Crowdfunding has been tipped to change the way investors can access real estate, but is it appropriate for financial advisers?
The Australian Federal government has recently changed the legislation surrounding equity crowdfunding, allowing numerous individual investors to collectively finance a business in exchange for stock.
This opens up a new window for property investment, allowing multiple parties to purchase assets collectively and reap the benefits as a group – something already being done through the similar fractional property investment system – but understanding where these crowdfunding products fit within the property market can be confusing.
Crowdfunding is not a new concept, as Crowdfunding Institute of Australia chair Matthew Pinter notes, although presently there’s “quite a range of views as to what qualifies as crowdfunding”.
The basic premise is that multiple investors are able to syndicate their investment, in this case allowing those investors to contribute a portion of the funds used to acquire a property.
“I think you’ll find it starts going in a direction where there’s a peer-to-peer relationship,” Mr Pinter explains. “It’s not institutions dictating terms to the other parties, it’s one party dictating terms to another party on a flat platform basis.”
Initially, investors could only access property crowdfunding through a platform using a registered managed-investment scheme regulatory structure, but recent legislative changes to permit equity crowdfunding in Australia have resulted in the creation of a second regulatory regime through which investors can participate in property crowdfunding rounds.
The two regulatory regimes each impose different legal requirements on their respective platforms, and the result of this, DomaCom chief executive Arthur Naoumidis notes, is two considerably different products. “There’s two types; what’s called transactional and there’s fund manager based ones,” Mr Naoumidis says.
Those operating under the managed account structure, such as Mr Naoumidis’ DomaCom, have to be registered as a managed investment scheme, and are subject to the same legal requirements any other managed investment scheme would be.
This means needing a product disclosure statement, sub-product disclosure statements and a different set of rules for raising money, Mr Naoumidis says, but allows investors to put their money into selected properties. “We’re like the separately managed account version of a realestate investment trust,” he says.
This is one key area in which the new equity crowdfunding model differs – investors accessing property through this kind of platform put their money into a proprietary or proprietary limited company that owns the underlying property portfolio, rather than a stake in specific properties. “In other words, you get shares in a company and that company owns the property,” Mr Naoumidis says.
Different regulation, different uses
These two investment structures will enable more people to access property in more ways, making property more affordable for retail investors, but Mr Naoumidis said the pair were unlikely to be used in the same way given their different legal structures and, presumably, different fee models.
Crowdfunding platforms that operate under managed investment scheme regulation charge management fees, Mr Naoumidis explains, however equity crowdfunders will not be able to use this system to make money.
“Because it’s not an asset management company, equity crowdfunding won’t charge ongoing asset management fees so they must make their money on the transaction,” he says.
“So what you’ll find is these crowdsource platforms that make between 3 and 7 per cent transaction fee.” Mr Naoumidis predicts this will affect the way these companies operate, hypothesising that the equity crowdfunding model will be most effective for investors looking to access the property development market rather than holding on to property assets to generate rent yield.
“When you look at global crowdfunding – our crowdsourced equity funding is similar to the JOBS Act in the US – when you look in the US, I’m not aware of any crowdfunding that occurs for existing properties, they’re all developments,” he says.
“That’s where there’s enough margin to pay for the upfront fee that the platform needs, and so the difference between that and say DomaCom and other managed investment schemes, is that we’re asset management businesses and are licensed as fund managers, so we don’t make any money from the transaction.”
That’s not to say that platforms using a managed investment scheme regulatory structure can’t be used for property developments as well, Mr Naoumidis says, but that those properties are typically then kept on the platform so it then “starts to make a return, a profit, and all that kind of stuff”.
Crowdfunding in financial advice
Of most interest to advisers and investors, however, is the impact this will have on the property market, with Mr Naoumidis cautioning that the next few years are going to be “a bit of a wild west” as equity crowdfunding platforms become increasingly popular.
“Every man and his dog’s going to have a property crowdfunding platform,” he says, “and they’ll all be marketing themselves to investors as the next best thing since sliced bread.”
Additionally, Mr Naoumidis suspects that rather than serving as a new product to offer clients, equity crowdfunding platforms could start taking funds away from advisers. “There’s going to be hundreds of them marketing themselves direct to consumers. They’re going to market themselves direct to trustees of SMSFs, they’re going to market themselves to direct investors through social media, but I fail to see how they can market themselves through advisers,” he says.
Equity crowdfunding sees investors put their money into a private company, which Mr Naoumidis notes will limit the ability for advisers to recommend them as an investment option for their clients.
“These are structured as private companies, you name one adviser whose professional indemnity insurance will allow them to advise on private companies,” he says.
“An adviser can’t recommend this to their clients because you aren’t covered with insurance, so how would a little crowdfunding thing, financing a proprietary company, get on to an approved product list? “Advisers need a product that has a research rating, can you imagine Lonsec approving this? What would they be approving? They’d be approving a private company doing a development effectively, they’re raising money for a development, so how will an adviser include that?
The whole professional indemnity insurance industry will have to change.” This, Mr Naoumidis says, will mean equity crowdfunders will be “effectively competing against advisers” for funds. “If an SMSF or an investor participates in one of these crowdfunding campaigns, where does the money for that investment come from?” he says.
Jason Huljich, chief executive of unlisted property funds at Centuria Capital, adds that this is not the only problem that presently faces the property crowdfunding sector, and trying to work out where crowdfunding fits in with the broader investment market was something of a confusing issue – not helped by the fact it currently only accounts for a “miniscule” portion of the market.
“It’s tiny in the scheme of things, and you have to expect with the technology platforms that that will change and that over time it will grow, but I think it will just be another area where equity is raised for property investment,” Mr Huljich says.
One of the key issues Mr Huljich sees facing the application of crowdfunding in the property investment market is in its seeming lack of differentiation from other, existing methods of property investing, which he argues provide investors with access to better quality investments on a larger scale.
“Traditional funds and REITs allow investors to take a share of a very high-quality investment-grade asset – the assets we buy can range anywhere from $50 million up to $300 million,” he says. “Obviously, very few individuals can buy those sorts of assets, but going through an unlisted property fund you can have a share – anywhere from $10,000 to $50,000 and above – of a particular asset because often they’re single asset funds.”
Regardless of these challenges, both Mr Huljich and Mr Naoumidis agree the crowdfunding space will undoubtedly grow in the future, with a number of flow on effects to other parts of the industry. Some of the effects will be relatively minor, such as traditional property fund managers updating their own technology offerings in order to compete with the newer breeds of investment platform, Mr Huljich notes.
Other effects will be more noticeable to financial advisers, such as the loss of funds under management as individual clients choose to invest directly through one of the presumably numerous new crowdfunders, according to Mr Naoumidis.
Where these new products will have the greatest impact, however, will not be in the advice or investment world, but rather in the property development sector, Mr Naoumidis predicts. This, he says, will primarily be due to the ease with which a new equity crowdfunder can be set up to finance a development.
“The biggest thing all this crowdfunding will do is disrupt the property development market and the financing market for these developments. People are going to do it themselves,” he says.
“There’s going to be hundreds of them, and what they’ll do is whitelabel the American platforms, and you can have a new one, some of which are copied and others you can just go to a technology provider and pay them $500 and you’ve got a white-labelled version of it, so you can have a new crowdfunding platform available next week if you want.”
This, Mr Naoumidis contends, is unlikely to be sustainable, but unsuccessful equity crowdfunders will typically still leave their investors with shares in a property portfolio rather than lead to major losses.
Ultimately, these products are unlikely to have a large-scale effect on the financial advice industry, instead offering self-directed investors new avenues to access the property market to achieve a number of different financial goals. While the next few years are likely to be something of a “wild west” for direct investors, as Mr Naoumidis suggests, financial advisers will be relatively unaffected.
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