Development Magazine Spring 2019

Finance

Lessons from the Fall of RealtyShares

RealtyShares’ business model aimed at deals that were less than $40 million.

The real estate crowdfunding platform lost sight of its core competency, but it also proved that there’s a demand for what it provides.

Several lessons can be learned from the recent collapse of RealtyShares, but the most important might be the realization that the demands of investors should serve as a guide and not the driver for a company’s success.

Nav Athwal founded RealtyShares, a major real estate crowdfunding platform, in 2013. Before stepping down a year before it closed, he had grown it from two people in a living room to a company that had financed close to $1 billion in deals and raised more than $60 million in venture capital. RealtyShares had 100 employees and a business that spanned almost every state in the country.

The company’s premise was that there is a segment of the commercial real estate finance world that is underserved by institutional capital. This is an area where deal sizes are below $40 million, and the debt and equity requirements are small enough that it doesn’t make sense for large institutions to fund them. While this premise remains true, RealtyShares sought its own growth capital from the tech industry, which was out of sync with the world of real estate.

The Lessons

The first lesson is that any startup must remain focused on its core competency because it has limited capital and resources. RealtyShares funded multiple opportunities in pursuit of the rapid growth demanded by its venture partners, which created a difficult model for the company. It moved from single-family debt to commercial equity to broker-dealer. This created complexity for the company during its early stages of development that put excessive burdens on its systems.

The second lesson was that Realty-Shares forgot its real estate roots because it was being financed by capital from the tech world. Like the developer who builds where investors will provide capital even if there is little demand for the project, RealtyShares built and pitched a tech company when the focus should have remained more concentrated on the fundamentals of real estate. RealtyShares did not reach a point of independence from outside capital soon enough. Its business model was driven by its investors, who demanded rapid growth at the expense of fundamentals. The company failed because it was sustaining itself by external capital infusion and not internal profitability. When that dried up, the company had nowhere to go.

This put it at odds with timing. Realty-Shares became reliant on outside venture capital that demanded a business based on ultra-fast growth and a quick exit, seeking IPO-level scale within five to seven years. While growth rates for a healthy real estate company might be in the 30-40 percent range per year, the company’s partners wanted growth rates of 100 percent-plus per year. For a startup putting out capital, growth rates that rapid can create an urgency to do deals that, as Athwal says, “you may not otherwise do or to grow in a way where cracks are forming in the company.”

The third lesson was that finding people interested in the concept of crowdfunding was a lot easier than converting them into active investors, and then managing those investors once they came on board. RealtyShares’ model was to create a conduit between investor and developer to remove the burden of investor relations from developers so that they could concentrate on development. The responsibility for investor management, therefore, fell upon RealtyShares to handle.

In the early days, having the individual investors was helpful because the company was able to aggregate them at a time when it didn’t have the scale or volume. The deals RealtyShares funded and the volume investors expected were small enough to be able to cover a lot of the early deals. But as the platform scaled and the company started funding much bigger projects, the ability to scale was limited more by the capital base, made up as it was by individual investors, than by anything else.

In the end, the crowdfunding element of RealtyShares’ business became a limiter.

“It required us to have to solve two parts of the two sides of the market at the same time,” Athwal says, “which made it very difficult for us to create efficiency at a time when efficiency was key.”

The Aftermath

RealtyShares allowed the capital that its business model relied on to dictate how the company was to be built. Rather than taking a lesson from its own playbook by providing immediate returns to investors and seeking to generate positive cash flow early on, the company was subjected to the high-octane world of tech startups seeking super-rapid growth. RealtyShares lost sight of the sedate principles that drive prudent real estate investing, where a steady, long-term perspective is the key to longevity and wealth.

Despite what happened to Realty-Shares, the premise that undergirds real estate crowdfunding remains strong. RealtyShares proved that there is a gap in the middle-market real estate finance world that can be filled by individual investors. It is how the business model is built and what capital is utilized that needs to be thought through before entrepreneurs think about building online investment and syndication platforms for commercial real estate.

 

Adam Gower is the founder of the National Real Estate Forum podcast.

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