Crowdfunding Local Real Estate—Great Promise and Great Peril

Emily Badger has a great long piece in Atlantic Cities about Fundrise and the general idea of “crowdfunding” local commercial real estate ventures. The basic idea is that large-scale impersonal financing models naturally end up steering neighborhoods in the direction of standardized development patterns, generic structures, and national chains. People are often much more enthusiastic about quirkier local businesses, and said businesses can actually be much more successful than efforts to pound square pegs into round holes. But it’s much more challenging to assess a quirky business from the standpoint of arm’s length finance, so it tends not to get financed.

Some evidence for this theory, incidentally, can be seen in the growing food truck trend around the country. Food trucks require much less startup capital than traditional restaurants, and consequently can be financed without arm’s length finance and they tend to be considerably quirkier than your average new retail development.

The current way around the problem Badger identifies is what you might call “friends and family finance.” You need to get some financial support from people who actually know and trust you, rather than from impersonal financial markets. The crowdfunding idea is to reduce the legal restrictions on marketing certain kinds of securities to small investors, therefore allowing the creation of something between friends and family finance and arm’s length finance. Call it neighborhood finance. You’re familiar with the area (perhaps because you live there!) and the prevailing retail ecology. You know your friends and neighbors and what they might be into. And you’re therefore perhaps able to make up for a lack of financial sophistication with specialized neighborhood knowledge, and thus invest wisely.

Things like the JOBS Act passed this past congress should, among other things, make it easier for this to happen.

That’s all rather utopian and optimistic. And, in fact, I am optimistic that some really awesome things will come from crowdfunding. But I think that should be tempered with several heaping doses of skepticism. Crowdfunding will unquestionably lead to some great ventures, but will also unquestionably lead to some scams. The question is whether scams or great ventures will predominate. And I think there’s ample reason to fear that scamming is the dominant strategy in this space. We already see that an awful lot of mass market investment products are basically scams, extracting management fees from middle class 401(k) holders for no good reason. Opening the door to less transparent vehicles seems very unlikely to change that. There’s a good reason that Kickstarter—the crowdfunding site that people like to point to—is explicitly not organized as an “investment” vehicle. They’re trying to keep scams away by emphasizing to people that supporting projects is meant to be a kind of consumption experience.

Long story short: Exciting possibilities here, but beware!