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Cash startups are separating from the crowd

Crowdfunding startup Fundrise raised $31 million to expand.
Americas crops of crowdfunding start-ups are starting to show signs of diverging.

By Konrad Putzier

In the trial-and-error gospel of creative destruction, failure is arguably as important as success. For every startup that turns an industry on its head, there are dozens more who disappear, never to be heard from again. Their downfall offers valuable lessons to more successful competitors.

It is too early to point out winners and losers in real estate crowdfunding. But the two-to-three-year old crop of startups is starting to show signs of diverging.

At the top, a few firms — most notably Fundrise, Realty Mogul and Prodigy Network — are entrenching themselves as industry leaders. Others have started to fall behind. Their fate is raising questions over the future of crowdfunding. Can the field sustain dozens of firms in the long run, or will it consolidate into a handful of behemoths?

Marty Burger
Marty Burger

Fundrise, founded in 2012, can legitimately claim to be the most successful real estate crowdfunding startup in the US. It is certainly one of the best-known ones. The DC-based firm claims to have raised more than $40 million through its platform to-date — a significant increase from the cumulative $17 million of early June. More importantly, Fundrise managed to raise $31 million in Series A venture funding from investors this spring to finance its own growth, an amount none of its competitors came even close to matching. Its investors include well-known real estate executives, such as Silverstein Properties’ Marty Burger and Ackman-Ziff’s Simon Ziff.

California-based Realty Mogul has also raised almost $40 million through its platform, according to Crowdfund Insider. But the startup can’t quite match Fundrise’s success among venture capitalists, having raised $9 million in a Series A round in March.

Still, industry insiders usually mention RealtyMogul in one breath with Fundrise as a success story.

A third firm that has had early success is Prodigy Network. Unlike most of its competitors, the New York-based firm shuns secondary markets and smaller properties. Its resume includes the purchase of 17 John Street for $85 million, 84 William Street for $60 million and 234 East 46th Street for $68.5 million, all in Manhattan. The firm has raised more than $60 million through its crowdfunding platform, according to its own press releases – albeit primarily from foreign investors.

Rendering of Prodigy Network's 17 John Street.
Rendering of Prodigy Network’s 17 John Street.

“Prodigy Network, without a doubt,” said David Drake, who has been tracking the crowdfunding sector for The Soho Loft, when asked whom he considers to be the most successful startup. “They’ve done $100 million-plus deals. Nobody else can touch them. No one comes even remotely close to that.”

Behind these market leaders, a void has opened up. Ahead of a handful of firms that have raised around $10 million or less, iFunding still stands out with a total volume of about $27 million, according to its co-founder Sohin Shah. But the firm seems to have lost momentum recently. $27 million is hardly more than the “more than $20 million” it claimed to have raised by early March. This pales in comparison to Fundrise’s expansion. While its competitors have raised millions from venture capitalists, the firm has failed to secure well-known backers.

“They are trying to do too much at the same time,” said a person familiar with the firm.

IFunding, Fundrise and Realty Mogul all became established around the same time, so first-mover advantage likely wasn’t a factor. Ties to the real estate industry may be a bigger issue. Ben and Dan Miller, the founders of Fundrise, are the sons of an influential real estate developer.

A real estate investor active in Brooklyn recently told Real Estate Weekly that they chose Fundrise to raise capital because the Millers come from a real estate family and know the business. Others may think similarly.

Another factor may simply be luck. High-profile deals are important in making a company’s name known and attracting future investors.

Realty Mogul got a lot of publicity for crowdfunding a Hard Rock Hotel in Palm Springs, while Prodigy Network’s Manhattan deals made headlines on the east coast. IFunding had its own breakout deal lined up in January, when it went under contract for the development site 90-94 Fulton Street in Lower Manhattan with plans to build a $250 million tower with the Mavrix Group. The deal fell through. IFunding declined to elaborate on the failed project. In real estate, deals fall through all the time for a host of reasons. But if the deal happens to be the chance for a big break, the setback can be severe.

JASON FRITTON
JASON FRITTON

IFunding could well end up catching up with Fundrise, Realty Mogul and Prodigy Network. Moreover, there are a number of smaller platforms that are growing rapidly and could join the industry’s elite. California-based Patch of Land, for example, has raised a modest $11 million. But it recently partnered up with a hedge fund that will invest up to $25 million per month through its site. Co-founder Jason Fritton said he expects the firm to raise “easily upwards of $4 – $5 million per month by end of the first quarter of next year.”

Still, as the most successful crowdfunding firms grow in size, entry barriers rise and it becomes harder for smaller upstarts to compete.

Larger firms tend to have a much easier time finding and vetting investments. Their operating expenses are lower as a share of total investment volume, so they can offer their investors better rates. But perhaps most importantly, size and the money that comes with it allow crowdfunding platforms to offer pre-funding – a crucial advantage.

Fundrise recently announced that it now pre-funds all its deals up front. Developers looking to raise money through the platform get it directly from the firm in as little as two weeks. Fundrise then raises an equal amount from its retail investors, assuming the risk of not finding enough of them. For developers, this removes the risk and delays currently associated with crowdfunding. But to offer pre-funding, crowdfunding firms need significant capital reserves. This means a lot more venture capital is needed to compete with players like Fundrise.

All these advantages of size seem to indicate that the real estate crowdfunding sector will one day be dominated by a few big players. But for now, insiders don’t see a consolidation wave. Soho Loft’s David Drake reckons there will be 600 real estate crowdfunding platforms by the end of 2015.

Douglas Ellenoff, a lawyer at Ellenoff Grossman & Schole LLP who has worked extensively with crowdfunding firms, agrees in principle.

“You’ll have many more niche funding platforms that weren’t meant to be anything other than small platforms,” he said. “I do believe that in the long term there will be a concentration, but not in all likelihood in the near future.”

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