Most people can benefit from having real estate in their portfolio. However, buying a property and renting it or selling it at a higher price isn’t always possible or desired. Investors may not want the responsibility of collecting rent, managing repairs, paying taxes, and vetting prospective tenants. They also might be unable to afford the cost of buying a property for investment purposes. Alternative methods of real estate investing try to get around these obstacles. They let you benefit from property ownership without buying and managing properties themselves. Two popular hands-off methods include real estate investment trusts (REITs)?and real estate crowdfunding. Read on to see which might be best for you.
- Real estate investment trusts (REITs) purchase commercial properties and distribute the rental income to shareholders as dividends.
- Crowdfunding enables entrepreneurs to raise capital for projects from a large group of individuals.
- Investors can purchase shares of REITs as shares on the major exchanges or through exchange-traded funds.
- If you don't want to buy property, you can invest in a crowdfunding company that specializes in real estate.
REITs are essentially companies run by real estate professionals who invest in different income-generating properties for their investors. Real estate crowdfunding, meanwhile, pools investors together to raise capital to fund specific projects.
REITs have been around since the 1960s. Investors buy shares in trusts that own and manage the real estate. A REIT buys different properties—condominium complexes, large apartment buildings, hotels, office buildings, storage centers, retail outlets, and other similar properties—and leases or rents them out to tenants. Investors buy shares in the REIT. The rent collected by the REIT is distributed to investors as dividends.
How REITs work
REITs are firms that own, operate, or finance real estate to generate income. They pool capital from many investors in a manner similar to mutual funds but with a focus on real estate assets. These trusts include equity REITs, which own and manage properties; mortgage REITs, which put money in mortgages or mortgage securities; and hybrid REITs, which use both approaches.
Many REITs are traded on major stock exchanges, making them accessible to individual investors who buy and sell shares in them like stocks. REITs must distribute at least 90% of their profits to shareholders as dividends.
Investing in REITs
REITs offer a way for individuals to invest in large-scale, income-producing real estate without directly buying, managing, or financing properties. This accessibility is one of the key attractions of REITs.
REITs often appeal to individual investors because they are traded on major stock exchanges, just like stocks, making them easy to buy and sell. They also can provide regular income through dividends and have the potential for capital appreciation. In addition, since REITs must distribute at least 90% of their taxable income to shareholders, they can have higher dividend yields than some other investments.
While institutional investors, like pension funds or insurance companies, invest in REITs because they have income-generating properties and provide diversification, the structure and regulation of REITs make them equally viable for individual investors seeking exposure to real estate.
You might also consider REIT exchange-traded funds (ETFs). These ETFs generally invest in equity REIT securities and related derivatives. Characterized by their relatively low expense ratios, these funds typically adopt a passive investment strategy, mirroring the performance of broader real
estate market indexes. You can choose specific REIT ETFs based on which parts of the real estate market you want a stake in. This way, you can diversify your exposure across the industry, mitigating the risk of investing in a single real estate company.
REITs trade like stocks, while crowdfunding is done through social media or website-based platforms.
Crowdfunding is not new. However, it has been put to more sophisticated uses with the rise of social media and the trust-enforced platforms that create a marketplace for crowdfunding.
The term refers to raising capital from a large pool of individuals to finance an entrepreneur's project, idea, business, nonprofit, or invention. Entrepreneurs and project owners can reach those who value their idea, startup, or cause beyond the usual suspects of family, friends, and venture capitalists.
How Does Real Estate Crowdfunding Work?
Crowdfunding provides a way to raise funds or invest in projects for people who want to start their own business or project but don't have the money to do so. They may not necessarily have the best credit score, which would disqualify them from getting a loan through traditional avenues. Crowdfunding sites match these people with a large pool of investors to raise the needed funds. Real estate crowdfunding applies this model to real estate. If you want to invest in property but don't want to own or maintain a building, you can become a shareholder through a crowdfunding platform. Any profits from rental income or flipping of the property are passed, minus fees, to you.
Investing through the best real estate crowdfunding sites can help diversify your portfolio and offer competitive returns. Be careful: crowdfunding is an area that's not yet tightly regulated, and you should do your due diligence to research the team managing the project.
Which Investment Strategy Is Right for You?
The idea behind both REITs and crowdfunding is that you get a share in the profits without all the risk. There are pros and cons to each.
REITs: Pros and Cons
Because they pay out dividends, REITs provide investors with guaranteed income and trade just like stocks. They help diversify a portfolio and provide you with exposure to the real estate sector without having the headaches that come with owning properties.
The biggest drawback that many find with REITs is that they generally have higher expenses. A portfolio of properties can be difficult to manage, as real estate can come with some hefty maintenance costs. These costs are then passed on to the REIT's investors.
Exposure to real estate without having to deal with the headaches that come with owning properties
Provide investors with stable income
Easy to buy and sell like stocks
High expenses eat into returns
Returns are sensitive to interest rate rises
Dividends are subject to ordinary income tax
Crowdfunding: Pros and Cons
One of the biggest advantages of participating in real estate crowdfunding is that you can use less capital to do so. You can find projects that may only require as little as $500 or $1,000. Another benefit of real estate crowdfunding is that there are generally no investment fees. In traditional real estate ventures, you'd have closing costs, realtor commissions, and other fees and costs.
There are a few potential disadvantages to real estate crowdfunding. The biggest risk is that the project you choose won't meet expectations. Moreover, the real estate market can be volatile, and crowdfunding sites can add on several fees. For some projects, you may have to be an accredited investor. That means you have to meet specifications set by the Securities and Exchange Commission. Lastly, any share in the profits can be diluted by the number of other investors involved.
Real estate crowdfunding
Possible to invest in real estate projects with a relatively small amount of cash
Minimum investments can be as low as $500
Potential for enormous gains
There is no guarantee the venture will deliver on its promise
Many sites charge fundraiser fees, donor fees, and processing fees
Some options may only be open to accredited investors
What Are the Differences in Liquidity Between REITs and Real Estate Crowdfunding?
Liquidity is a major difference between the two forms of real estate investments. Traditionally, real estate serves as a paradigm case of an illiquid asset. Yet, REITs offer good liquidity since they are traded on stock exchanges, allowing investors to buy and sell shares readily, like trading stocks, though this will vary between REITs based on their volatility and trading volume. Alternatively, real estate crowdfunding investments are usually less liquid since they are frequently tied to the life cycle of a specific real estate project, which can last several years. This means that your capital is locked into the crowdfunded project until it's completed and the property is sold or refinanced.
How Do REITs and Real Estate Crowdfunding Differ in Risk?
Real estate crowdfunding can involve higher risks since these investments are usually tied to specific projects or developments, making them more susceptible to market fluctuations and specific project risks. REITs, meanwhile, often have stakes in a diverse set of real estate assets, which can help spread and potentially lower the risk. However, REITs are also subject to market volatility.
Can REITs Beat Inflation?
REITs are known for paying a steady income, and the rents they charge do tend to rise with inflation. They generally offer decent yields that, in most cases, will comfortably beat inflation. That said, real estate can be volatile and can face a downturn even when there is an inflationary spike.
What Are the Tax Implications For REITs and Real Estate Crowdfunding?
The tax treatment of real estate crowdfunding and REITs can differ significantly. For real estate crowdfunding, you can have different tax issues arise depending on the investment structure, such as direct property ownership, partnership, or a limited liability company. These can involve complex tax considerations like property taxes, income taxes on rental income, and capital gains taxes after a sale.
By contrast, REITs offer a relatively simpler tax situation. REITs must distribute at least 90% of their taxable income to investors as dividends, which are then taxed as regular income for the recipients. However, some of these dividends might qualify for a lower tax rate under certain conditions. Additionally, REITs do not pay corporate income tax on the profits they distribute, which can be a tax advantage for investors. It would be prudent to consult with a tax advisor to understand the specific tax implications for your situation.
The Bottom Line
Real estate can be a great investment, but most people don’t want to worry about owning the actual property. Managing rentals can end up being a full-time job. The stress of renters can be a nightmare, and the rates of return can be negative if done incorrectly. REITs and real estate crowdfunding take away this stress and open up real estate investment to everyday investors.
REITs let you invest in a basket of investment properties, while real estate crowdfunding lets you back specific projects. REITs provide higher liquidity and a stable income. Real estate crowdfunding, meanwhile, potentially gives investors more control to select specific types of property they want to invest in and has higher risk and reward potential.