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American entrepreneur and well-known Chicago department store founder Marshall Field once said “Buying real estate is not only the best way, the quickest way, the safest way, but the only way to become wealthy.”
Over a century later, there is still a lot of truth to those words. Many people on the path to financial freedom are choosing to buy investment properties not only as a way to invest beyond the stock market, but also to fulfill their entrepreneurial ambitions.
However, in the digital age, capitalizing off of real estate doesn’t always have to mean buying a physical property. A new breed of investors are using crowdfunding platforms like Fundrise to put their money into high-end real estate projects. This leaves some people wondering: which is better?
Investors trying to choose between Fundrise vs rental property will find opportunities with both. Each strategy allows the investor to make money off of real estate through the income asset appreciation. However, they both carry their own unique advantages and disadvantages to consider.
Fundrise and rental properties are two totally different animals. For that reason, I’d like to use this post to walk through the pros and cons of investing in each one. Once we get the full picture of what each strategy entails, we can then determine which one will be the best fit for you.
Fundrise vs Rental Property – What's the Difference?
Is the concept of crowdfunded real estate new to you? Or did you know that rental properties can be more than just single-family homes?
Before we dive into the pros and cons of each strategy, it will be helpful to introduce them and explain how they relate to one another.
What Is Fundrise?
Fundrise is a crowdfunded real estate platform that allows participants to invest in high-end real estate. Commercial projects that would usually be reserved for private equity and accredited investors (those with at least one million dollars of net worth not including their primary residence) are accessible for as little as a $10 initial investment.
Fundrise’s business model is to pool investor money together and then spread it over a wide variety of real estate projects (similar to a REIT – real estate investment trust). This means investors are well diversified and the risk of potential losses is mitigated. It also allows investors to participate from the comfort of their laptop screens without ever having to touch or manage the physical properties whatsoever.
This combination of low cost, diversity, and passivity is what can make Fundrise seem so appealing over rental properties. “Previously, if you wanted to buy an investment property, most of us are looking at tying up a significant portion of our net worth in a single asset,” said Fundrise CFO Alison Staloch, “not to mention taking on what usually amounts to a second job managing the property.”
Investors who are curious about the kind of money they might make from Fundrise don’t have to look any further than the company’s own website. Here are the stats they’ve published:
In short, the annual returns over the last 5 years have ranged from 7.31% to 22.99%. A portion of these earnings was delivered as dividends which averaged around 5.42% per year. Compared to publicly traded REITs and even the stock market, that’s not a bad return!
What Is A Rental Property?
A rental property is any residential, commercial, or vacation property that’s leased to a tenant. Tenants can occupy the properties for anywhere from a few days to several years.
Most investors are familiar with the classic investment property business model of a single-family home where the tenants pay a monthly rental payment. However, with the rise of such platforms as Airbnb and VRBO, short-term rentals are also becoming an increasingly popular way for landlords to make money from condos, vacation homes, and even spare rooms in their own homes.
There are a multitude of factors that can dictate if a rental property will be a financial success or not, including such things as the:
- Buying price
- Rental payments
- Equity appreciation
- Operational costs (mortgage, property taxes, maintenance, insurance, etc.)
- Operational losses (inoccupancy, tenants missing payments, damages, etc.)
To give you a real-life example of how this all plays out, check out a rental property case study like this one from the Listen Money Matters podcast. The couple being interviewed revealed all the dirty details of their experiences managing 3 rental properties over the past 2.5 years. There were ups, downs, and many lessons learned. But in the end, they made a net profit of $144,085.81.
Of course, this is just one example out of millions. These figures could easily be even greater depending on the deals in your area, your knowledge and skill level, and the quality of the tenants you take on. For those reasons, many real estate entrepreneurs are adamant that owning physical properties is far more lucrative than investing in stocks or passive real estate platforms.
Which is a Better Investment – Fundrise vs Rental Properties?
Clearly, an investor could put money into Fundrise or rental properties and have a high probability of making money over time. But is one choice really better than the other? To find out, let’s list out each of the pros and cons for each option and explore them more thoroughly.
Here are some of the advantages to investing in Fundrise:
- Low cost – Investors can get started with as little as $10. Reoccurring investments can also be as little as $10.
- Access to commercial real estate – Participants will have the opportunity to capitalize off of real estate projects that would normally be reserved for accredited investors
- Diversification – Investor capital is put into funds that sponsor a wide variety of real estate projects
- Passive income – Similar to a REIT, Fundrise pays out a large percentage of its profits to shareholders in the form of dividends. This can be a nice stream of income, especially for those investors who are retired and looking for positive cash flow.
- Asset appreciation – In addition to dividends, shares of Fundrise funds can increase in value and be sold for a capital gain at a later date.
- Hands off – All aspects of the real estate including acquisition, development, management will be handled by the project sponsor. Investors will participate passively and never touch a single piece of property
- Low risk – Investors who are risk-averse but want the possibility of higher returns will appreciate Fundrise’s investment strategy. As shown on their website, investing in private real estate can be less volatile than stocks or publicly-traded REITs.
Of course, investing in Fundrise or any crowdfuned real estate platform isn’t completely risk-free. Here are some of the disadvantages a person will have to deal with when partnering with Fundrise.
- Minimum 5-year investment – Due to the amount of time it takes for real estate projects to mature, Fundrise discourages early withdrawals by adding a 1 percent penalty. This can be a problem for investors who have short-term needs.
- Shares are illiquid – Since Fundrise shares aren't sold in the open market, investors who want to cash out have to wait for Fundrise to resell them. This can take some time or be put on hold indefinitely during times of economic distress.
- No control over the projects – Although investors can see the details of the projects they're contributing to, they ultimately have no say over how individual projects are handled.
- Better features require more capital – Although a minimum investment of $10 is required to open an account, users will not have access to the bulk of Fundrise's most attractive investment options until they reach the Core account level ($5,000 minimum).
- Some investments not registered – Starting at the Core account level, users will have the chance to invest in non-SEC registered funds. This means that similar to private equity, there will be minimal third-party oversight and investors will largely have to trust Fundrise with how their money is being managed and distributed.
Rental Property Pros
For those people who prefer to go the traditional approach, here are some of the benefits to investing in rental properties:
- You choose the property – It's up to you what type of rental property you'd like to have. It could be a single-family home, condo, vacation property, etc. It's also your choice what price range you'd like to work with.
- You choose the location – Even though many people buy rental properties that are relatively close to their homes, sometimes there are advantages to picking them out of state. For instance, it could double as both a rental property and your personal vacation home.
- Passive income – As long as your tenants pay on time and in full, then rental properties can be a consistent source of income. Many landlords describe the experience as being truly passive when their tenants never complain or cause any disturbances.
- Returns may be greater – Depending on how much you spent on your rental property and charge tenants, you could make a few hundred dollars in profit every month. This can be significantly higher cash flow than the dividend payments you'll receive from Fundrise.
- The asset is 100% yours – Once you're ready to sell your rental property, you can do this anytime. On top of that, any equity you've built along the way (using your tenant's rental payments) will be yours to keep.
- The investment is tangible – One of the best features of owning property is that it’s something that you can physically see and touch. The same can't be said for stocks, REITs, or even equity shares from Fundrise.
Rental Property Cons
While it may seem like investing in rental property has a lot of upside, there are also plenty of risks to be aware of too. Here are a few to consider:
- Large initial investment – Investors can count on putting down at least 20 percent (or more). For a property that costs $100,000, that's an initial investment of $20,000. And that figure doesn't even include all the other expenses such as mortgage costs, renovations, insurance, etc.
- Inoccupancy – Just because you have a rental property doesn't always mean you'll have tenants. For a multitude of reasons, there could be weeks or even months where your property sits vacant and generates no revenue.
- The time needed for property management – Since most new rental property owners will try to do the majority of the tasks themselves to cut costs, they’ll be faced with a huge time commitment. It will mean having to sacrifice nights and weekends to maintain the yard, perform light repairs, and manage all tenant-related issues.
- Dealing with nightmare tenants – Speaking of tenants, there's only a 50/50 chance that'll have good tenants. There are many horror stories of tenants who are late or never make payments, cause destruction to the property, or cause legal disturbances that you'll have to deal with.
- Legal obligations – If the situation with your tenants does go extreme, then you may have to appear in court. Or if an incident occurs on your property, then you may be held responsible since the property is legally in your name.
Risk of financial failure – With the possibility of having no tenants, tenants that don't pay, or constantly needing to make repairs to the property, there is a much greater risk that the venture could go belly-up or even leave you in debt.
Choosing an Investing Method for You
After going through all of the pros and cons between rental properties and Fundrise, you may be confused about which route is the best one to go. Here are five questions to ask yourself that will help you to decide which option is really the best fit for you.
1. What Are Your Goals?
What are you hoping to get out of this experience? If investing in real estate is only about the money, then either option could be successful.
However, real estate enthusiasts will argue that owning physical property can be far more entrepreneurial. It can be exciting to hunt for the best deals, make renovations, and work with tenants. You might even grow to have long-term aspirations about building a rental property empire.
Beyond that, what if you'd like to pass on one of these units to your children or make it your new primary residence in the future? There can be many factors beyond just the financial aspects that will influence your decision, and investors have to be honest with themselves about their true motivations.
2. How Much Money Can You Invest?
Not everyone who wants to make money in real estate will have tens of thousands of dollars upfront to sink into a down payment, mortgage costs, and renovations. If you're tight on cash or would just like to ease into the real estate game, then Fundrise might be a better fit. Since it only takes $10 to get started, the barriers to entry to far lower.
3. What is Your Tolerance for Risk?
Owning and managing a physical property can be a huge financial risk. Not only are you legally obligated to pay for the mortgage, even if the property is sitting empty and not producing revenue, but there’s also no guarantee that you’ll be able to sell it for more than you paid.
When it comes to Fundrise, illiquidity and withdrawal penalties made in less than 5 years could also be frustrating. As with all investments, there's no promise that your shares will increase in value. However, Fundrise does offer better diversification over a single rental property.
4. How Much Time Do You Have?
If you're the type of person who doesn't have a lot of time to give, then investing passively through Fundrise will make a lot more sense. Taking on an investment property will be a time commitment. However, this can also be somewhat mitigated by hiring a property management service to handle the day-to-day duties.
5. Which Option Makes You Feel More Comfortable?
In the end, it will come down to your gut. If you don't mind a hands-on approach and look forward to owning physical land sound appealing, then go for the rental property. However, if the responsibilities and possible negative outcomes are going to keep you up at night, then going with Fundrise will be the smarter choice.
Which Will You Choose – A Rental Property or Fundrise?
Anyone who wants to make money in real estate would be wise to invest in either Fundrise or a rental property. Both can produce reasonable streams of income while also providing the opportunity for asset appreciation. However, each has a totally different approach, and investors need to understand the full picture before they sign up for the long haul.
The main advantage of choosing Fundrise is its low cost, highly diversified, and completely hands-off. However, the 5-year time commitment, illiquidity, and non-registered funds may turn some people off.
Rental properties are the classic model of an investment property. They've been known to produce great passive income if you can get great tenants and keep your costs down. But the high start-up cost combined with the huge time commitment and possibility for terrible tenants could turn owning a rental property into a complete disaster.
The best thing any real estate investor can do is just be honest with themselves about what they feel comfortable doing. People who are more hands-on may enjoy rental properties whereas those who just want to passively invest will find Fundrise to be more than adequate.
Remember that the point of financial freedom is to put your money to work for you, so tailor the path that's going to fulfill that role in the best way possible.