By Adam Hooper
When legislators dropped the JOBS Act onto the real estate industry’s doorstep last year, not everyone noticed. Of those who did, many shrugged, some debated the implications, while a few of us formed companies to explore the possibilities centered on these legal changes.
There are now over a dozen such companies based on the JOBS Act. (Disclosure: I count myself as CEO of one, RealCrowd.) Each is attempting to carry its own vision and carve its own niche, but what they all have in common is that this time last year, none would have been possible.
The basic idea behind them is this: The JOBS Act has opened up new ways for real estate operators to interact with investors, and for investors to interact with opportunities. Legislators laid a groundwork that companies are now exploring, by asking questions such as, “What problems can this solve? What are the pitfalls? Is there more than one viable way for everyone to benefit?”
The process of answering those questions will result in a big shift in the way real estate deals are communicated, funded and transacted. As activity moves from offline to online, as deals move from exclusive to accessible, the deal flow landscape is going to change. There’s little doubt that five to ten years from now, this particular piece of legislation will have reformed how things are done in the industry.
Of course, whenever anything undergoes big, dramatic changes, it’s always “for better or for worse.” Case in point: Even in the early stages of development, critics are raising one major point of concern.
Is Adverse Selection a Red Herring?
Without a doubt, the most visible push of the JOBS Act into real estate has been via “crowdfunding” initiatives, whose underlying idea is to make big-money real estate opportunities accessible to everyone.
It’s the self-professed start of the “Great Democratization” of real estate capital flow. As attractive as its political overtones might sound, this approach presents a serious challenge.
When the barrier of entry on a platform is low enough, as on some crowdfunding sites, it attracts investors that have difficulty distinguishing good deals from bad ones. Unseasoned investors have a tendency to go with their gut, assessing the value of real estate using anecdote rather than data. Sensing opportunity, operators pile in, looking to fund deals they have been unable to finance through traditional channels, often because the deals are of low quality.
The result of all of this is “adverse selection,” which is the tendency for bad opportunities to get funding over good ones, dominate a given channel, and suppress quality deal flow on the whole.
It’s of such rising concern in the real estate crowdfunding space that it lead one commentator in the pages of The Registry to label last year as “a great year to unload crap.”
In a way, he’s right. Low barrier-to-entry platforms, pools of unseasoned investors willing to take poorly assessed risks, will always cause adverse selection. Penny-stock investing, Iraqi Dinar scams, and sight-unseen properties in the swamps of Florida have always managed to attract money, whether online or offline, through traditional channels or novel ones. This has been the case since time immemorial.
If you want to unload crap, every year is a great year.
The upshot is that this has nothing to do with the JOBS Act or Rule 506(c), and instead it has everything to do with the quality of the investment platform being used.
In fact, there is more than one way to bring these new regulations to bear on real estate. A focus on crowdfunding, popular as its been, is just one way to go about things, and, as it happens, it’s a way that tends to highlight the old issue of adverse selection.
Another, better possibility is to take Rule 506(c) and build excellent tools and technologies around it, ones that the solve problems of successful operators and improve their businesses. Instead of causing adverse selection, such solutions counteract it.
The Antidote to Adverse Selection
Before the new regulatory framework, the business of a real estate operator was constrained. Growing an investor network, scaling a business, reaching out, and obtaining funding all meant significant labor commitments. Phone calls, document distribution, transactions, and management were inefficient. Not out of necessity, but because the ways in which investors could be interacted with were hampered by SEC regulation.
Rule 506(c), which allows for the sale and marketing of investment opportunities to the general public, opens up new channels for operators to contact and manage investors, allowing these activities to be moved online, centralized and automated. Given the right technologies and tools, this improves everyday operations significantly.
Managing sophisticated money with the well-built tools and technology has been nearly non-existent up until now. Creating the technology for operators to manage investors allows them to further focus on assets and maximizing value, which are the tasks where great operators shine.
Building those tools, rather than focusing on crowdfunding, is the approach that my own company takes. From bottom to top, the technology we’ve built provides all of the working parts operators and investors need in order to connect, administer, invest and transact more efficiently, and with greater transparency and control.
The more successful operators are — because the technology here addresses problems of scaling a business — the more they stand to benefit. As a result, the operators attracted to the solutions we provide bring better deals to the table, not worse.
From where I’m standing, last year, hardly a year to “unload crap,” was an amazing year to unlock quality deal flow. Operators using RealCrowd’s platform tell me the same thing, as do the investors in our network.
The better the tools, the better operators, the better the deal flow. It’s as simple as that. RealCrowd’s challenge is to build the best technology. The problem of adverse selection isn’t even on our radar.
Adam Hooper is the founder and CEO of RealCrowd, a crowd-funding organization based in San Francisco. He can be reached at email@example.com.
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