Real estate crowdfunding or REITs? This is a question many savvy real estate investors are considering post pandemic.
With interest rates so low, the demand for real estate has gone way up. It also takes a lot more capital to generate the same amount of risk-adjusted income.
Personally, I'm bullish on the housing market for years to come. As a result, I'm actively investing in real estate crowdfunding, REITs, and physical rental properties.
Let's go through a deep-dive analysis between real estate crowdfunding and REITs.
Real Estate Crowdfunding Or REITs
By way of background, I've invested in physical real estate in Honolulu, San Francisco, and Lake Tahoe since the mid-1990s. I've investd in REITs since the late-1990s. Today, I have invested $810,000 in real estate crowdfunding since 2016.
Previously, I spent 13 years working in the equities department of Goldman Sachs and Credit Suisse. I got my MBA from UC Berkeley and have been writing about real estate investing online since 2009.
A real estate crowdfunding platform gives their investors direct access to real estate investments. A REIT gives you broader exposure to real estate without directly owning the property.
REITs do not provide defensive protection to stock market volatility. What we saw was that publicly-traded REITs sold off EVEN MORE than stocks. You can seen some examples and more detail here. In other words, publicly-traded REITs have a higher beta, or higher volatility.
If you're looking for a more stable real estate investment, then investing in real estate crowdfunding may offer less volatility.
What is a REIT?
A REIT is essentially a corporation that owns and manages a portfolio of income-producing real estate properties such as apartments, hotels, malls and office buildings. Mortgages are secured by such real estate (Mortgage REITs or MREITs) or a combination of the two (Hybrid REITs).
REIT’s can also be private or public. Private REIT’s are not registered or traded with the Securities and Exchange Commission (SEC). They usually raise equity from accredited investors (i.e. individuals, trusts or other entities). Whereas publicly traded REITs are registered with the SEC and traded in major stock exchanges such as the NYSE, NASDAQ and AMEX.
There are over 800 private REITs and over 200 publicly traded REITs in the United States. Their total assets are roughly $400 billion. Accordingly, REITs make up only a fraction of the $11-12 Trillion Dollar US Commercial Real Estate Market.
Some of the most popular publicly traded REITs include:
Realty Income Corporation (Ticker: O, 4% dividend yield)
Omega Healthcare Investors (Ticker: OHI, 7.6% dividend yield)
How REITs Compare To Real Estate Crowdfunding
Real Estate Crowdfunding and REITs are similar in a lot of ways. Both options offer investors balance and diversification from the traditional stock and bond markets. Both investments also offer value from both the current income produced from rents. Finally, both investments offer the potential for long term appreciation of the underlying real estate asset.
Both investment options also permit investors to pool their capital with other investors. This offers a less capital intensive way to invest in a wider range of real estate.
Finally, as with a Fundrise investment when you invest in a REIT, you do so passively. Thus you don’t have to worry about the day-to-day operations and management of the asset. Instead these things are handled by reputable management team.
Important Differences In REIT Versus Real Estate Crowdfunding
The main difference between a Fundrise investment and a REIT investment is that with Fundrise you are investing directly into tangible commercial real estate. Whereas with a REIT, you are investing in a corporation that in turn invests your money into real estate.
In fact up to 25% of a REIT’s total investments can be in assets other than real estate. Accordingly, Fundrise offers investors more control and transparency than a REIT since investors have the ability to personally select each pre-vetted investment opportunity.
Advantages Of Real Estate Crowdfunding Over REITs
1) Potential Higher Leverage & Higher Returns. Direct property ownership benefits from the power of leverage (up to 80%) whereas REITs are generally leveraged at or less than 50%. Higher leverage means higher potential returns (because you can buy more property with less equity).
2) Less Volatility. Although touted as an effective way to diversify a stock portfolio, the performance of REIT shares have closely tracked overall equity market performance resulting in correlation coefficients as high as 0.86 (as early as 2011).
This means that publicly traded REIT’s are moving in near lockstep with the market at large. REITs are subject to the same volatility as we saw in March 2020. During the same period, the comparable equity market correlation for private real estate has been close to 0.14 (ranging from -0.03 and +0.25; a very low correlation).
3) More Transparency and Control. When you invest directly into a real estate asset, you know exactly what you are getting. Thus the process is transparent and you maintain a certain level of control. On the other hand, when you invest in a REIT you are buying into a corporation that owns a pool of properties. You may not know exactly where your investment dollars are going.
Real Estate Crowdfunding Changing Investor Access
REITs have been the only viable option for retail investors until the passage of the JOBS Act in 2012. Real estate crowdfunding has democratized access to commercial real estate.
If you are not an accredited investor ($200K income or $1M net worth excluding primary residence), not a problem. You can look into Fundrise's eREIT option.
Here are the current three Fundrise investment plans investors can choose from after investors decide the size of their investment. Investing a portfolio is a more diversified, safer way to go than investing in just one commercial real estate project.
Bullish On Real Estate Crowdfunding
Real estate crowdfunding is going to be a huge opportunity for investors in the coming decade. The technological platform will open up a flood of capital from expensive coastal cities towards inexpensive midland states.
Further, the income growth opportunities in the heartland look to have some of the largest upside in the country. This is espceially tru as investors are more able to work from home after the global pandemic.
Good investors always think about secular changes, regardless of where they stand on the political spectrum. Thus, I believe heartland real estate should outperform over the next 10 – 20 years.
Why Heartland Real Estate Will Outperform
- There will be a net migration out of Blue states into Red states. More people realize it’s a great deal living in Texas if you can get 3X as much for 1/3rd the price.
- As our country gets older, more retirees will move out of Blue states to stretch their retirement dollar.
- The remote work trend will continue due to technology and a tight labor market.
- Income growth should be higher in Red states due to demographic shifts and companies expanding inward.
- Now that investing in real estate is more efficient, Red State 10%+ cap rates compared to <4% cap rates in Blue cities are too hard to ignore. The spread should narrow.
- A potential expansion of who can invest in real estate crowdsourcing will lead to an increase in demand and prices.
- The rise of real estate crowdsourcing platforms such as Fundrise and CrowdStreet increases the supply of capital. Thereby increasing the demand and prices of previously hard to tap investments. Both are free to sign up and explore.
- SALT deduction of $10,000. Further, a reduction in the mortgage interest deduction limit to a $750,000 mortgage is a net-negative for coastal city real estate. But good for the rest of the country who benefit more from the doubling of the standard deduction.
I'm also bullish on real estate overall in 2021 and beyond. With incomes rising, mortgage rates falling, the stock market recovering, and real estate-related stocks outperforming the S&P 500, I see physical real estate prices catching up.
I like being able to diversify into commercial real estate with as little as $500. Not have to leverage up to buy a single property thanks to Fundrise is nice in this uncertain environment.
I'm confident real estate will continue to be one of the best ways to build wealth over the longer term. Between real estate crowdfunding or REITs, I prefer real estate crowdfunding. I don't like the volatility of REITs, as demonstrated during the March 2020 stock market crash.
About the Author:
Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of it. He spent the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
FinancialSamurai.com was started in 2009. It is one of the most trusted personal finance sites today with over 1.5 million pageviews a month.