Why Pre-Funding is a Game Changer for Real Estate Crowdfunding
Whether you're a sponsor or an investor, pre-funding matters to you.
Earlier this month, PeerRealty announced that it is introducing pre-funded real estate crowdfunding offerings via a new credit agreement with a private family office. What does this mean, and why should sponsors and investors care? We discuss in this blog post.
“Best Efforts” Crowdfunding
Most real estate crowdfunding platforms operate on what is called a “best efforts” model. This means, essentially, that the portal lists a deal on the platform and waits for the “crowd” to fully fund the deal...or not. While most platforms certainly perform due diligence on deals before listing them (with the exception of “listing platforms” that accept all submissions), there are no guarantees that these deals will be funded in full.
Obviously, this can create some issues for sponsors. The most obvious problem is funding risk. Time is of the essence in the real estate industry - if a developer needs funding quickly in order to close on an acquisition, even a partial delay can often kill a deal. With no guarantee of funding, a sponsor is forced to list a deal on a crowdfunding platform and hope that potential investors are interested. Frankly, this funding risk has made some sponsors reluctant to turn to real estate crowdfunding up to this point.
“Best efforts” crowdfunding is also a problem for investors. Even if an investor sees a deal that they’re interested in and invests, they have to wait for other investors to fund the deal. This means that their investment sits dormant, not earning a return, until the deal is funded. In a worst case scenario, if a deal is unable to be funded or doesn’t go forward due to delays, the investor simply gets their money back having earned no return.
What is Pre-Funding?
Pre-funding is an alternative to the “best efforts” crowdfunding model. By pre-funding a deal, the real estate crowdfunding platform provides the sponsor with funding for their deal almost immediately (typically within days), allowing the developer to proceed with the project. The platform then makes the offering available to potential investors. The obvious effect is to transfer risk from the sponsor to the real estate crowdfunding platform. Since this requires a lot of capital, only a few platforms, such as Patch of Land, currently provide it.
Thanks to the new revolving line of credit, PeerRealty is now one of those platforms! The credit agreement will allow PeerRealty to commit up to $500,000 for select deals immediately upon completion of the due diligence process. With pre-funding, PeerRealty is putting its own “skin in the game” and investing in deals right alongside its investors.
For sponsors, the benefits of pre-funding are clear. Pre-funding allows real estate developers to get their deals funded in a matter of days rather than weeks or months. This helps sponsors avoid delays, minimize the risk of deals falling through, and focus on what they do best - real estate - instead of spending time raising capital.
The benefits for investors are less obvious, but just as large. First, pre-funding aligns a real estate crowdfunding platform’s interests with that of its investors. Any platform that pre-funds a deal is displaying confidence in its due diligence - after all, if the “crowd” doesn’t fund a pre-funded deal, the platform itself continues to own the investment. Pre-funding also allows investors to start earning returns immediately upon investment, and almost entirely eliminates the risk that a deal will not go forward.
So if pre-funding is so great, why doesn’t every platform do it? The easy answer is that it requires a lot of money to pre-fund deals in advance, and that is certainly true. Beyond the cost, though, pre-funding also requires platforms to expand a great deal of time and effort in the due diligence process. A platform cannot simply put up a deal and hope for the best when its own skin is in the game. The exhaustive due diligence efforts that are required for pre-funding ensure that only the highest-quality deals will be listed.
If pre-funding requires so much time, effort and money, what’s in it for the platforms? It’s simple - pre-funding will allow PeerRealty to attract the most elite sponsors and greater institutional-caliber deal flow. This in turn will help us attract more investors to our offerings. We believe that pre-funding will eventually be the industry standard for all real estate crowdfunding platforms, and we’re excited to be ahead of the curve at PeerRealty!