and companies growing to service them. Check the Internet and you will find new ones each month, with early adopters called Realty Mogul, Realty Shares, Real Crowd Realty, etc.

How does it work? In simplest terms, accredited, and potentially non-accredited, investors can invest as little as $1,000 directly into most every type of real estate project. These typically are actual individual properties as opposed to pooled properties such as in a REIT. In a Wharton Business School interview of a Realty Mogul executive, the pitch was enticing. The executive said: “The technology combines Big Data, marketing, online marketing technology, and a crowdfunding platform. It’s really easy to invest. You can put in as little as $5,000 and you own a piece of real estate.” He went on to say that the big difference between this and a REIT is that you actually know what you are going to be investing in, typically a specific property, not an opaque investment pool. The plusses were: owning a piece of an individual building, more transparency in the process, allegedly fewer middlemen, and enough due diligence to make your own individual decision.

But, as you listen to this, there is a nagging voice in your ear of “it sounds too good to be true”. The literature is full of potential downsides, if not at least caveat emptor. The most prevalent question is whether or not the stuff that we real estate professionals do, that is, rigorous analysis and due diligence, is possible under the fast pace of this investment platform. Instead of a detailed case by case analysis of the project, studying economic, geographic, and other factors affecting outcome, many crowdfunded projects are proposed by the developer/sponsor itself, with their analysis. Depending on the crowdfunding platform, due diligence follows in varying degrees. But how much can they know, about so many different types of properties, in so many different places, sponsored by typically so many smaller investors and developers?

I would add to this potential of under-analysis, the ability to manage. Property management is difficult enough, but at least with larger investment platforms, larger projects, and REIT-like pools, the economies of scale are there to have strong, experienced management teams. One wonders how, with a huge variety of size and type projects, in a variety of geographic locations, how management companies can be depended upon.

One writer decided to actually test the concept by investing in three projects. He invested $17,000 in three deals, figuring that that wasn’t too much exposure. He admitted the projects did not go too well. The first was a debt offering on a single family home, and this project was the best, with monthly payments starting right away and no foreclosure. The second was a short term fix up and flip equity deal. Several months after the project start, and no word from the developer, it was discovered he had bungled the project, underestimated, overpaid, and could not deliver. The third project had similar problems: zero communication from the developer, and a timeline and budget very underestimated.

Just as many were originally skeptical of real estate syndications, REITs, and other vehicles, it is healthy to view crowdfunding in real estate with squinty eyes and a wrinkled brow. There will be plenty of problems on the way, but on the other hand, this may mature into a completely reliable and acceptable format for real estate investment. For the present, if I decide to invest my $5,000, I’ll rely on my own analytical skillset, not theirs, to pull the trigger.

Daniel Calano, CRE, is the managing partner and principal of Prospectus, LLC, Cambridge, Mass.