Published October 26th, 2019 by Financial Wolves
This is a guest post by Financial Wolves. Financial Wolves is a blog focused on helping you make more money to achieve financial freedom. After repaying student loans, I’ve shifted my focus to make more money from side hustles, real estate, freelancing and the online economy. Follow us on Twitter and Facebook.
Investing in the real estate sector has diversified a lot over the year. The traditional buying, flipping, and renting of property is no longer the only way to make money with real estate investment.
Two very popular ways to invest in real estate are Real Estate Investment Trusts (REITs) and Real Estate Crowdfunding. Here is a detailed REIT vs real estate crowdfunding comparison.
In this article, we will look into the differences between the two investment options to decide which one is better for you. But first, it is important to understand the basic definition for each.
However, both of the options provide investors with an opportunity to make money by investing in real estate. This is why, for all real investors, it is necessary to learn about both concepts.
REIT Overview
A Real Estate Investment Trust, commonly known by its abbreviation REIT, is a corporation that owns real-estate properties. It allows people to invest in their properties without actually buying them. Investors can buy shares of the REIT, which owns a portfolio of real estate.
These could be apartment complexes, hotels, offices, retail outlets, storage facilities, and other similar commercial properties. They rent or lease these properties to make money and distribute it to shareholders in the form of dividends.
Within the REIT sphere, there are essentially two types: equity REIT and mortgage REIT. The former is the most common one. They invest in real estate and make money from rental incomes. The latter makes up only 10% of REITs. It invests in mortgage real estate and makes income from the interest on these mortgages.
Even though to invest in REIT company, you can buy shares, but not all REIT companies are listed on the stock exchange. Public Non-listed REITs (PNLRs) are registered with the SEC. However, their shares are not publicly traded. Private REITs are completely private and only available to institutional investors to invest in.
What are the Pros and Cons of REITs?
Pros
- Tax breaks for corporations
- 90% of profits are paid back to the shareholders
- Low-risk investment
- Expert management of assets
Cons
- Generally suited for institutional investors
- Less transparency
Real Estate Crowdfunding Overview
Crowdfunding is not a new concept. You must be familiar with how it works on the internet for entrepreneurial ventures. Real estate crowdfunding is similar as it is open to the public on the internet.
It allows individual investors to invest in a property directly without actually buying it or managing it. The profits made by renting or flipping the property are returned to the investors in the form of real estate crowdfunding dividends.
It is a relatively new but viable alternative to REITs. It started with developers getting on the crowdfunding bandwagon started by technology entrepreneurs. There are websites where the general public can invest in property projects, like Fundrise, RealtyMogul, and CrowdStreet.
As everything is online, your investments and earnings are more transparent. You also don’t need to own or manage the property to make a profit off it, the company behind the crowdfunding website does it.
Unlike REIT corporations, these companies are not publicly listed. They do not file with the SEC. This is why fluctuations in prices are not common with properties in a crowdfunding real estate setting. You may not be able to liquify your investment at any time. Any money you make is mostly at the end of the quarter.
What are the Pros and Cons of Real Estate Crowdfunding?
Pros
- Individuals can invest
- Freedom and ability to choose the property
- Small initial investment
- Easy to monitor the real estate project you are investing in
- Does not require any credit checks
Cons
- Investment risk in case of a recession
- Hard to liquify
- Company or asset may not necessarily share 90% of profits
REIT vs Real Estate Crowdfunding: The Difference
From the outlook, both investment opportunities look pretty much the same. You invest your capital in properties indirectly and get dividends from cash flow.
Not only do you get rental income, but the value of the property appreciates with time. However, there are significant differences in how each of these works.
Real Estate Crowdfunding Offers Direct Investment
The primary difference between a real estate crowdfunding investment and a REIT investment is access. Real Estate Crowdfunding allows you to invest in properties directly, while REIT allows you to invest in a corporation that, in turn, invests your money in properties.
This means that when dealing with crowdfunding, you can invest in several small or big real estate projects. However, with REIT, you cannot directly choose the properties to invest in.
That decision making falls on the corporation you are choosing. Usually, REITs own hundreds of properties.
It does not mean that you do not get the list of properties in the REITs portfolio. It is just that they are so many, not all may fit your requirements.
As a result, it would also be difficult to track and follow the progress of all of them. You can easily target a specific approach like core plus real estate investing. Use my free investment property spreadsheet to model out the financial returns of your prospective investment.
REIT Shares Have Higher Liquidity
It may not be that easy or quick to cash the investment in a crowdfunding real estate website. However, shares in REITs get traded daily on stock exchanges. They can be liquified rather quickly in comparison.
It may be impossible to get cash for the shares you bought on a real estate crowdfunding website before the property you invested is disposed of. This would not bode well in an emergency situation.
REIT has Less Transparency
With a real estate investment through a crowdfunding website, you, as an investor, have more control and transparency. It may be easier to track how the individual properties are performing.
However, with REIT, there is not much transparency. You may not be able to track properties and their performance directly. You do not know where the corporation will spend your investment money.
REITs Have Better Management
Unlike real estate crowdfunding, experts with years of experience manage REITs. During the stock market crash of 2008, many of the better managed REITs weathered the crisis. That was only possible because of active management by experts who are great at their jobs. They carefully invest in properties that have great potential to make money. They also keep a close eye on markets.
You cannot expect this level of management of properties listed on crowdfunding websites for real estate. This leaves your investment in a bit of risk should the real estate sector see a recession as it did in 2008-2009.
Real Estate Crowdfunding Allows for Investments in Multiple Properties
With crowdfunding real estate websites, you may be able to buy shares in multiple properties with small amounts of money.
However, you invest in a large pool of properties when you invest in a REIT. Since you hold a share in the main corporation, you hold a share in all the properties in its portfolio.
Conclusion
Both REIT and real estate crowdfunding are foolproof ways to make money by investing capital in real estate. You do not have active involvement in the actual properties you are investing in. Make sure you understand the tax implications on the income you generate from these investments. Generally, the tax on dividends is based on normal income rates, unlike corporate dividends.
If you are deciding between the two, it just comes down to personal preference and level of investment. Now, we see a hybrid of both. The company Fundrise, which started off as a real estate crowdfunding platform, is now offering an online REIT called eREIT.
