Real Estate Crowdfunding vs REITs: Which Is A Better Investment?

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Invest In REITs Or Crowdfunded Real Estate?

Disclaimer
    Investing Simple is affiliated with Fundrise and Realty Mogul. This relationship does not influence our opinion of these platforms.

    Most investors are familiar with the benefits of diversification, particularly through a real estate investment. As the old saying goes, you don’t want all of your eggs in one basket! In the past, the best option for a passive real estate investment was to go out and purchase a REIT or a real estate investment trust. This is, essentially, a portion of a real estate portfolio that trades just like a stock!

    Recently, due to changes in legislation, a brand new real estate investment has emerged that is increasing in popularity. This investment is called crowdfunded real estate. Investors from all over pool their money together to purchase real estate. Two of the most popular platforms out there today are Fundrise and Realty Mogul.

    In this article, we will be peeling back the curtain on this new investment and helping you decide between a REIT vs crowdfunded real estate.

    real estate crowdfunding vs reits

    Summary: REIT vs. Crowdfunded

    •  A publicly traded REIT offers investors liquidity, meaning it is easy to sell. 
    •  Crowdfunded investments are private, meaning that liquidity or the ability to sell is not guaranteed. 
    • Publicly traded REITs correlate almost directly with the overall stock market, defeating one of the key purposes of diversification.
    • A publicly traded REIT must pay 90% of profits as dividends, this ensures investors receive a fair share of the profits each year. However, this may mean there is less capital to spend on additional real estate projects.
    • Crowdfunded real estate platforms have no required distributions, giving them greater flexibility and the potential to put more capital to work.
    •  Fees are often lower for publicly traded REITs, but so are returns. Instead, investors should consider the return “net of” or after fees. 
    • Some crowdfunded real estate platforms let you pick and choose individual properties to invest in, while a REIT does not offer this level of flexibility.
    • Most crowdfunded real estate platforms provide greater investor communication and updates about individual properties when compared to a traditional REIT.

    What Is Real Estate Crowdfunding?

    real estate crowdfunding

    Real estate crowdfunding is a type of investment where people pool their money together to purchase real estate equity or debt investments. Each investor will own a portion of the investment equal to the amount of money (shares) they contribute.

    In return, investors aim to earn a return from the underlying real estate assets, which can generate returns in a variety of ways. Lease payments, interest payments or appreciation from a sale are some of the most common ways investors can earn a return on their investment. 

    Most crowdfunded real estate platforms offer investments through a private LLC which acts as a holding company for the real estate assets. Once investors contribute money to the real estate investment, they are purchasing a share of the LLC, which holds the underlying real estate assets. All earnings, interest or appreciation will be paid to the LLC and passed through to the underlying shareholders.

    A significant factor when considering real estate crowdfunding as an investment is liquidity. Most crowdfunded real estate investments are illiquid in nature, and investors will not be able to offload or sell their investment on a secondary market. 

    These investments can be long term, so investors must understand what exactly they are investing in and the liquidity implications surrounding that investment. As each crowdfunded real estate investing platform is different, it is important to understand the platform you are using. We have seen a handful of platforms close to outside investors. Platform risk is an essential factor when choosing between crowdfunding or traditional REITs.

    To help you learn about each platform, we put together an overview of the top 12 real estate crowdfunding platforms.

    Real Estate Crowdfunding Platforms

    real estate crowdfunding vs traditional REIT (real estate investment trusts). Real estate crowdfunding investments allow investors to choose their specific real estate investment portfolio.

    Fundrise is our favorite platform overall for investing in crowdfunded real estate. The minimum investment is just $500 for the starter portfolio, and you do not need to be an accredited investor. This means that anyone who is legally allowed to invest in the US can invest with Fundrise. 

    They take all the guesswork out of real estate investing through their different portfolio offerings. You do not need to screen properties yourself! Fundrise offers income oriented, growth oriented or blended portfolios.

    Realty Mogul is a great platform for both accredited and non-accredited investors, as they have options for both! Realty Mogul follows the same portfolio investment strategy as Fundrise, meaning that you are not picking and choosing properties yourself. Both of these platforms offer a passive, beginner friendly real estate investment option. 

    The minimum investment is slightly higher at $1,000. This is still significantly less than most private real estate investments out there. Realty Mogul offers Private Placements which are specific portfolios designed for accredited investors only.

    What Is A REIT?

    A Real Estate Investment Trust (REIT) is a trust that purchases real estate assets and then issues thousands or millions of shares of the company to investors. This gives retail investors the ability to invest in real estate investments they may not have been able to before often due to high costs or exclusivity of the investment. REITs can give you exposure to real estate that you would not typically be able to buy directly.

    REITs are securities which can be bought and sold on exchanges, this allows for liquidity if you ever need to sell your investment. This liquidity can come at a cost, however, as these REITs are susceptible to the same panic selling as stocks. 

    Traditional REITs may be an attractive investment because of the relatively high dividend yields along with the ability to provide passive exposure to real estate. To be classified as a REIT, at least 90% of the taxable income needs to be passed along to shareholders in the form of dividends.

    REITs allow investors to gain diversified exposure to thousands of real estate assets throughout the world. Before the invention of the REIT, investors would have to purchase real estate themselves or in syndicates, which were limited to wealthy and accredited investors. REITs have opened up real estate markets to common everyday investors, providing more liquidity and an explosion of investment into real estate.

    Publicly Traded REITs vs. Non-Traded REITs

    There are two core types of real estate investment trusts, publicly traded REITs, and non traded REITs. Most of us are familiar with publicly traded REITs, these are investments that trade on public security exchanges and offered to everyday investors. Publicly traded REITs are highly liquid, and you can buy and sell them on exchanges such as the NYSE.

    Non traded REITs are investments which are bought and sold privately. This means you must have a buyer or seller willing to conduct a transaction to provide liquidity as many times there is no secondary market.

    Non traded REITs are less common because of their exclusivity, liquidity and often high front end load fees. Front end load fees are commissions you pay to brokers on the purchase of your investment. Non traded REITs have an advantage of gaining exposure to private real estate and sometimes offer higher distributions, on average, than publicly traded REITs.

    Another advantage is that non traded REITs may be less correlated to the overall stock market, as they do not trade on an exchange. Publicly traded REITs also hold liquidity premiums. This means there is a high price of the security due to the liquidity characteristics it holds.

    What Is An Accredited Investor?

    Many private real estate investments are limited to accredited investors only, this includes certain REITs and crowdfunded real estate investing platforms.

    An accredited investor is someone who is permitted to invest in securities that may not be registered with financial authorities. Public investments available to average retail investors are heavily regulated by government authorities such as the SEC and FINRA. These agencies aim to protect investors from unforeseen risks.

    It is impossible for them to regulate every investment out there, so some go unregulated. They expect individual investors to do their own due diligence. As a result, they want to make sure these investors have the financial capacity to take this risk.

    Most of these private real estate deals are entirely legitimate, but you need to know what you are looking for. Before these crowdfunded real estate platforms emerged, only these accredited investors were able to invest in these private or “closed door” real estate offerings.

    How To Become An Accredited Investor

    To be an accredited investor, you must meet two requirements:

    1. The annual income of $200,000 or more ($300,000 for married couples)
    2. Net worth exceeding $1,000,000 (excluding primary residence)

    These individuals have the means to burden the risks associated with unregulated private investment offerings. This includes private real estate deals, hedge funds, venture capital deals and other unregulated investments.

    Real Estate Crowdfunding vs. Traditional REIT

    real estate crowdfunding vs reits

    Most crowdfunded real estate investments are similar to the non traded REIT structure. Investors pool their money together to purchase underlying real estate assets, where many times there is no secondary market. Many of the crowdfunded real estate platforms call their investments eREITs.

    This is just another word for a type of non-traded REIT or a representation of your share of the LLC which holds the real estate assets. The main difference is these REITs do not change hands on a major exchange like the NYSE or NASDAQ.

    When trying to choose between crowdfunded real estate investment platforms or traditional REITs, there are a few key differences investors must understand…

    1. Liquidity & Correlation

    Liquidity is a measurement of how easily an asset can be converted into cash. Listed stocks, like Apple or Facebook, have high liquidity because you can easily sell them on a stock exchange. Physical real estate, on the other hand, has lower liquidity because it is more difficult to sell or convert to cash.

    A REIT is basically real estate in the form of a stock. It trades on the same exact exchanges as the companies we know and love. This means that you could buy or sell them with the click of a button.

    While this may seem like a desirable trait on the surface, consider the following. Since stocks can be bought and sold with ease, they are susceptible to panic selling. This happens when massive amounts of investors are selling shares out of fear and uncertainty. There have been many occasions where a 5% or larger drop was seen in the overall stock market in one day.

    So… what does this have to do with REITs? Well, what do you think happens to the share price of these REITs when stocks fall? You guessed it, they fall too. In fact, REITs are almost directly correlated with the performance of the overall stock market. This makes sense really, as your REITs are held within the same brokerage account as your stocks.

    When investors panic and decide to sell off, the sell the REITs too. One of the goals of diversification is to have less asset correlation, meaning your assets should ideally be doing different things at different times. Since publicly traded REITs almost directly correlate with the overall stock market, it defeats this key purpose of diversification.

    Why Crowdfunded Real Estate Is Different?

    Private crowdfunded real estate investments do not trade on major exchanges. This means that you cannot simply log on and sell everything at the click of a button. In fact, some platforms even have lock up periods to prevent this type of panic selling. In some ways, they are protecting you from you. Panic selling is often a result of short term thinking and out of control emotions.

    As a result, you do not typically see this same correlation between the stock market and private REITs or real estate investments. However, investors need to be comfortable and familiar with this illiquidity. It is a long term investment that you should see through to the end. In fact, Fundrise recommends investors have a minimum time horizon of 5 years.

    2. Fees

    Every platform is different when it comes to the fee structure. However, in many cases the fees associated with a crowdfunded real estate investment are lower than the fees with a private or non-traded REIT. 

    In many cases, the fees associated with a publicly traded REIT are lower than the fees you pay for a crowdfunded real estate investment. However, it is important to consider the returns as well. In many cases, the returns for private real estate investments exceed the returns for publicly traded REITs. You should always consider the returns “net of” or after fees for a fair assessment.

    3. Investments

    Investments vary widely depending on the platform or REIT. A significant difference is that REITs are required to distribute 90% of the net profit to shareholders, while crowdfunded real estate is not necessarily required to. This can allow the crowdfunded platforms more flexibility on how to put capital to work. However, having a guarantee of profit distribution can also be a decisive factor for investors.

    Most would agree that it is best to leave the investment decisions to the professionals. These crowdfunded real estate platforms have dozens of real estate professionals on the team with decades of real estate experience. The forced distribution associated with a REIT limits the flexibility these professionals have.

    4. Control & Transparency

    Investors can choose crowdfunded real estate platforms where you can decide which specific properties you can invest in. This is a feature not typically available to traditional REITs. Most REITs have an investment manager who chooses which specific properties that go into the REIT. Crowdfunded platforms can give you more flexibility in choosing your specific property investments. 

    Both of the platforms mentioned in this article follow a portfolio model of investing, meaning that you cannot pick and choose properties. This is because these are beginner friendly recommendations, and newbie investors should not be selecting individual real estate investments. However, intermediate to advanced investors should consider other real estate crowdfunding platforms that allow this individual property selection.

    Another important differentiator is the level of transparency. With a publicly traded REIT, it is often difficult to tell exactly what you are investing in. Some are even REIT funds, meaning they own many pieces of potentially dozens of different REITs. It can become very complicated in no time at all.

    Platforms like Fundrise are very transparent about what you are investing in. They send you email updates every time a new property or project is added to your portfolio. You know down to the property exactly what you are investing in.

    Final Thoughts

    Real estate has been turning average people into millionaires for decades. Both REITs and crowdfunded real estate platforms provide solid options for the average retail investor to get access to this asset class in a passive way. These options take the guess work out of real estate investing, and allow you to invest in portfolios of real estate.

     In most cases, a REIT is better for an investor looking for liquidity. 
     In most cases, crowdfunded real estate is better for an investor with a longer time horizon looking to reap the benefits of private real estate ownership. 

    Every real estate investment is different, so it is important to do your research before committing to a long term investment. Most experts would agree that real estate plays an important role in any well diversified portfolio, so why not add some today?

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