McNellis: A Great Year to Unload Crap

By John McNellis

There are bad ideas—say, ordering spaghetti on a first date. And there are worse ideas, like telling someone what you really think of his fiancée. And then there are truly terrible ideas, like oh say, budget skydiving.

salesmanYet the idea of investing in real estate through crowdfunding is in a class all by itself. Short of looting your 401(k) to invest in the lottery, it could be the worst financial strategy ever.

Crowdfunding should be distinguished from its fraternal twin, crowdsourcing.

Crowdsourcing matches those willing to work with those willing to pay. In essence, it’s the net’s version of hiring one of those day laborers waiting in front of Home Depot.  And in marrying economic to common sense, it often works. The taxi service, Uber, may stand the test of time and, on the canine front, the concept of boarding your dog at a private home rather than a commercial kennel has, if you’ll pardon the expression, curb appeal. In crowdsourcing, the stakes are low and, more importantly, there is face-to-face accountability between the service provider and the buyer.

Crowdfunding is another story. Like that generous Nigerian who keeps offering to share his millions if you will only advance him twenty five thousand dollars, crowdfunding is nothing more than electronically soliciting the masses for money. While it has an innocent side (the Red Cross is using it effectively for disaster relief fundraising), real estate and innocence seldom march down any aisle for long and crowdfunding will do nothing to keep the two together. On the contrary, it will likely prove just the latest weapon in the swindler’s arsenal.

Why? Because good real estate deals are very hard to find and a tsunami of sophisticated money is already waiting to flood any decent deal that developers stumble upon. If a respected developer were to lock up a deal that required say a million dollars in equity, ask yourself this: Would he prefer a single knowledgeable partner with whom he could do multiple deals over the years or would he like to raise that million among a couple hundred tiny investors at five thousand dollars apiece? If the project were successful, would that developer rather send out one check a month or two hundred? If it were to fail, would he prefer to explain his missteps to one expert who could readily afford the loss or to an inexperienced mob whose life savings he just blew?

Who then in real estate will elect to crowdfund? The inexperienced, the incompetent and the outright fraudulent—those with either no track record or, worse, a criminal one. Young, honest developers—especially those with a technology background—may be tempted to seek crowdfunding, but so will those who will view it as a form of high-tech sheep shears.

One real estate crowd funder on the east coast remarked in a recent magazine interview that he wished to “fully democratize investment in real estate.” This may sound high-minded—for a moment—but this promoter was talking about convincing the SEC to drop its rules requiring that investors be accredited (that is, that they have a certain minimum income, net worth and liquidity). If the SEC were to do so, this would allow syndicators to go after lunch money. Hopefully, the SEC will say no; like putting stop signs at busy intersections, protecting the naïve from themselves financially is further proof that our government actually works pretty well most of the time.

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