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Typically when it comes to real estate, the most that an everyday investor could hope for is a single-family unit that they could use as a rental property. If someone wanted to invest in large-scale real estate, the opportunity simply didn’t exist unless they had significant wealth or resources to offer.
Then came along REITs. Short for “real estate investment trusts”, these were investment products that made it possible for anyone to passively invest in commercial real estate.
However, within the last ten years, there’s been another evolution in the way people can capitalize on large-scale commercial properties called “real estate crowdfunding”.
Similar to REITs, real estate crowdfunding allows investors to participate in projects that they would have never previously had access to. But with this new business model being so new, this has many wondering if one is better than the other.
When trying to decide between real estate crowdfunding or REITs, investors need to consider the potential benefits and disadvantages of each. Though both can produce great returns, there may be some unique advantages that make one tool a better fit for an investor than the other.
Admittedly, there are also a lot of similarities between the two, and many people tend to confuse them as being almost interchangeable. In this post, we'll explain what publicly-traded REITs are and how they differ from real estate crowdfunding. We'll also explore the pros and cons of each so that you can confidently decide which one you'd like to add to your portfolio.
Real Estate Crowdfunding Or REITs?
Classically, if someone wanted to make money on large-scale real estate projects, they’d have to approach a private equity firm or similar type of investment group. You could think of large-scale real estate as:
- Commercial buildings
- Office buildings
- Apartment complexes
- Medical buildings
However, before these types of organizations would be willing to allow this person to participate, the client would have to prove that they’re what's called an “accredited investor”. An accredited investor is someone who either has a net worth of over $1 million (not including the value of their primary residence) or who earns $200,000 per year as a single-filer ($300,000 if they file a joint return).
Unfortunately, since most people don’t have this level of income or resources, they simply wouldn’t make the cut.
However, this is where REITs and real estate crowdfunding came in and changed the game. With each type of investment vehicle, investors from all walks of life could now passively participate in the spoils of commercial real estate.
To explain this better, let’s dive into exactly what makes a REIT and how this differs from real estate crowdfunding.
What Are REITs?
A REIT is a company that specializes in the acquisition, operation, and sale of income-producing real estate or real estate-related assets. REITs were first established back in 1960 by Congress as a way to let non-accredited investors participate in these types of business ventures.
As an investment security, REITs are sold just like stocks. Investors can buy shares of a REIT and this makes them entitled to a portion of the earnings. Most REITs are sold publicly in the open market, and investors can trade their shares whenever they wish.
Aside from the opportunity to capitalize on large-scale real estate, REITs are very attractive to investors for another reason: Dividends. The average dividend yield of a REIT is approximately 4.3 percent while the S&P 500 stock market index is 1.4 percent.
This has to do with the tax structure of a REIT. To qualify for special tax treatment with the IRS, a REIT has to pay out at least 90 percent of its income to the shareholders. To avoid corporate taxes altogether, most REITs will payout as much as 100 percent of their profits.
There are three main categories of REITs:
- Equity REITs – These companies own and operate income-producing real estate. For instance, the REIT “Realty Income Corporation” (ticker: O) specializes in providing commercial real estate to well-known businesses like Walgreens. Walgreens pays rent to O for the use of its building, and O’s investors get a cut of the income through their dividend payments.
- Mortgage REITs – These REITs either provide mortgages to other businesses or buy mortgage-backed securities. An example would be a REIT that provides the funding needed for the construction of a new hotel or office building.
- Hybrid REITs – These are REITs that combine elements of both equity and mortgage REITs. This allows them to diversify and capture the benefits from multiple angles.
Within each of these categories, the REITs may further specialize in a specific type of real estate. For instance, the equity REIT “Omega Healthcare Investors” (ticker: OHI) operates facilities for nursing homes and assisted living facilities.
What Is Real Estate Crowdfunding?
Real estate crowdfunding is the concept of investing in real estate ventures through the use of a crowdfunding platform. Entrepreneurs will use the platform to raise capital for their latest ventures, and users of the platform can participate by purchasing shares of various funds or investing directly in the project itself.
Crowdfunding has been around for the better part of the 2000s. However, the original purpose was to provide a place to promote a special social cause and accept donations. It wasn’t until 2012 with the passing of the JOBS (Jumpstart Our Business Startups) Act that these crowdfunding platforms were given the green light to include property ownership.
Similar to REITs, many of the real estate ventures you’ll find on crowdfunding sites will typically include commercial real estate projects like warehouses or apartment buildings. But they may also be for various rental properties and housing flips.
Here are a few of the most popular real estate crowdfunding platforms on the market:
Notice that some of these platforms may require the investor to be accredited before they can participate. This is because many of the projects require a relatively high direct investment before the user can participate.
Generally speaking, non-accredited investors will be placed in one of the platform’s private REITs. For instance, a new investor to Fundrise with $10 will be placed in their Flagship Real Estate Fund, a general-purpose REIT that sponsors dozens of different projects. As the investor reaches a threshold of $5,000 or more with Fundrise, they will then have the opportunity to invest in Fundrise’s other more exclusive funds.
One major difference between REITs and real estate crowdfunding is that the shares are often highly illiquid. Investors cannot freely sell them anytime they wish without having to pay an early redemption penalty. In fact, many of these platforms recommend to their users to only invest if they can lock up their capital for at least five years.
Despite all of this, real estate crowdfunding has grown incredibly popular over the past decade, thanks mostly to the ease it provides to both investors and businesses to raise capital. For these reasons, experts expect the global real estate crowdfunding market is anticipated to grow 33.4 percent annually throughout 2028.
Real Estate Crowdfunding VS REITs – Which Is Better?
On the surface, it may appear like REITs and crowdfunded real estate have a lot in common. Both sponsor large-scale investment properties and make them accessible to the public. In fact, most crowdfunding platforms have their own private REITs.
However, there are some unique nuances between publicly-traded REITs and crowdfunded real estate that can make one better than the other for certain types of investors. Below are the advantages of each type of investment vehicle.
Advantages of Real Estate Crowdfunding Over REITs
While real estate crowdfunding may be a relatively new business model, it’s already proving to have some unique benefits over publicly-traded REITs.
One of the major draws to crowdfunded real estate is the consistency in returns. Though the shares may not produce as high of returns as publicly-traded REITs some years, they do tend to increase in value over time without a lot of price fluctuation.
As an example, take a look at these returns published on Fundrise:
Notice how Fundrise posts a positive return each year whereas publicly traded REITs do not?
This is because of the way private REITs and crowdfunding work. Since investment funds are locked up for so long, that means there’s less capital going in and out of the projects. The outcome is better price stability for the funds.
Better Dividend Yields
Whereas publicly-traded REITs had an average dividend yield in the 4 percent range, the private REITs from crowdfunded real estate tend to produce higher returns – some in the 6 to 8 percent range.
This, of course, will vary from REIT to REIT. For instance, you can find publicly-traded REITs right now that pay dividend yields of 10 percent or higher. But then you’d have to also contend with the price fluctuations of these REITs in the open market, and so it may not necessarily be the better option.
It should be noted that when comparing publicly-traded REITs and crowdfunded real estate private REITs, you have to take into account the management fee. Publicly traded REITs are like stocks, and so the dividend yield you receive is after the REIT has taken out its portion for expenses. However, crowdfunded real estate platforms also charge a management expense ratio that comes after the dividend has been already paid.
Here's a simple example: Suppose you have a publicly-traded REIT with a dividend yield of 4.0 percent and a crowdfunded real estate REIT that has a 5.0 percent dividend. At first, the crowdfunded real estate sounds higher. But if the crowdfunded real estate platform has a management expense ratio of 1.0 percent, then your actual return will be 5.0 – 1.0 = 4.0 percent … the same as the publicly traded REIT.
More Portfolio Transparency
Something that a lot of crowdfunded real estate investors really appreciate is their diligence in transparency. For example, an investor with Fundrise can go to their account and see exactly what projects their money is going towards. They can even see pictures, maps, and financial information if they’d really like to get into the details.
This is not true with publicly-traded REITs. REITs will provide their investors with a general idea of what’s in the portfolio of the company. But in reality, those shareholders will have no idea what buildings or assets it actually contains.
The Ability to be More Selective
Another aspect of crowdfunded real estate is that investors can be more selective about what types of properties they’d like to be involved with. For instance, if there’s a specific apartment project that you’d like to participate in, then you can opt to fund it.
However, note that this privilege is generally reserved for members with substantial amounts of capital to invest (usually $10,000 or higher). On some crowdfunded real estate platforms, the investor may even have to be proven to be accredited before being allowed to participate.
Advantages Of REITs Over Real Estate Crowdfunding
While crowdfunded real estate has its merits, there are some unique benefits that publicly-traded REITs can provide to investors too.
The ability to trade your shares anytime you wish is a huge advantage for publicly-traded REITs. Investors don’t have to wait for any specific amount of time or face a penalty. Whether it's for strategic reasons or because they need the money, investors can freely sell their shares in the open market just like stocks.
While crowdfunded real estate has the advantage of being able to invest in specific funds or projects, this can be a double-edged sword. What if the investor put their money into an apartment complex that went bust or didn’t produce the income they were hoping to achieve?
Just like how mutual funds and ETFs can help stock investors to become widely diversified, REITs can be useful to investors who want to spread out their risk across many different assets. In some instances, investors may even choose to buy a REIT ETF which provides an additional layer of diversification by holding multiple REITs.
Even though Fundrise has the lowest investment minimum of $10, most crowdfunded real estate platforms will require initial investments of $5,000 or more. For many new investors, that’s a lot to ask – especially for just one asset class.
By contrast, the cost of a share of a publicly traded company is similar to that of a stock – usually anywhere from $10 to $100. However, thanks to some brokerages allowing fractional shares, even that’s not an issue. Fractional shares are when investors are allowed to buy shares according to the dollar amount they wish to invest rather than by the nearest whole number of shares (usually resulting in owning a mixture of whole and partial shares).
For instance, you could go to the M1 Finance platform and buy $100 of a REIT that costs $30 per share. This would result in you owning 3.333 shares (3 whole shares and 0.333 partial shares).
REITs do not charge fees in the way that crowdfunded real estate platforms do. Again, REITs are similar to stocks where the costs are taken out before profits are declared and dividends are distributed.
By contrast, crowdfunded real estate platforms will often charge a management fee of around 1.0 percent after dividends have been paid out. These additional fees can eat into your profits and reduce your overall returns.
Finally, let’s not forget that REITs have been around since the 1960s whereas crowdfunded real estate platforms are still a relatively new concept. For this reason, there’s a higher probability that management experience is on the side of the REITs.
Real estate crowdfunding platforms will boast a vetting process where they only select the best of the best business projects. However, this part of the operation is not as transparent, and so platform members have to go on faith that the projects have been thoroughly investigated and are truly legit.
The Verdict – Real Estate Crowdfunding Or REITs
REITs and crowdfunded real estate are both great ways for people to passively invest in the large-scale real estate market like office buildings, apartment complexes, and other commercial properties. Though each type of investment vehicle can produce great returns, there may be some advantages to one over the other that will make it a better fit for some investors.
For instance, investors who wish to avoid the price fluctuations of REITs will appreciate the stability of crowdfunded real estate. They'll also like the fact that these funds may do a better job of producing consistent, higher dividend yields than REITs.
If transparency is important to you, then you'll love how crowdfunded real estate allows its investors to see exactly what projects their money is going towards. For those investors with lots of capital, they can even be more selective about the projects or funds they participate in.
Of course, REITs also have their advantages too – the biggest one being liquidity. Investors are free to buy and sell their shares anytime they wish without fear of having to pay a penalty.
REITs can also provide some much-needed diversification across various sectors of real estate, including debt and mortgage-backed securities. This will help to reduce the risk to the shareholder.
Additionally, REITs don't have minimum investments or external management fees. Investors can buy fractional shares and invest any amount they wish, usually for free with a trading app.
Overall, each individual investor will have to determine which of these elements is the most important to them before they make a decision. Regardless, either type of investment will be a great way to passively capitalize on investment properties and add real estate to your portfolio.