Investors today have several options for adding real estate to their portfolios that help make it more accessible and less complicated than it used to be. With options like real estate investment trusts (REITs) and real estate crowdfunding, some of the biggest obstacles keeping investors out of traditional real estate investing — like large down payments, extensive due diligence required for each property and high overheads for managing properties — are no longer the barriers to entry they once were.
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As accessible as they are, they are not without their risks and requirements so it’s still important to learn about these investment options before putting your money on the line. As your first step, read about the basics of REITs and real estate crowdfunding and start thinking about which option makes the most sense for you.
What is a REIT?
A REIT is a company that owns or manages income-generating real estate. Most focus on a specific type of real estate like multifamily buildings, retail, hospitality, office space or industrial property. Some also focus on specific regions, investing only in properties located in, say, the northeastern United States.
Congress established REITs in 1960 as a way for individual investors to invest in large-scale, income-generating real estate ventures that were previously only accessible to the very wealthy or to institutional investors like banks and hedge funds.
In order for a company to qualify as a REIT, it must meet certain requirements including:
- Distribute at least 90% of its taxable income to shareholders each year in the form of dividends
- Invest at least 75% of total assets in real estate assets and cash
- Derive at least 75% of its gross income from real estate-related sources (e.g. rents, mortgage financing, etc.)
As an individual investor, these criteria mean that there is a fair amount of transparency about how your investment dollars are being used because it has to go toward real estate investments. It also means that REIT shares come with especially high dividend yields because, unlike other companies, it has to pay out at least 90% of its income to shareholders.
When you buy shares of a REIT, you’re investing in the company, not directly in the properties it owns or manages, so there are some key pros and cons that come with that.
The pros to REITs include:
- High dividend yields. The average REIT dividend yield is about 5% for an equity REIT, compared to just 1.9% for the S&P 500.
- More liquidity. You’re holding tradable shares, not physical property, so it’s easy to buy and sell as needed.
- Easier to defer taxes. While you technically can hold property in a tax-deferred account like an IRA, doing so is complicated and comes with a lot of rules. With a REIT, you can just hold the shares in that tax-deferred account like you do with ordinary stocks.
- No management or financing responsibilities. As a shareholder, all you have to do is sit back and collect dividends. The company handles the work of finding investment opportunities, managing properties and securing financing.
- No minimum capital requirements. An investor can become a shareholder in a REIT for the price of a single share. This is much more affordable than saving up to buy a property outright or to meet some of the higher minimum investment requirements of some crowdfunding platforms. It’s also easier to scale up at your own pace. You can keep buying new shares as your budget allows, earning interest and dividends on each new share immediately rather than waiting to save up enough money for your next property, meanwhile earning negligible interest while it sits in a savings account.
- Gain more exposure to the real estate market. As an individual, investing in real estate at a large scale may not be practical. Typically, you’re buying just 1 property at a time, and you have to personally manage each property you own directly so there’s a limit to how much real estate you can realistically manage. With a REIT, that’s no longer a problem. You’re instantly gaining exposure to a large-scale portfolio of multiple properties.
The major cons of REITs include:
- No direct control over decision making. You’re close to the action and can choose a REIT that aligns with your investment priorities, but you won’t have control over which specific properties are added to the portfolio or how those properties are managed. For investors with little interest in actively managing real estate, that’s not a major drawback but for those who want to be more hands on, you might feel too limited by a REIT.
- Prices fluctuate like stocks. Because REIT shares are traded on public exchanges like other stocks, the price fluctuates according to market sentiment just like other stocks. While that won’t affect your dividend yield, it can impact the net worth of your investment portfolio — and it can also be a little nerve wracking to watch if you’re risk averse.
What is Real Estate Crowdfunding?
Real estate crowdfunding is a newer option investors have for investing in real estate without the same barriers to access as direct real estate investing but offering a little more decision-making power than REITs do. Investors can go to 1 of the many real estate crowdfunding platforms that have emerged in the last few years and choose to invest in specific projects or deals.
Benefits to Crowdfunding
As an investor, going the crowdfunding route offers the following benefits:
- Direct ownership. As a crowdfund investor, you become part of a pool of investors who directly own this property or this development project. This typically translates into a much larger share of the total project. REIT shareholders don’t have this same ownership. Shareholders own shares of the company — not of the properties it owns.
- More transparency. Those who advertise projects or deals on a crowdfunding platform have to provide in-depth detail and clear parameters for what your investment will go toward and what you can expect in return. With REITs, you know most of its money is going toward real estate investments, but you won’t really know what specific decisions are being made or how the money is invested.
- Higher returns. The annual returns on a project you invest in vary depending on the investment but are usually somewhere around 15%. As a direct owner, you also usually get a higher proportion of that return because it’s being divided among a smaller pool of investors.
- Choose your deals. Crowdfunding platforms present a wide range of different projects and deals, empowering you to choose which specific properties or projects you want to invest in.
Drawbacks to Crowdfunding
While crowdfunding gives you more control and more ownership, it does carry higher risks. Here are the main drawbacks of crowdfunding:
- Higher risk. Because you’re investing in a single property rather than in a portfolio of hundreds or more, the potential loss if this project doesn’t pan out is much higher. As a shareholder in a REIT, performance might fluctuate from year to year, but the failure of a single property in the portfolio won’t cause you to lose your entire investment.
- Less liquidity. Because you’re investing more directly in real estate, you run into the same liquidity problems that come with that. Your investment will be tied up in this project until it’s completed, or the property is sold. Many projects also have restrictions around when you can withdraw your investment so it’s not possible to cash out early if you change your mind.
- Strict minimum requirements. While the 2016 Jumpstart Our Business Startups Act removed the requirement that you had to be an accredited investor to invest in real estate through a crowdfunding platform, many platforms still restrict access to accredited investors only. Even when they don’t, many of the projects have higher minimum investments ranging from a few thousand dollars to hundreds of thousands of dollars. These requirements can make them less accessible to many individual investors.
What Real Estate Investment is Better?
There’s no one right answer here. The best option is the one that aligns best with your interests and goals. To make the best decision, you have to think about what your priorities are and how you see real estate fitting into your investment strategy. With that in mind, here are a few guidelines that can help you decide:
REITs are a better option for investors who prioritize:
- Consistent, passive income from annual dividends
- A hands-off approach that doesn’t require extensive knowledge of the real estate market
- High liquidity so that your portfolio can be rebalanced as necessary
- The ability to hold your investment in a tax-deferred account
Real estate crowdfunding is better for investors who prioritize:
- A more hands-on approach that allows them to choose specific properties and projects.
- Directly owning real estate
- The potential to earn a substantially higher return on their investments
This also doesn’t have to be one or the other decision. If you value having the steadier, more passive income stream of a REIT but you’re also drawn to the excitement and high return potential of crowdfunding, you can certainly do both. Incorporate some great REITs into your portfolio but reserve a little play money to put toward crowdfunding projects.
Benzinga’s Best REIT and Real Estate Crowdfunding Platforms
Whether you decide REITs or crowdfunding platforms (or a mix of both) are more aligned with your investment goals, choosing the best options for either is key to any successful investing strategy. To get you started, you can check out our best REITs for the month. You can also see reviews on real estate crowdfunding platforms below.
- Best ForLow Cost Real Estate Investing
- Best ForAccredited Investors
- Best ForNon-accredited Investors
- Best ForSmall Account Real Estate Investing
- Best ForDiverse range of alternative assets
- Best ForFarm Investing
For Accredited Investors Only
- Best ForBeginner real estate investors
Become a Real Estate Investor Today
Now that you understand the basics of REITs and real estate crowdfunding, including the key differences between them, you’re better equipped to make the right decision about where to invest in your money. Make sure to come back to Benzinga for more information and tips to guide your investing career.
Frequently Asked Questions
Is a REIT crowdfunding?
Not really. With a REIT, you’re buying shares of a company through a broker rather than directly financing a real estate project. With crowdfunding, your money is going directly into a specific project. While you get a share of the income or profit in both cases, you’re not technically an owner of any property if you’re invested in an REIT.
REITS versus rental properties: Which is better?
Both can be great sources of consistent income. With your own rental property, you get to keep 100% of the income generated but you also have to manage the property — and cover overhead costs of operating and maintaining it even if tenants move out, and it’s not generating as much income anymore. With a REIT, you only get a small share of the income in the form of dividends, but you don’t have to do any of the heavy lifting, and there’s no ongoing overhead costs.
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