The collapse of RealtyShares has sent shock waves through the nascent online real estate syndication industry—colloquially known as real estate “crowdfunding”—but there are both reasons for optimism and lessons to be learned. The failure of RealtyShares is not an indictment of the premise upon which real estate crowdfunding is based. It is the application of a business model that, though it had worked in other industries (most notably, tech), was ill-suited to the world of real estate capital formation.
The first lesson is that a key requirement for any startup is to remain laser-focused on its primary mission because there are limited capital and resources. They must do one thing really well and not veer too far from their core competence. RealtyShares started with a focus on giving investors opportunity to diversify into real estate. As the company grew, the hunt for ever-expanding opportunities left the company spread too thin—moving from single-family debt to commercial equity to broker-dealer. It created significant complexity for a company still in its early stages of development.
“Having one focus area really does help a company scale more efficiently, conserve cash and build a more singular vision among the company and its employees,” said Nav Athwal, RealtyShares‘ original founder. Not having that focus caused horizontal expansion that disproportionately impacted the infrastructure the company needed to continue building momentum.
Being in large part a tech company, a second exacerbating factor for RealtyShares was the decision to capitalize their own growth with venture capital. This heavy reliance on outside capital forced the company to build a business that diverged from the core mission and was instead driven by the demands of the capital itself.
Venture capital mandates fast growth and a quick exit to an IPO, merger or sale. At a minimum, venture-funded companies need to at least double in size annually. That works for tech companies but for those putting out capital as did RealtyShares, accelerated growth rates create a disproportionate amount of urgency that, as Athwal says, can lead to doing “deals that you may not otherwise do or to grow in a way where cracks are forming in the company.”
Venture capital has its place, of course. In the early pre-revenue stages of a company’s life, venture capital will take risks that no other capital will. However, as a company grows, its investors’ interests must remain aligned with the company’s mission. A disconnect there can create problems that won’t surface until the company is more mature and nearing the potential for an exit.
The third lesson learned is that in real estate finance there has to be certainty of close. Where crowdsourced capital works well on smaller deals, scaling the investor network is disproportionately harder than scaling the deal and the deal size pipeline. As RealtyShares grew from funding $20-40 million a year to $100s of millions a year, their ability to scale was limited more by their capital base than anything else. “The crowdfunding element of our business became a limiter,” said Athwal, because “it required us to have to solve two parts of the two sides of the market at the same time.”
When they reach a certain degree of maturity, real estate crowdfunding platforms will, by necessity, have to move to institutional capital to be able to scale more efficiently. For RealtyShares, being a venture-backed company with the growth expectations they had, relying on the crowd as much as they did was very cash inefficient. Venture capital, for RealtyShares, was not a scalable source of funds.
The fourth lesson is to move to profitability as soon as possible. Many businesses, especially in the tech space, aren’t thinking about profitability or building sustainable business models soon enough. The primary objective of any startup should be to create a business that can sustain itself without any outside capital, whether debt or equity; its rate of growth should be secondary. High-tech venture capital entrepreneurs constantly think about raising more money and are less worried about building the right kind of business with positive unit economics and a path to profitability.
Athwal learned that “thinking about the former and not the latter, you oftentimes build a business based on the venture capital markets.” The problem with this, he says, is that “you’re not building a business where the fundamentals of the business are what are keeping the business around, but rather you’re sustaining yourself due to outside capital infusion.” Companies that employ business models away from the high-growth demands placed on them by external capital sources will be able to sustain their business model as they build to profitability.
These lessons are as true for the new world of online capital formation as they are for real estate development itself. Focusing on the fundamentals of the deal and avoiding excessive debt, while resisting the seduction of investor pressure to deliver unrealistic returns, are the keys to success in real estate development as much as they are in building a platform in the new world of real estate crowdfunding.
About the author
Dr. Adam Gower, Founder, National Real Estate Forum, is a highly sought-after educator for investors wanting to invest prudently in crowdfund real estate deals, and for developers seeking to raise capital online. He has 30+ years and over $1.5 billion of commercial real estate investment and finance experience. He holds a Ph.D. in risk mitigation, and his second book, Leaders of the Crowd, covering the origins of real estate crowdfunding is to be published by Palgrave Macmillan in January 2019. You can hear his entire conversation with Nav Athwal at the National Real Estate Forum podcast series.