For the larger part of Indian real estate history, the major source of funding for the sector has been the public & private banks as well as HFCs. As the sector grew the need for newer and more innovative sources of finance was realized. The government has taken multiple steps in the recent past to infuse transparency and facilitate funding in the sector.
These steps include introduction of RERA, relaxation of FDI norms, NIIF etc. On the back of these measures, Indian real estate now attracts private equity funding and joint ventures and ECB are no longer unheard of. However, a very popular real estate financing model that is yet to completely hit the Indian real estate is Çrowdfunding’.
So, what is crowdfunding? Crowdfunding is a financial model wherein a venture is funded by raising money through a large number of people, who contribute relatively smaller amounts as compared to a typical real estate investment. For this model to be a success, three parties should be involved. The developer who proposes the project, people who would contribute towards the funding and a regulatory body or a moderator. In India, the lack of this third party is what restricts crowdfunding from becoming a feasible financial model. Let’s delve a little deeper.
The Indian real estate market is estimated to reach USD 180 billion, by 2020, while institutional funding in real estate is estimated to reach USD 100 billion by 2026. The figures for investment in commercial office space looks promising as the asset class witnessed investments increase by 150 percent, between 2014 to 2017. But, how can the Indian real estate reach to these numbers, without mobilizing the funds of retail investors.
An innovative way to alleviate this problem, would be through a funding option called ‘crowdfunding’ or the collective ownership of an asset by the public. It’s mechanism is similar to an IPO, in the sense that the general public owns the asset, just like public shareholders are the part owners of the company.
The Government of India has already given permission to REIT‘s, but even though these instruments have reduced the initial investment, it is still out of reach of many, given the fact that minimum investment is around Rs 2 lakh.
A crowdfunding mechanism allows for a smaller minimum investment and would open the real estate sector to a larger number of people and create a sort of a formal market for real estate. This will introduce transparency into the otherwise opaque sector.
The developers too stand to benefit from this, as it opens up a cheaper funding channel, than the traditional institutional funding, which generally charge in the range of 12-25 percent, depending on the stage of the project. In addition to this, increased participation of the public in the crowdfunding initiative would provide a good indication of a developer’s/ project’s success, which could make the subsequent funding rounds successful.
These points make crowdfunding a lucrative option for both small investors as well as developers.
Although crowdfunding has the potential to revolutionize real estate funding, it has it’s own share of troubles.
The main point to consider here is that the risks in crowdfunding are same as those applicable to any other real estate investor. If the market turns sour, investors can lose money.
The risks of default by a real estate developer is also higher with individual investors, than it is for traditional institutional investors. This is mainly because the latter have the resources to professionally scrutinize the developers and their projects, constantly monitor their progress and seek redressal.
Another factor that can a pose a slight threat to investors in crowdfunding is that unless the secondary markets picks up pace, liquidity can be a major concern.
The above mentioned risks can be mitigated if both the managers of the fund platform as well as the investors carry out a robust due-diligence process. This has now become slightly easier with the RERA in place. .
Thus, in order to make crowdfunding a viable option in Indian markets, there needs to be action taken from a myriad of stakeholders like the government, real estate professionals, real estate developers and also the investors. The bad reputation of the real estate sector should be cleaned and stringent laws need to be put in place to check for defaults and malpractice by the stakeholders.