There are several ways you can invest in real estate. Real estate investment trusts (REITs) give you the opportunity to generate some passive income by investing in stock-traded companies that manage properties. It requires neither much experience nor a high initial investment and allows you to have your capital handled by professional trust managers. On the other, “wild”, side of real estate investing is house flipping. For people with a lot of free capital as well as significant experience and expertise in real estate valuation, marketing, and renovation, buying and selling of properties can provide juicy gains. Even buying a house to live in can be considered a real estate investment – although you don’t collect any profits directly (the opposite – you might have to pay your mortgage), you save money on rental and get a tangible high-value asset whose value will hopefully increase making you wealthier.
Buying a rental property (i.e. a property you rent out to tenants) is still probably the most common, and definitely the most “classic” way to invest in real estate. Is it the best way though?
Is buying a rental property a good idea?
Owning rental properties certainly comes with some strong benefits. You have full control over your investment – you own and manage your asset(s), owe no fees to anyone and can maximise the investment leverage. Forget about making and losing money based on some secretive green and red numbers that pop up on your screen – the property is as tangible as it can get and you know exactly where your money is. Given the historical trends, it is also highly likely to appreciate in value, and you can help make it happen by properly maintaining or upgrading it – simple things such as repainting, refinishing, or landscaping the yard can increase the property value in the eyes of tenants and potential buyers. While you hold on to it waiting to reap the profits from value appreciation, the tenants can provide you with an income stream that is potentially relatively steady, substantial and de-correlated with most financial investment instruments (stocks, bonds).
Sounds good? Well, it might not be so rosy in reality. There are some serious drawbacks to owning a rental property, including:
Lack of diversification
For most people, owning a rental property, if they can afford it in the first place, means a serious concentration of assets. Real estate isn’t cheap and buying a property is likely to consume most, if not all, your investment capital. This means you will end up depending not only on one asset class but on a single asset (a specific property). Any rookie investor will tell you that “putting all your eggs into one basket” is not a wise strategy.
Dependence on external factors
Real estate, in general, seems like a safe bet – it’s largely decorrelated with financial markets and provides steady and high returns. But remember – you’re not just dependent on the real estate market, but also the specific city, neighbourhood, street and building. Several things can go wrong – what if the local economy suffers? What if the neighbourhood goes downhill? What if something unfortunate happens to the building? Well, in all of these cases, you’re likely to lose money.
Lack of liquidity
Real estate is an extremely illiquid asset. Even if the market is hot, it might take several months to sell a property. If you’re in an emergency, you might have to agree to an otherwise unsatisfactory price. Finally, if any of the above-mentioned bad case scenarios happen and your property starts losing value and attractiveness, you might not be able to get rid of it at all.
Owning a rental property, you will have to do the usual work associated with being a landlord, including looking for tenants, doing the paperwork, arranging for maintenance and repairs, and so on. If you own more than one property, this can amount to being almost a full-time job. You may also feel shy about increasing rents, especially if tenants are your family or friends, or have insufficient or inadequate information about the rent prices in the first place, and end up collecting rents that are below the market price.
There’s a lot of potential trouble with renting your property to someone else – they might damage it or otherwise decrease its value. They might fail to pay the rent on time, or fail to pay it at all – worst-case scenario you may lose several months dealing with their non-payment and eviction. Due diligence and security deposits can mitigate those risks to an extent but they won’t eliminate them entirely. There’s also the risk of not finding a tenant at all, resulting in periods where the property generates no rental income.
Real Estate Crowdfunding: The Best Alternative?
Alternative, passive options for investing in real estate often have little to do with owning a property. For example, investing in REITs resembles more (and actually is) a stock investment – you are exposed to market fluctuations, and you don’t really have a clue where exactly your money is invested. Real estate crowdfunding, arguably, offers much more benefits traditionally associated with owning property but at the same time alleviates its many risks mentioned above.
First, you still have solid control over your capital – you can personally review available options and choose the specific deals you want to invest in. Your gains are still based on the rent income from tenants as well as the appreciation of the underlying asset. But things get even better – with crowdfunding you can choose the amount you want to invest in a particular property (as long as it’s above the required threshold) – that’s freedom you don’t have buying a property directly in the market.
Instead of buying one property in one location for $250,000, you can spread this amount across several, dozens or even hundreds of crowdfunding projects throughout different locations and property types. This can help you spread your risk and shockproof your property portfolio – one deal going south is unlikely to substantially hurt the overall profitability.
No direct management
Real estate crowdfunding frees the investors of the burden of actively managing the property, saving them a lot of time and plenty of headaches. You are still exposed to the problems that may arise – issues with tenants can affect the cash flow and profitability of a particular deal – but at least you don’t have to stress out and lose time on resolving those issues.
Investing made easier
Lower initial capital requirements are a big plus for those who want to invest in real estate but don’t have the cash to buy a property on their own. But getting started in general is much easier with crowdfunding. Many platforms offer deals only available to accredited investors, but you can find more and more platforms where you can set up an account and start browsing the investments. The research process is also made easier for you. The platforms typically perform the due diligence before they approve a project and you can choose among the deals that have already been filtered out.
Should you own a rental property or invest in real estate through crowdfunding?
Of course, buying a property is likely to turn out to be an excellent investment – you can enjoy reliable tenants, no damages or repairs for years and a flourishing neighbourhood. On the flip side, real estate crowdfunding isn’t perfect either – you have limited management control, the investment is still very illiquid and requires relatively long holding, and the sector itself is new and untested (e.g. there is a chance of the platform going bust, which may be your worst nightmare). But in principle, real estate crowdfunding does alleviate some serious flaws and risks inherently associated with concentrating our investment in a single asset – the rental property. It also opens the door to real estate investment for all those who lack the capital required to buy a property on their own. Finally, in many ways, it provides a middle ground between owning a property (high involvement) and passive real estate investment options such as REITs (no control at all).