Real Estate Crowdfunding vs REITs
Investing Simple is affiliated with a number of real estate investing platforms mentioned in this article. This relationship does not influence our opinion of these platforms.
In the past, investors basically had two options for investing in real estate. The first option was to go out and purchase a physical piece of property. The second option was to invest in a REIT, which is basically real estate portfolios that trade like stocks.
Now, thanks to changes in legislation, there is a third option which is real estate crowdfunding. Sites like Fundrise and Realty Mogul now allow average retail investors to get a slice of private real estate deals that were traditionally reserved for the high net worth investors.
So… what is the best way to invest in real estate? Going out and buying physical real estate is an active investment that will require a lot of your time and energy. Real estate crowdfunding and REITs, on the other hand, are relatively passive investments. We are going to compare real estate crowdfunding vs REITs, focusing on the passive side of real estate investing.
What Is Real Estate Crowdfunding?
Real estate crowdfunding is an investment structure where investors pool their money together to purchase real estate equity or debt investments. Each investor will own a portion of the investment (or shares) equal to the amount of money they contribute. In return, investors look to make money 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.
Important Factor #1: Liquidity
An extremely important 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.
If you are looking for a shorter term investment in real estate crowdfunding, there are options out there. With some debt investments, your cash is tied up for as little as 6 months. One example of this is bridge loans to developers looking to buy, rehab and flip properties. Equity investments, on the other hand, are 5+ year investments in most cases. The reason for this is because they often generate returns through asset appreciation, which naturally takes time.
Investing in crowdfunded real estate platforms is nothing to be afraid of, but you need to do your research first. Become familiar with the duration of each investment to avoid a case of buyers remorse!
Important Factor #2: Platform Risk
Each crowdfunded real estate investing platform is different. As a result, it is important to understand the platform you are using. Some platforms like Fundrise and Realty Mogul are designed to be beginner friendly investments. You do not need prior real estate experience to invest with them because you are investing in prebuilt and diversified portfolios.
Other platforms like EquityMultiple put you in the drivers seat. You hand select each project to invest in based on your own criteria. This platform is for those who have a lot of prior real estate investing experience. Investors need to know how to determine what projects are investment worthy and a good fit for their portfolio.
Real Estate Crowdfunding Platforms
Fundrise is our favorite platform for investors who are non-accredited. You can choose from a variety of portfolios depending on your investment goal. The user interface is the best available today. The starter portfolio has a minimum opening balance of just $500, making this investment accessible to just about anyone.
Realty Mogul is another great platform for both accredited and non-accredited investors. Realty Mogul offers two portfolios that are not limited to accredited investors, but the minimum balance to start out with them is $1,000. For that reason, we are partial to Fundrise. The Realty Mogul Private Placements are available to 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 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. Most commercial real estate buildings are millions of dollars, but you can buy shares of them through a REIT that owns a portfolio of commercial real estate. REITs are securities which can be bought and sold on exchanges, providing near immediate liquidity if you decide to sell your investment.
A REIT can be an attractive investment because of the relatively high dividend yield along with the ability to provide passive exposure to real estate. In order 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 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 they are offered to everyday investors. Publicly traded REITs are highly liquid investments. You can buy and sell them on exchanges such as the NYSE and NASDAQ.
Non-traded REITs are investments that are bought and sold privately. This means you must have a buyer or seller willing to conduct a transaction to provide liquidity as often there is no secondary market for the transaction. Non-traded REITs are not as liquid as publicly traded REITs.
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. As a result, many investors are willing to pay the high fees.
Another advantage is that non-traded REITs may have less correlation to the overall stock market as they do not trade on an exchange. Publicly traded REITs also hold liquidity premiums, which is a slight increase in the price of the security due to the liquidity characteristics it holds.
Real Estate Crowdfunding vs Traditional REIT
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.
Crowdfunded real estate typically does not have the same liquidity when compared to traditional publicly traded REITs. Though liquidity can come at a premium, it can be a highly desired feature for any type of investment. If you are comfortable with the illiquidity of many of these crowdfunded real estate platforms, it can come with a lot of benefits.
Most fees in crowdfunded real estate are similar to those of publicly traded REITs. There is no cut and dry method for comparing crowdfunded real estate vs traditional REITs. Fees vary widely depending on the investment platform or the investment company who manages the REIT. Crowdfunded real estate platforms tend to have less front end load fees (commissions) when compared to traditional non-traded REITs.
While the fees may be higher than the publicly traded REITs, the returns are often higher too. Since the laws surrounding real estate crowdfunding only recently changed, we don’t have a ton of data to go off of. But what we have seen so far is that some of these platforms have beat the overall S&P 500 in the short term and exceeded the returns of most publicly traded REITs.
Investments vary widely depending on the platform or REIT. One of the important differences between publicly traded REITs and non-traded REITs (including crowdfunded real estate) is the difference in price volatility. When investing in a non-traded REIT, there is typically less volatility when compared to a publicly traded REIT which can be subject to more volatile swings in price.
Since publicly traded REITs trade just like stocks, they often behave just like stocks. This means that you will often experience the same ups and downs as the stock market. One of the key goals many investors have is to diversify asset classes. The main goal of this is to own a variety of different assets that all perform differently to offset risk. Since publicly traded REITs behave just like the stock market in most cases, this essentially defeats the purpose of asset diversification.
A final point to make on volatility is that publicly traded REITs are susceptible to panic selling. This is when groups of investors panic and sell off, causing prices to plummet. Since it is so easy to sell these investments, people often get caught up in this emotional frenzy. The illiquidity of these non-traded REITs (and crowdfunded real estate investments) eliminates this panic selling entirely because you simply cannot sell these investments quickly.
Investors can choose crowdfunded real estate platforms where you can decide which specific properties you can invest in. One example of this is EquityMultiple. 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 investments.
6. Accredited Investor
Publicly traded REITs are available to any investors out there that meet the requirements to open a brokerage account. This is often just being 18 or older, living in the US with a valid social security number. Non-traded REITs and crowdfunded real estate platforms on the other hand often require investors to be accredited.
What Is An Accredited Investor?
Many private real estate investments are reserved for accredited investors only. This includes both certain non-traded REITs and crowdfunded real estate investing platforms.
An accredited investor is someone who is allowed to be involved with investments that may not be registered with financial authorities. Public investments available to average retail investors are heavily regulated by governing authorities like 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.
EquityMultiple is an example of a crowdfunded real estate investing platform limited to accredited investors only. Investors can choose individual real estate projects to invest in using the EquityMultiple platform. Not all platforms are for accredited investors only. Fundrise and Realty Mogul offer investments for non-accredited investors.
How To Become An Accredited Investor
In order to be an accredited investor, you must meet two requirements:
- Annual income of $200,000 or more ($300,000 for married couples)
- 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 REITs: The Verdict
With the new regulations and increasing improvements in technology, real estate investments are becoming more accessible to everyday investors. Real estate crowdfunding is a perfect example of a new investment medium which makes investing in private real estate deals available to average joe investors.
When comparing crowdfunded real estate platforms to traditional REITs, it is important to determine your goals as an investor. If you are more hands-on and would like to control which real estate projects you invest in, then crowdfunding may be a good fit for you. If you would like to have less involvement in investment management and you would like high liquidity, then traditional REITs may be the better option for you.
Just bear in mind that the high liquidity associated with REITs has a number of downsides, which we discussed earlier. For those who are comfortable with the illiquidity of many of these real estate crowdfunding platforms, there are a number of benefits to this. If you are looking to learn more, check out our review of the top real estate crowdfunding platforms here!
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