Here’s part three of the conversation between Ben Schulman of Small Change and Dr. Adam Gower of Gower Crowd when they got together for a real estate crowdfunding chat. Watch the video or read the transcript below.
Ben: Well, that brings up an interesting point: that crowdfunding is just one component of this larger fintech industry and that there’s creativity happening throughout. But I think it’s interesting how you mention the institutional partners – because this is financial technology that is not disruption in the same way that we think about technology companies disrupting old models of production.
Adam: Oh, I don’t know. I think it’s entirely disruptive.
Ben: Even though it’s reliance on relatively old distribution methods of capital?
Adam: I think’s it’s totally transformative for real estate. So, the distinction that I’m making when I think of it being transformational – and we’re back to crowdfunding real estate, right, not the creative uses, etc., particularly, but just the general premise of crowdfunding a real estate deal – the reason it’s transformational is because now everybody can invest and every developer can now advertise their deal online. It’s transformational, it’s changed the way it’s done, I mean it’s just….look, I think of the developers that I speak to, the seasoned developers, who like to tell me “Yeah, but you know, we’ve already got our pool of investors who’ve been investing with us for years, why do we need this?” Well, you know why you need that? Because everybody else is now after your investors, right? So, look it might not be today and it might not be tomorrow but in six months, by the end of next year, your investors are gonna suddenly discover that you aren’t the only game in town and that they can now look on any number of websites and seek out any number of first-class sponsors that they can invest in exactly the same way as they’ve been investing with you. You need to up your game, right? You need to start changing things around.
I was just going to say, from that perspective it’s transformational. I don’t think people really realize it yet, and that’s the process of education. You need to know because if not, you’re gonna be drowned by this tidal wave that’s just gonna sweep over you. You won’t know what hit you.
Ben: Crowdfunding is being used as a way to mitigate the potential ill effects of a downturn and I’m wondering what you think are some of the other creative ways in which crowdfunding can be used, whether it is to stem systemic losses from traditional means of defaults or whatever else you observe out there where crowdfunding is being used in a way to come up with new types of products and new types of financial models that we’re just starting to entertain?
Adam: Yes, so some of the people that I’ve spoken to really have some very, I want to use lofty ambitions, ambition perhaps is the wrong word, but lofty vision of where this industry could go. At the extreme end, the idea is that crowdfunding debt, which is what you’re talking about, crowdfunding debt could replace traditional channels, right? Banking channels. So you would, instead of – and the example that was discussed with me was that now, you know, you put your money on deposit at the bank and they pay you .01 percent and then that money passes through multiple hands until eventually it reaches a developer who’s out there building a property and he gets charged six/seven percent. And somewhere along the way, all the way through that, there’s people taking a cut of that margin. So why not just invest directly with the developer on the debt side, right? Why get .01 at the bank when you could get four or five percent directly with the developer? And the idea is that – well the idea that’s been expressed to me is that – once crowdfunding at its extreme, or at its maturity will have replaced bank lending on the debt side. And I know that this is certainly something that you guys have taken a look at, on a limited level, is to provide the entire stack to a developer, perhaps with some skin at the very, very top on the developer’s side. So I think that that has some very interesting possibilities. Particularly, so I’m not sure if it’s going to replace banking (I’ll let that out) but I do think that there is a place for it particularly on the local level where you have the opportunity to invest in local businesses that might want to build their own facility or own their own property, right? So, and maybe they don’t have the kind of track record that a bank will underwrite. Remember banks are not doing it vindictively in any way. They’re restricted by regulations as to how they underwrite risk, right? So if you don’t fit their box, now you’re out of luck. But in those cases you can go to the broader community and you can say, “Look, I’ve got a business that I want to run and I want to set it up and it would be better for me if I was paying a mortgage than it would it I’m paying rent so would the community like to support me in that way?” So I do think there is a place for that.
The institutional route in terms of financing is a lot easier, right? So instead of having to go out and collect small change from a bunch of investors….
Adam: (laughs)…from a bunch of investors it’s a lot easier, if the numbers make sense and you can prove that it works, to go to large institutional investors who just capitalize the whole deal for you.
Ben: It really depends on what the impetus is toward crowdfunding. If it’s meant to be used as a community buy-in tool, then Reg CF is gonna be that more compelling. It also depends on the market and the sub-market in which you’re developing. In a market like Pittsburgh, let’s say, or the South Side of Chicago, the bank is gonna be involved in the deal and they want, let’s say 25 percent of what that developer comes in with. 25 percent of a four million dollar deal is a million bucks. A million bucks goes a long way in Pittsburgh or the South Side of Chicago. Four million dollars goes a hell of a long way. So I think it’s a matter of geography, really and motivation when thinking about that cap. You’re spot on, though, that right now it’s just arbitrary because there are only 34 funding portals that are actually allowed to raise capital under Reg CF. Until some type of mass awareness of this vehicle, we’re building it as it’s, or rather a better way to phrase is it is we’re driving it as it’s being built.
Adam: And now you’ve got an entire class, or an entire generation of potential investors who really don’t know how to invest. So it’s very…I think that a lot of developers don’t realize how much they have to put into marketing and selling their deal online to raise any kind of money. And the problem, I think the biggest challenge for Reg CF is that the developer – and I’m learning this through you, actually, and through Small Change – is so dreadfully restricted in what they can actually do in terms of marketing. So, you know the burden of reliance, I suppose, is on the platform, on the funding portal to do the marketing and the heavy lifting.
I’ve spoken to, as you know I’ve spoken to a lot of the founders and CEOs of many of the major platforms. And one of the biggest issues that everybody faces is one of education, on two levels. One is just that you can do this now, right? Like, yesterday you couldn’t, now you can. So, once you get past that hurdle the next is: OK, great, now I can invest in real estate like, you know, the moguls of real estate in America, the ultra-wealthy of America have been investing. But how do I do that? You know, how can I tell what’s a good deal from a bad deal? What are all these terms of art that are used – a cap rate, IRR, LTC, LTV? You know, there’s just this whole catalogue of concepts now that people have to understand in order to be an informed investor. And so, I think that a lot of the websites do a good job of that but in my view there is no doubt that they are hampered by their own exalted levels of understanding and experience in the industry and don’t really realize how little – that’s not really the right word – but how advanced their dialogue is when they’re trying to explain these concepts to somebody who really has no experience of it at all. And this is actually something that you guys have done at Small Change that inspires me and has caused me to really think hard about the way that I articulate these questions and that is, or how I articulate these answers, and that is the use of plain English, right? Well I remember reading your documentation and being absolutely blown away, thinking this is….I’ve never….how did you do this? I’ve never read anything as perfectly well worded, as clearly worded that anyone can understand it.