Crowdfunding Gone Bad?
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Crowdfunding Gone Bad?

9 months ago 0 0 911

Crowdfunding has a place in the real estate capital market as it serves the very small investor or investors, and I stated this in my blog “Crowdfunding: A Viable Option?” posted four years ago.

Sponsor + Investor Relationship

What is concerning about this fundraising platform is the disconnect between investor and deal sponsor. Sponsors should have a degree of familiarity between themselves and their investors. While potential investors with crowdfunding might be “financially qualified,” they have no actual relationship with the sponsor since crowdfunding raises the money. A close sponsor and investor relationship reduces the possibility of serious implications if a deal goes awry.

The recent Wall Street Journal article, “Missing Millions and a Rabbinical Arbitrator: Real-Estate Deal Gone Bad Hits Popular Crowd Funder,” proves my point.

The article claims large crowdfunding platform CrowdStreet “missed red flags” and is now “facing deals gone bust where $63 million of customer cash has gone missing.” Ouch.

What’s the Deal?

Crowdfunding platforms offer the small investor the ability to invest in commercial real estate and pitch deals to these investors via webcasts. An investor can buy-in with as little as $25K. However, investors using this platform might miss that bad deals or deals falling short of expectations are just an unpleasant reality in real estate investing. It’s problematic when the fundraising entity sells optimistic returns without adequately exposing the risks.

According to the WSJ, “Sponsors of more than 770 deals have raised more than $4 billion on [CrowdStreet].” However, the article claims that many deals do not meet projected returns for investors. In fact, “hundreds of CrowdStreet users lost some $34 million on 19 deals that underperformed as of this July.”

The article did note that 20+ deals outperformed projected return, but hundreds of deals remain unresolved. This might imply a shady practice or just reflect that real estate sponsors do not always succeed. A problem also arises when an underperforming deal requires additional cash to continue.

A Real Option?

I think CrowdStreet shepherding in a new CEO and shifting from a marketplace to a registered broker-dealer is a step in the right direction and will improve transparency and accountability.

The platform experiencing a situation like the one highlighted in the article is not surprising. Still, I think small investors should consider REIT stocks since they are more transparent and more regulated. The returns may not be as good, but the risks are lower. Qualified investors with large sums to invest should secure reputable sponsors to invest directly.

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