The Backbone of Real Estate Crowdfunding is a Solid Underwriting Practice

underwritingLate last year, RealtyShares, one of the pioneers in real estate crowdfunding, announced it was shutting down. Then, in January, National Real Estate Investor wrote: “In addition to understanding economic fundamentals, local markets, and the capital markets, becoming a successful real estate investor requires highly specialized underwriting, and asset and property management skills, among many others. While technology is important, it is merely the facilitator for real estate crowdfunding.”

I couldn’t agree more. Solid underwriting practices are one of the most important components for a successful real estate crowdfunding platform.

Now, I’m not saying RealtyShares didn’t have solid underwriting practices. There are a number of reasons why a business would go under, but as real estate crowdfunding matures, solid underwriting practices will become much more important to the survival of the platforms that remain.

Why Underwriting is Important to Real Estate Crowdfunding

Underwriting is an important aspect of real estate investing in general, but for real estate crowdfunding, in particular, for a number of reasons. For starters, if investors can’t trust the platform, they won’t stick around for long. Crowdfunding platforms earn the trust and respect of investors by performing due diligence on borrowers and sponsors of real estate projects.

Another aspect of this is the risk assessment process itself. While it is important to perform a risk assessment on borrowers and sponsors, it’s just as important to perform a risk assessment on the properties. It’s the properties, after all, that investors are investing in.

Underwriting is also important for the sponsor. When a sponsor approaches a real estate crowdfunding platform to ask for a loan or to offer equity in a deal, they understand they will have to prove they, and the property they are sponsoring, are worth investors taking a risk. It’s expected that not every deal will be worthy of investment. By performing due diligence, the real estate crowdfunding platform can weed out some of the competition, which increases the chances for worthwhile projects to receive funding.

What Makes for Good Underwriting Criteria?

Every real estate crowdfunding platform has its own criteria, of course, but there are some specific details that should be important to anyone in the real estate crowdfunding industry. Some of the most important criteria for assessing a lending or equity risk for the sponsor include real estate development experience, experience specific to the type of deal they are sponsoring, credit history, success ratio to development deals, and whether or not they are backing their own project.

For properties, it’s important to look at how much of the total project is the investor seeking funding for, what is the loan-to-value ratio, what is the after-repair value of the property, and is the property in a good location? One other thing to look at is the type of project it is that is seeking funding. A residential fix-and-flip project is very different than a new office development project built from the ground up.

After assessing all the risk factors and analyzing the criteria, the real estate platform should be able to justify to potential investors why a particular project, and a particular project sponsor, deserve funding. If the platform cannot do this, investors should question their underwriting practices.

What Makes Sharestates Unique Among Platforms

Sharestates is unique among real estate crowdfunding platforms because it’s founding team came from a traditional real estate background rather than from a technology background. Because of that background, we’ve developed a sound underwriting and risk assessment strategy that we use across the board on every project and every sponsor. That doesn’t guarantee success, but it greatly increases the opportunities for both investor and sponsor to see a positive return on investment.

Real estate crowdfunding is entering a very critical time in the life of our industry. The platforms that survive the next crisis will be the ones who have a solid underwriting practice in place, a strong financial position, and the ability to justify the investments it’s willing to offer investors.

Click here for a deep-dive into Sharestates’ underwriting process, including our detailed risk matrix.