Call it the democratization of real estate financing.
A Raleigh startup, Groundfloor, is seeking to create a new real estate asset class by allowing small investors the opportunity to buy into early-stage development projects for as little as $100.
The idea is to take the online crowd-funding model made popular by such sites as Kickstarter and apply it to real estate development, a realm that until now has relied nearly entirely on bank lending and wealthy investors to finance projects.
“We’re matching up real estate developers who would otherwise be going to the bank with lenders on the Web, $100 at a time,” said Brian Dally, CEO and co-founder of the six-person company. “ ... In fact, we let the lenders become the bank themselves, which is a radical idea but one whose time has come.”
Last week, Groundfloor announced that it had closed a first round of funding led by Bandwidth Labs, the venture arm of Raleigh-based telecom company Bandwidth, and American Underground, the incubator owned by Capitol Broadcasting. The company didn’t disclose the amount it raised.
Groundfloor expects to launch pilot projects by the end of the year in select markets. Dally said the company has already gotten approval from the necessary securities regulators to launch in those initial markets, which the company has not disclosed.
Dally co-founded the company with Nick Bhargava, a securities law expert. Dally is no stranger to attempting to upend. He led Bandwidth’s launch of Republic Wireless, which is taking on the major wireless carriers by offering low-cost smartphone plans that use Wi-Fi as their primary network.
“It’s an unknown product and an unknown category from an unknown company,” Dally said of Groundfloor. “We take that very seriously. We are proceeding very deliberately.”
Naturally, Dally sees parallels between what Republic Wireless is doing in telecom and what Groundfloor is seeking to do in real estate finance.
“It’s a classic case of a bloated antiquated intermediary being replaced by the Web,” Dally said “The Internet has done it to many industries, and real estate finance is just the next one.”
‘Just like eBay’
Maybe. Groundfloor’s business model is premised on the fact that there is a tremendous appetite among the masses to become investors in real estate development projects.
“Unless you are wealthy or unless you have expertise in actually building your own projects, you don’t have a way to invest your money in local real estate projects around you or any real estate projects for that money,” Dally said. “... The fact is real estate is a safer, better investment for a lot of people than the stock market. It’s just not as accessible.”
It should be noted that investing in real estate, particularly residential real estate, did become widely accessible during the boom years thanks to extremely lax lending standards. That period ended disastrously for all shapes and sizes of investors, and it is one of the main reasons that many developers today continue to have difficulty securing financing.
Investing in real estate is risky, though that risk can vary wildly depending on the type of project and the amount of debt a project takes on.
Groundfloor’s initial product is a secured note that investors can buy into for as little as $100. The note will have a fixed interest rate for a set term and will give the investor secured interest in the property in case of default.
The rate and terms of the note are set through a bidding process, with each project first being given a suggested rate.
“You can decide for yourself what you think the project should return,” Dally said. “You get to determine that yourself. Just like on eBay you’ll get to bid.”
Groundfloor will make money by charging loan origination fees and by servicing the loans.
“We favor shorter-term loans rather than long takeout loans,” Dally said. “They’re structured like acquisition and development loans or possibly bridge loans, depending on the project.”
Appetite for risk
Dally said it remains to be seen just how much developers will be able to raise on Groundfloor’s platform. This will likely be a crucial factor in whether the platform succeeds.
Even smaller real estate development projects require significant capital when compared to other types of crowd-funding efforts. If Groundfloor is going to be an attractive alternative to bank or other traditional financing sources, it will need to have a large investor base and offer terms that are competitive to other options.
“The Web has an appetite for taking some risks that perhaps banks don’t, and I think the result of that is that some projects that might otherwise have been done are going to get done,” Dally said. “And I think that’s a good thing. That’s going to be a good thing for the Triangle when we bring it to the Triangle.”
As for the risk to those investors, Dally said Groundfloor will do its own due diligence on developers before allowing them to raise money on the platform.
“We screen every borrower for background checks and to make sure they have the track record required in order to pull off these projects, especially while this concept is new,” he said. “We need to make sure the projects meet a certain bar.”
It’s easy to be skeptical about whether Groundfloor will truly be able to upend the status quo, or even become a reliable source of financing for developers. But it seems like any company that challenges the traditional gatekeepers should be welcomed.
As the market collapse revealed, real estate financing has become incredibly complex in recent years as Wall Street has come up with various ways to carve up and repackage loans. The systemic risk posed by many of these products was poorly understood until it was too late.
When compared to those products, the Groundfloor approach seems refreshingly straightforward.
Bracken: 919-829-4548 or firstname.lastname@example.org; Twitter: @brackendavid