Real estate is my favorite asset class to build long term wealth. Not only can you borrow other people's money at a low rate to control 100% of an asset, you get to rent out that asset to pay down other people's money! However, let's look at how to invest in real estate without owning property. This way, you can benefit 100% passively from capital and rental appreciation. No maintenance or tenant hassles sounds great.
If you happen to own in superstar cities such as New York City, Los Angeles, San Diego, Seattle, Portland, Denver, Colorado Springs, or San Francisco, you've seen tremendous growth over the decades.
Historically, US property values have risen by 3.5% per year, and certain geographical regions like San Francisco have risen at double the pace in recent years. However, closing costs (2-5% of a property’s value), the ongoing cost of ownership and the opportunity cost all combined with the commitment and headache involved have caused many to look for other ways to invest in real estate.
As an asset class, real estate investing often behaves independently of the stock market, meaning that it can provide diversification to most portfolios, and tends to deliver above average returns.
Fortunately, the Fintech world has opened up a multitude of ways to invest in real estate without having to be a homeowner. These methods have made real estate investing possible for a new generation that doesn’t want the added headache of owning and maintaining a property.
Here are five common ways for investors to invest in real estate opportunities without having to own the physical real estate.
How To Own Real Estate Without Owning Property
Owning rental properties is one of my favorite asset classes for people in their 20s and 30s. However, once you start having kids and more responsibility, owning rental properties isn't as enjoyable. Here's how to own real estate without owning physical property.
1) Invest In REITs
Real Estate Investment Trusts, or REITs, are companies that own real estate (commercial or residential) and allow investors to buy and sell shares of the REIT, allowing the trust to pay dividends while continuing to earn value.
Depending on their structure, they can be publicly traded or held privately, usually in the form of equity, and not debt. They usually include a large pool of cash-generating properties, with the total value in the high millions or billions.
REITs may be good options for hands-off investors, but if you’re looking to customize your portfolio or dislike some of the holdings of a REIT, there are few opportunities to customize those holdings.
Just know that during times of stock market volatility, publicly-traded REITs are often MORE volatile. Hence, REITs aren't a great hedge to reduce stock market volatility. I did a recent case study during the March 2020 crash, and REITs sold off harder.
2) Invest In Private Equity Funds
Private Equity (PE) Funds pool capital from institutional and ultra high net worth investors in order to invest in an asset class (they can include oil, gas, or other alternatives, but often consist of real estate portfolios). This kind of fund is usually run by a management team. It allows investors to participate in the security of having their funds managed professionally.
Many enjoy the extra security of having someone work for them, especially when they’re a real estate expert with a proven track record. But there can be serious trade-offs. PE Funds often require high minimums ($250,000+) and their offerings frequently have long durations of 10+ years. This effectively locks up investors’ money for that period of time.
Private equities a long-term, illiquid alternative investment that wealthy individuals and institutional fund managers like to invest in.
3) Invest In Home Construction
Real estate is not just about buying and profiting from existing companies. There is an entire industry of homebuilders responsible for developing new neighborhoods in growing metropolitan areas. These companies may be involved with multiple aspects of the home construction process.
When evaluating homebuilders, look at all aspects of the business. Ask yourself if the company is focused on a region with poor real estate performance if the company is focused on only very high or low-end homes, and compare the focus to real estate trends.
Large homebuilders include Lennar Corp (LEN), D.R. Horton Inc (DHI), KB Home (KBH), PulteGroup (PHM), and NVR (NVR).
Keep in mind that homebuilder performance can be highly correlated to the economy. When job growth is strong, people want to buy new homes. When the economy is sluggish, new home sales tend to fall.
However, post pandemic, the housing market is booming. There is no signs of the housing market cooling off given rates are low and the economy is opening up.
4) Invest In A Real Estate Mutual Fund Or ETF
In real estate, a single asset typically costs well into the six-figure range. Only one company, Berkshire Hathaway (BRK.A) trades at that level. Few stocks reach high into the three-figure level.
To get diversification in real estate, investors can turn to real estate focused mutual funds, index funds, and ETFs. Some real estate funds work just like a traditional mutual fund, primarily invested in real estate stock. Others are focused on REITs or even direct purchases of real estate.
One of the most popular REIT ETF is the Vanguard REIT ETF (VNQ). This ETF trades just like a stock but gives you instant exposure to a portfolio of REITs. This fund holds 145 different stocks. Top holdings include Simon Property Group Inc. (SPG ) and Public Storage (PSA).
If you prefer a real estate mutual fund, Prudential Global Real Estate Fund (PURAX) is a global real estate fund. The fund is 97.5% invested in real estate. 52% of holdings are in North America. The remainder invested in Europe (17% of holdings), and Asia (31% of holdings). This fund is primarily focused on developed markets, with less than 2% of funds invested in emerging markets.
5) Invest In Real Estate Crowdfunding
Real Estate Crowdfunding involves many investors raising funds for an individual property or a portfolio in order to participate in deals that they normally wouldn’t have the individual capital to get into. In the past, an individual investor would not be able to gain access because the required minimum was much too high, or the project would be invite only.
Fundrise based in Washington DC, is the leader in the space. Fundrise is my favorite real estate crowdfunding platform. They were founded in 2012 and are the creators of the private eREIT fund. All their deals are fully vetted as well with research and documentation. Fundrise is free to sign up and explore.
Three main investment categories in commercial real estate:
1) Single family residential property. Target 9% – 11% annual return. You are the senior debt holder (first position on lien). The investment duration is usually 6 – 24 months and income usually paid out monthly. This product is considered their least risky investment for investors and has been around since the beginning. Roughly 40% – 45% of total investments on the platform are in this category.
2) Preferred Equity/Mezzanine debt. Target 12% – 14% annual return. You provide bridge loan for sponsors and are a lower position in the capital stack. The investment period is usually 2 -3 years. Investments are mostly in commercial property. Roughly 20% – 25% of total investments on the platform are in this category. This is where I will probably focus most of my investments since I already own single family residences.
3) Joint venture equity. Target 10% – 16% annual return. You are an equity owner alongside the sponsor and take part in profits once preferred returns are hit. Typical duration is 5 years, but can be as short as 3 years. Income is usually paid quarterly once the deal is closed. This category accounts for roughly 25% – 30% of all investments.
I've personally invested $810,000 in real estate crowdfunding to gain exposure to the heartland of America. Valuations are cheaper and rental yields are much higher compared to coastal city real estate.
There are no guaranteed returns. But I like that Fundrise aggressively screens all their deals. Only 5% of the potential deals make it onto their platform.
Fundrise Growth And Performance
According to the latest public offering documents by Fundrise for its IPO, the firm manages roughly $1 billion in assets under management, has over 150,000 active investors. Their AUM grow and investor signups have been very promising. In fact, Fundrise is emerging as one of the main institutional investors in the real estate space today.
Fundrise’s five-year average platform portfolio has also done quite well, yielding a 10.79% return versus 7.92% for the Vanguard Total Stock Market ETF and 7.4% for the Vanguard Real Estate ETF. Their massive 14%+ outperformance in 2018 versus the Vanguard Total Stock Market ETF is particularly impressive.
By generating a strong 5-year return, Fundrise has taken a huge step forward in proving out what they have believed for so long. A model of individuals diversifying into real estate through a direct, low-cost technology platform is a superior investment alternative to owning only publicly traded stocks and bonds.
Real estate crowdfunding through a company like Fundrise is my favorite way to diversify my real estate exposure, earn passive income, and focus on a specific region of the country.
About the Author: Sam worked in investing banking for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis and taking care of his family. Financial Samurai was started in 2009 and is one of the most trusted personal finance sites on the web with over 1.5 million pageviews a month.