Commercial real estate crowdfunding remains intriguing, especially to investors looking to diversify their portfolios. And unlike swings in stock or bond prices, commercial real estate values continue to hold steady despite the economic turmoil brought on by the COVID-19 crisis. But how exactly will the pandemic affect the commercial real estate crowdfunding industry, which is now facing its first downturn since inception in 2014?
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Drawing on more than 30 years and $1.5 billion of transactional experience in commercial real estate finance and investment, Adam Gower—a real estate professor at the Orfalea College of Business at California Polytechnic State University and the founder of GowerCrowd—is an expert in raising capital during good times and bad. He believes the real estate crowdfunding industry is still “a blue ocean of opportunity” and expects those “who play offense and not just defense” to emerge as winners in the aftermath of the health crisis.
How is the COVID-19 pandemic affecting the commercial real estate investment landscape, particularly the crowdfunding sector?
Gower: The same is true for real estate crowdfunding as it is for any sector of the real estate industry. Some areas are performing well and others are struggling. I have been working on a $20 million-plus crowdfunding deal that raised almost the entire amount in the first few hours it went live. But it’s not all roses, as you would expect during a period of massive macro-economic dislocation. Some real estate crowdfunding platforms are attempting to adapt quickly as circumstances change by laying off staff and others are gearing up to take advantage of a likely flood of opportunistic transactions.
Keep in mind that this is the first downturn that the real estate crowdfunding industry has faced since inception around 2014, when Jumpstart Our Business Startups Act regulations were first promulgated. Everyone is a winner when the market continues to go up and it is inevitable that some crowdfunded deals will fail, and novice investors will be exposed to the downside of commercial real estate investing for the first time. It is possible that some crowdfunding platforms may fail as their financial models come under pressure, or their sponsor cohorts stop paying dividends or start to lose deals to lenders in greater numbers, though all this will largely depend on how deep the downturn actually goes.
Is the cost of capital going up?
Gower: There is more capital searching for good investment opportunities than there are deals to fulfill them, so while there is not necessarily an increase in the cost of capital, there will likely be an increase in risk appetite from the capital that is being invested and that will, in turn, demand higher returns.
Is the pandemic creating new opportunities?
Gower: Most definitely it is creating new opportunities, in various ways. On the one hand, the amount of distressed real estate opportunities is beginning to grow from a trickle to more of a steady flow, and that is likely to continue for quite some time particularly, as the various government stimulus packages come to an end. This will expand distressed investment opportunities beyond the early retail and hospitality sectors into other more resilient sectors such as office, multifamily and industrial, in that order.
That said, downturns expose the weakest in the industry and the winners this time around will, as always, be those who play offense and not just defense. Take, for example, the office sector. There will be some attrition in tenant demand as a result of the increase in remote working, however there will always be demand for offices. What will change will be the nature of that demand.
Office operators who have been successful during the good times, but who have relied on high levels of debt, short leases and noncredit tenants, will find themselves playing defense, as they attempt to keep their buildings occupied and rents paid on time.
Seasoned operators, on the other hand, with the experience of multiple downturns who have put in place recession-resilient debt levels, credit tenants and longer leases, will be in a stronger position to capture market share from weaker competitors by addressing tenant pain points more effectively. This might involve doubling down on building improvements to ensure healthy work environments, by using available cash that weaker operators simply do not have. For those operators, this is the period of opportunity to capture market share, and this applies equally to apartment owners, office operators and other sectors.
How does crowdfunding compete with alternate forms of fundraising at a time when transaction activity has slowed?
Gower: They don’t compete. Crowdfunding is complementary to other capital formation methods. Indeed, there are funds that specialize in crowdfunding 1031 exchanges, qualified Opportunity Zones, opportunistic funds, and there are plenty of family endowments that thrive in the real estate crowdfunding environment by having access to diversification options that have never before been available.
One of the big issues with crowdfunding is that the ventures that raise capital don’t often have the expertise to efficiently buy and manage properties. How do you match capital with expertise?
Gower: I’m not sure that I agree with the assumption inherent in your question. Many of the largest, most accomplished, experienced institutional caliber operators are using crowdfunding to raise capital. As with any investment, the challenge for the investor is in distinguishing from those who do not and those who do have the track record and experience to be able to deliver results as projected. This is not unique to real estate crowdfunding, however. The same is true of any stock that is publicly traded. As an investor, the onus is on you to conduct thorough enough research to ensure that you are investing only with best in class.
Why has it been so difficult to establish crowdfunding in commercial real estate?
Gower: Let’s put this into perspective. At least one crowdfunding platform, CrowdStreet, has alone raised over $1.2 billion in equity since it started less than six years ago. In aggregate crowdfunding platforms, including some of the other leaders in the industry such as RealtyMogul, RealCrowd, Fundrise, EquityMultiple and others have probably raised in aggregate $4 billion to $5 billion in equity since the industry started, equating to tens of billions of total asset value.
Individual sponsors have also enjoyed success in real estate crowdfunding. The client that I mentioned earlier in this article was able to raise nearly $20 million in just a few hours, and this is not uncommon across the industry. Origin Investments, for example, famously raised $105 million in only 17 hours in late 2018.
And despite an industry that has a growth curve like a hockey stick, still, only a tiny fraction of the investing population has yet invested in commercial real estate. In fact, data from the Securities and Exchange Commission suggests that only a few hundred thousand accredited investors have invested in their capacity as accredited investors, and yet there are more than 11 million accredited investors in the U.S.—each with either high annual incomes or net worth of more than $1 million.
Put another way, though the real estate crowdfunding industry growth trajectory over the last few years has been as rapid as it has been, the industry still remains in its infancy, and for early adopters it remains a blue ocean of opportunity.
What is the key to successfully raising money online?
Gower: In order to be successful raising capital for real estate there are two things that are critical whether you are raising it online or doing it the old-fashioned way, in person: patience and a good deal flow. Just as you would never sit down to a first in-person meeting with a prospect, and immediately start offering documents and wiring instructions, neither would you do that online. Before a prospect writes a check, you still must patiently establish a relationship of trust with that prospect and, although much of that can be done automatically online, it still takes time and requires finesse.
We only take on clients who have a good track record and a solid deal flow. There is little point building a world class digital marketing equity raising system if you don’t have any deals to plug into it at the end of the day.
What needs to happen for crowdfunding to grow in the commercial real estate industry?
Gower: When was the last time you called a travel agent to book a flight or a hotel? Or how about the last time you called a stockbroker because there was a share you wanted to buy? Do you remember life before Amazon? How quaint it was that we used to actually go to shops to buy, well, anything really.
The disruption of the real estate capital formation industry has already begun. It is only a matter of time before we look back with nostalgia at the idea of financing commercial real estate investments through in-person meetings at the country club.