Real Estate Crowdfunding vs. REITs

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Investing in real estate is, in principle, an awesome idea. Property provides a natural hedge against inflation, ensures a great deal of stability and downside protection (the investment is backed by a tangible asset), and offers outstanding returns, often even outperforming the stock market. 

Most investors aren’t suited to own rental properties though. For one, even a single property requires a relatively large amount of capital, which most of us don’t have. But owning one or a few properties also comes with a lot of pain – managing rentals can come close to being a full-time job and vacant periods can seriously affect your cash flow. On top of that, it offers very little diversification and high exposure to external factors – your profits might be affected not only by the local economy (country, region, city) but also by planning and management of your close neighbourhood (city district, street, building) and other shocks (e.g. online learning spurred by COVID is decreasing demand for rentals in student-dominated cities). 

Given the great benefits of investing in real estate and the serious constraints doing it directly, many investors choose among a variety of passive investment options. One option, long-established and probably the most popular of all, is investing in real estate investment trusts (REITs). Another, a more novel solution is real estate crowdfunding. Let’s see which one fits your investment needs best.

What is a Real Estate Investment Trust?

We provided a brief overview of what exchange-traded funds, investment trusts and mutual funds are in the article on P2P lending funds. To put this into the context, REITs are essentially companies that own and manage income-generating real estate or real estate-related assets. These can include office buildings, shopping malls, apartments, hotels, resorts, storage facilities, warehouses, but also mortgages or loans. Most REITs specialise in a certain type of real estate – you can find, for example, office REITs, residential REITs, healthcare REITs, or industrial REITs. Unlike other real estate companies, REITs can’t simply acquire, develop and resell properties – they must operate them as part of their investment portfolios (i.e. rent them out to tenants).

REITs can be private (not listed on the stock exchange) or non-traded (registered on the stock exchange but not subject to stock trading). However, these are relatively less common and are suited for institutional rather than individual investors. Therefore, we’ll focus on the publicly-traded REITs, which constitute the majority of the REIT market. Just like with ETFs, to invest in a public REIT, you simply buy its share(s) through a broker. Then, just like with any other stock, you can make money through two key mechanisms:

  1. Rent collected by the REIT is distributed to investors through dividend payments.
  2. The stock price increases (e.g. due to appreciation of the real estate value) and you can sell your stocks higher than you bought them.

How does Real Estate Crowdfunding compare to REITs?

Real estate crowdfunding essentially refers to a group of investors pooling money together to directly invest in a real estate asset (see our guide to real estate crowdfunding for a more detailed overview of real estate crowdfunding types). Real estate crowdfunding is similar to REITs in several ways. At the very core, both offer an opportunity to passively invest in real estate; both allow investors to pool their resources to invest jointly in high-value assets; both can provide income from rents and profits from the long-term appreciation of the underlying assets (the properties).

There are some fundamental differences as well though, which boil down to one key question: how closely engaged are you with your investment? Buying a share in a REIT, you invest in a company that invests in real estate – you have literally nothing to say or do, just sit back and hope for the best. With crowdfunding, you invest directly into tangible real estate and you can view, assess and choose a particular property yourself. But, at the end of the day, is that good or bad?

Which is the better investment?

Let’s review the two ways of investing in real estate across some key categories, our readers already know well from our posts comparing investment in peer-to-peer lending to stocks and bonds (see the table below for a summary).

Returns

Both options offer exceptionally high returns. REITs have made, on average, 12-13 per cent over the past 20+ years, outperforming even stocks as a long-term investment. Real estate crowdfunding should, in theory, bring even higher returns than REITs due to, first – much lower fees, and second – higher leverage (this basically means that a higher portion of the total capital is invested in real estate, thus potentially increasing the expected returns). Indeed, some estimates suggest that returns can be as high as 14.6 per cent (more cautiously, between 11 and 15 per cent). We have to remember though that while we have reliable and long-term data on REIT returns, the data on real estate crowdfunding has neither the reliability (most of it are just informed guesses) nor the sufficiently long time horizon (only a few years is the best we can hope for in most cases).

Volatility

One of the biggest perks of adding peer-to-peer lending or crowdfunding investments to your portfolio is their lack of correlation with most asset classes. This is also true for real estate crowdfunding – you are likely to make money from it even when equity markets are going wild. REITs, on the other hand, are much more correlated with the equity markets than the value of the underlying real estate. Thus, they are subject to relatively high volatility following the stock market ups and downs (they are stocks after all). This is bad news for those who wish to diversify their stock portfolio with de-correlated real estate investment. 

Portfolio diversification

Even though real estate crowdfunding is a great way to diversify your portfolio of, for example, stocks and bonds, it offers much less opportunity to diversify “internally”. With REITs, your money is spread across a large array of properties – for instance, if you invest in a REIT that owns 500+ rental apartments, one struggling property will not ruin your profits. Investing in crowdfunding, you are unlikely to build anything close to that – you will be much more exposed to a failure of every single venture you pick. On the flip side, REITs tend to put all the money in a single property type, whereas crowdfunding allows you to choose different properties, from apartments to hotels to storage facilities. This can somewhat improve the diversification issue. 

Liquidity and cash flow

Just like any other stock, publicly-traded REITs are highly liquid. This means you can withdraw your investment at any point in time in a matter of minutes. Real estate crowdfunding is exactly at the opposite side of the liquidity spectrum. Typically, your money will be tied up for three to seven years in a single venture and it is extremely difficult or even impossible to cash out before the maturity (most real estate crowdfunding platforms lack secondary markets where you can put your shares up for sale to other investors).

REITs also tend to guarantee more or less regular dividend payments, ensuring some stability of cash flow. The case of real estate crowdfunding is less straightforward. Even though many deals aim to produce some income gains, they might always be immediate or predictable. For example, if you decide to invest in a venture involving property renovation, it can take a while for the property to generate a distributable income.

Transparency and control

A REIT is, by nature, a “blind” trust – you do get a fair degree of built-in diversification, but you have very little idea about and influence on the decision-making and management processes. This is not necessarily a bad thing – many investors enjoy the hands-off approach and feel safe with their money entrusted to a professional management team rather than depend on their own instincts. However, if you’re not one of them, real estate crowdfunding is probably more suited for you – you can review available options, choose properties you feel strongly about, and engage with and even directly own (a portion of) the property.

Barriers

P2P lending investment options have typically unusually low entry barriers, including user-friendly platforms, quick registration, low initial investment requirements, and so on. Real estate crowdfunding does not. Although you may find deals that require as little as $500 or $1,000, in general, the capital thresholds are set high, so if you like to build a well-diversified portfolio, you better have some more money at hand. With REITs, you only need as much money as a single share price. 

On top of that, many real estate crowdfunding platforms have been historically preserved to accredited investors (i.e. corporations or wealthy individuals – in the US, those with at least $1 million in net assets or $200,000 in annual income). Again, with REITs, you can buy the stocks through a broker with few restrictions. Real estate crowdfunding seems to be democratising, as more and more platforms are removing barriers and making investing easier and more available to everyone, but those limitations are still in place on many platforms and have to be kept in mind.

Conclusion: When should you invest in Real Estate Crowdfunding?

REITs are a financial instrument that is really hard to beat – they offer remarkable returns, high liquidity and professional management of the portfolio. But real estate crowdfunding does not stay behind either. It can ensure similar, if not higher, returns and much less volatility (although at the cost of liquidity). Eventually, the key difference between the two is the level of control you want to have over your investment. If you’re a savvy investor that appreciates the freedom to choose and trust your own judgement, crowdfunding is for you. If you prefer to have your capital handled by experts and don’t care much about following exactly how your money is invested, you’re likely to be more than satisfied with a REIT.