Direct Real Estate Investing Versus REITs

Direct Real Estate Investing Versus REITsReal estate investment trusts ( REIT ) are a low-cost way to invest in the real estate market and are becoming increasingly popular. Ernst & Young reports that the global REIT market has grown to $1.7 trillion in 2017 from $300 billion in 2003 and the number of countries […]

Real estate investment trusts (REIT) are a low-cost way to invest in the real estate market and are becoming increasingly popular. Ernst & Young reports that the global REIT market has grown to $1.7 trillion in 2017 from $300 billion in 2003 and the number of countries now offering REITs has almost doubled to 37 in the last decade. (Learn more about REITs with this video.)

A REIT is a corporation, trust or association that owns and, in most cases, operates income-producing real estate and/or real estate-related assets. Modeled after mutual fundsREITs pool the capital of numerous investors. This allows individual investors to earn a share of the income produced through commercial real estate ownership, without having to go out and buy or finance property or assets.

REITs Vs. Direct Real Estate

Advantages of REITs:

Lower entry costs – You can invest in a fund for as little as $500 or $1,000 rather than having to buy a property for six-figures with a hefty down payment.

Increased liquidity – Like stocks, you can sell REITs shares whenever you like versus a home purchase which can take time to sell depending on market conditions.

No muss, no fuss – If you own a rental property, you are subject to tenant complaints; late payments; broken appliances; and yard, driveway, and home maintenance. With REITs, you’ll just track your investments on a reasonable and regular basis.

Investment flexibility – With REITs, you can invest in commercial properties, shopping malls and even a marina or a group of camping site vacation homes – all at a reasonable entry price. That’s much harder to do as a direct investor where up-front capital can often be a challenge.

Advantages of Direct Real Estate Investment:

You call the shots – As a direct real estate investor, you won’t answer to a fund manager. You decide on the rental price, the number of properties to buy and who lives in and rents your property.

Less IRS debt – With direct real estate, you can take advantage of tax breaks with strategies such as writing off depreciation to taking a mortgage tax deduction.

Potentially fatter investment returns – A bigger investment may equal more earnings. If you invest $100,000 on a property and it increases in value 10%, you’ll potentially earn $10,000. A $1,000 invested in a REIT with a 10% return nets $100.

Should You Invest in a REIT?

Due to the smaller size of individual real estate parcels, they don’t necessarily reflect all available information because it’s costly to perform due diligence on individual properties. In contrast, a REIT conforms more closely to the efficient market economic theory that states that asset prices fully reflect all available information described by Nobel Prize winner Eugene Fama. Since, in theory, a REIT’s share price is more likely to contain all available information about the REIT, investors may have a better chance of getting a higher return.

REITs can also be a good choice for investors who don’t want to operate and manage real estate as well as for those who do not like the risk associated with owning real estate. REITs can also be appropriate for new investors with limited experience in real estate who want to diversify their portfolio.

The Bottom Line

With the U.S. real market on the upswing again in 2018, real estate investing grows more appealing. When considering whether to invest in a REIT or through direct investment, consider the amount of risk and responsibility you can handle.

Real Estate and Crowdfunding: A New Path For Investors

Real Estate and Crowdfunding: A New Path For InvestorsCan two disparate investment markets – one old and one new – get along without driving each other crazy? That is the key question for crowdfunding and the real estate market, and one being answered in positive ways, as the odd couple appears to be pairing up quite nicely […]

Can two disparate investment markets – one old and one new – get along without driving each other crazy?

That is the key question for crowdfunding and the real estate market, and one being answered in positive ways, as the odd couple appears to be pairing up quite nicely and giving investors a new way to leverage profits from the burgeoning U.S. real estate market.

The real estate crowdfunding site iFunding estimates the size of the combined market at $11 trillion.

At a recent Innovations in Real Estate: Crowdfund Investing conference in New York City, Markley Roderick, a lawyer with Flaster/Greenberg PC and the conference moderator, addressed regulations linked to the Jumpstart Our Business Startups (JOBS) Act of 2012. The rules allow mostly affluent investors (with a net worth of $1 million or more) to gain direct access to the real estate market through crowdfunding, or peer-to-peer lending (among other investment markets).

While the U.S. Securities and Exchange Commission explores ways to allow investors of all income levels to access the real estate market online, Roderick says that wealthier investors are already investing on crowdfunding sites like iFunding, Realty MogulCrowdStreet, and Fundrise.

“If only a small percentage of them invest only a small amount of their assets in real estate, the market will be trillions of dollars,” explains Roderick.

Crowdfunding

Crowdfunding and the real estate market are a natural fit. In a word, crowdfunding makes use of the easy accessibility of vast networks of friends, family, and colleagues through social media websites like Facebook, Twitter, and LinkedIn to get the word out about a new business and to attract investors. Crowdfunding has the potential to increase entrepreneurship by expanding the pool of investors from whom funds can be raised beyond the traditional circle of owners, relatives, and venture capitalists.

Real estate industry groups are already climbing aboard the crowdfunding bandwagon, touting the relatively low-risk access to the U.S. real estate market to, for now, wealthier Americans.

“Crowdfunding for real estate is not an entirely new phenomenon,” said the Commercial Real Estate Development Association in a recent statement. “Numerous players have entered the field. Although each of these platforms has its own niche and strategy, with different levels of minimum investment, all are geared toward accredited investors who meet specific requirements for net worth and/or annual income. By contrast, crowdfunding under the JOBS Act will open the field to many more smaller investors.”

What are the pros and cons of crowdfunding for investors? In a word, it comes down to risk for both sides; specifically, how much investors want to absorb online.

According to the report, both real estate developers and investors can reap significant financial returns through crowdfunding, and both are able to spread their risks.

Pros . . .

  • Investors get access to the real estate market with small amounts of money.
  • Investors get to work directly with real estate developers and have a voice in the process.
  • Investors can choose in which real estate projects they want to invest their money.
  • Investors have access to myriad projects, so choice isn’t a problem.

Cons . . .

  • The investment risks are the same as for any real estate investor. If the market goes south, an investor will likely lose money.
  • The risk of investment default (from real estate developers) is higher for crowdfunding compared to peer-to-peer and direct real estate investment funding.
  • A lack of liquidity, as the absence of a secondary market restricts easy access to selling opportunities for investors.

To get started with crowdfunding in real estate, Jillienne Helman, chief executive officer at Realty Mogul, advises going with a firm that’s going to be around for a while.

“First, work with a crowdfunding company that will survive,” she says. “That means well-capitalized. What scares me is the number of crowdfunding companies out there that are headed up by two students who just graduated from college, and who aren’t capitalized themselves.”

Darren Powderly, co-founder of CrowdStreet.com, says doing your due diligence is more important for real estate than for other investments, as far as working with a crowdfunding company goes.

“From the investor’s perspective, one should take care to research the platforms on which they are searching for investment opportunities,” says Powderly. “Not all platforms are created equal, and multiple business plans are being tested in order to capitalize on this emerging trend.”

Powderly specifically advises investors to investigate the founders and senior management of the crowdfunding platform or firm to make sure they have a sterling reputation that rests on previous business experience.

“Key industry expertise in finance, real estate, and technology is essential to operate a trusted and reliable platform,” he adds. “Investors should gravitate toward platforms that deliver excellent customer service – not only during the fundraising process, but also after the deal is fully funded and closed. Despite the fact that there are 50-plus platforms in some mode of operation, there are only half a dozen or so that are emerging as leaders in the space. Investors should research multiple platforms, and select their Top Three based on their investment goals and preferred user experience.”

Transparency is Critical

Powderly advises looking for crowdfunding platforms and sponsors that acknowledge the risks, while providing an education-based approach to risk management. “Most real estate crowdfunding platforms today only permit accredited investors, as defined by the SEC, to invest,” he says. “Accredited investors are advised to invest amounts that they are comfortable with, given their overall investment portfolio.”

Another tip: only invest in offerings from sponsors you trust, and who you’re confident will look out for your best interests in good times and bad.

“If an investor does not understand how their money is being used, the risk factors of the investment, and what factors influence their return on investment, then they should seek the advice of their trusted investment adviser, or pass on the investment,” adds Powderly. “There will be plenty of other investment opportunities to choose from, so don’t get rushed into making an uninformed investment decision.”

A professional real estate crowdfunding platform should provide investors with ample opportunities to communicate about the offering, including making introductions directly to the sponsor of the particular property listing.

Is This Doable, and How?

The catalyst for launching crowdfunding for real estate investments, along with other types of business ventures, was the passage of the JOBS Act in 2012. Until recently, the ability to advertise and solicit investors for real estate investments had been restricted. The JOBS Act (Title II) dramatically changed the way investment capital can be raised by modifying existing Regulation D rules, specifically those rules pertaining to how companies can offer and sell their securities without having to register the latter with the U.S. Securities and Exchange Commission (SEC).

In the past, Regulation D, Rule 506 placed restrictions on fundraising efforts, specifically limiting fundraising to only pre-existing relationships and preventing a sponsor or other party from openly soliciting or advertising those private investment opportunities. The new Rule 506(c) allows issuers, sponsors, syndicators, and others who are raising capital from private investors to advertise those private-investment opportunities to accredited investors under certain conditions. That rule became effective on Sept. 23, 2013. The new federal legislation represents a huge change for sponsors raising funds for a real estate acquisition or development. Essentially, Title II gives crowdfunding firms the green light to direct-market to a large pool of potential investors via social media and the Internet. It has also created a new vehicle for investors to more easily access direct real estate investment opportunities.

As Powderly notes, for the first time ever, investors have direct access to a selection of private real estate offerings which they can browse, research, and make well-informed investment decisions about online.

The Bottom Line

Crowdfunding in the real estate market promises to be a revolution. It is just now taking off, but already attracting impressive levels of interest from serious investors.

Equity vs. Debt Investments for Real Estate Crowdfunding

Real estate crowdfunding has taken off since the passage of the Jumpstart Our Business Startups Act in 2012, and the market is expected to expand even further. In October 2015, the SEC issued its final ruling on Title III provisions of the JOBS Act, allowing non-accredited investors to participate in crowdfunded real estate deals alongside accredited investors.

Equity vs. Debt Investments for Real Estate Crowdfunding

Investing in real estate through a crowdfunding platform has certain advantages over REITs or direct ownership of property. One of those advantages is the ability to choose between debt and equity investments. Before taking the plunge into real estate crowdfunding, it’s helpful to have an understanding of how the two differ and what the risks are. (For more on the basics of real estate crowdfunding, see Real Estate and Crowdfunding: A New Path for Investors.)

How Debt Investments Work

When investing in real estate debt instruments, the investor is acting as a lender to the property owner or the deal sponsor. The loan is secured by the property itself and investors receive a fixed rate of return that’s determined by the interest rate on the loan and how much they have invested. In a debt deal, the investor is at the bottom of the capital stack which means they have priority when it comes to claiming a payout from the property. (For more, see the tutorial: Exploring Real Estate Investments.)

Pros:

  • Shorter hold time-Debt investments are most often associated with development projects. As a result, they typically have a shorter holding period compared to equity investments. Depending on the nature of the deal, the hold time may last between six and 24 months. That’s a plus for investors who aren’t comfortable tying up assets for the long-term.
  • Lower risk– Because of the way deals are structured; investors take on less risk with debt investments. The loan is secured by the property, which acts as an insurance policy against repayment of the loan. In the even the property owner or sponsor defaults, investors have the ability to recoup the loss of their investment through a foreclosure action.
  • Steady income– Debt investments are more predictable in terms of the amount and frequency of return payouts. While every deal is different, it’s not unusual for investors to earn yields ranging from 8% to 12% annually. These returns are typically paid on a monthly or quarterly basis.
  • Capped returns – Debt investments entail less risk, but one major downside is the fact that returns are limited by the interest rate on the loan. Investors have to be clear about whether they’re willing to sacrifice the potential to earn higher yields in exchange for a safer bet.
  • Higher fees – While most real estate crowdfunding platforms don’t charge investors anything to create an account and research debt investments there’s usually some type of fee involved to participate in a deal. The crowdfunding platform usually takes a percentage off the top before any interest is paid out, which can eat into your returns. There may also be a separate loan origination fee that’s passed on to investors. (For more on real estate crowdfunding platforms, read: Top 5 Real Estate Crowdfunding Companies.)

Equity Investment Basics

Most real estate crowdfunding deals involve equity investments. In this scenario, the investor is a shareholder in a specific property, and their stake is proportionate to the amount they have invested. Returns are realized in the form of a share of the rental income the property generates, less any service fees paid to the crowdfunding platform. Investors may also be paid out a share of any appreciation value if the property is sold.

Pros:

  • No cap on returns – Equity investments offer a broader horizon, in terms of earning potential. It’s possible to see annualized returns ranging from 18% to 25%. Since there’s no cap, however, the sky is really the limit from an investor’s perspective.
  • Tax benefits – One perk of owning an investment property is being able to deduct certain expenses associated with its ownership, such as depreciation and the cost of repairs. With equity crowdfunding, deals are normally structured through an LLC, which is treated as a flow-through entity for tax purposes. That means that investors can reap the benefits of the depreciation deduction without having to own property directly.
  • Lower fees – Equity investments have the potential to be cheaper where fees are concerned. Rather than paying upfront fees and monthly service fees, investors may pay a single annual fee to maintain their position in the property. The fee is calculated as a percentage of the total amount invested and often runs between 1% and 2%.

Cons:

  • More risk – Equity crowdfunding may put more money in investors’ pockets, but it means taking a bigger gamble. Investors are second in line when it comes to receiving a payback on their investment, and if the property fails to live up to its performance expectations, that can easily translate to a loss.
  • Longer hold period – Equity investors are looking at a much longer time frame compared to debt investors. Hold times can stretch out over five or even ten years, which is an important consideration if you’re interested in maintaining a high degree of liquidity in your portfolio.

The Bottom Line

Crowdfunding is an attractive option for investors who want to invest in private real estate deals in a cost-effective way. The minimum investment with many platforms ranges from $5,000 to $10,000, which is a relatively small price to pay to gain access to this asset class. Both equity and debt investments have their good and bad sides, which savvy investors must take the time to weigh carefully. Understanding what you stand to gain versus what you’re risking can help you decide whether one or both types of investments is a good fit for your portfolio.

Crowdfunding Beats Direct Ownership for Commercial Real Estate

Crowdfunding Beats Direct Ownership for Commercial Real Estate

Investing in real estate comes with certain risks, but the rewards can be lucrative, especially with commercial real estate. Owning office space or an apartment building that you lease, for example, may bring you a steady stream of rental income while adding diversity to your portfolio and providing greater insulation against market volatility. However, direct ownership has its downsides and may not be practical for every investor. Real estate crowdfunding has emerged as an alternative to owning property directly. From an investor perspective, there are several reasons why it’s the better choice.

To learn more, see this tutorial: Exploring Real Estate Investments.

Fewer Barriers for Commercial Investors

Investing in commercial real estate isn’t like buying shares of stock or purchasing a mutual fund. Buying a property typically requires a large amount of capital or, at the very least, approval from a lender to get a commercial mortgage loan. Banks often reserve commercial loans for business entities, such as real estate development groups or corporations. If you’re an individual investor, your only source of funding may be a hard money loan from an individual or private lending company. While hard money lenders may be more flexible in granting loans for commercial investment projects, they often charge significantly higher interest rates and fees, which will diminish your returns. (For more on financing options, see The Complete Guide to Financing an Investment Property.)

Real estate crowdfunding platforms, on the other hand, offer a much easier path to investing in commercial real estate. (For more, see Top 5 Real Estate Crowdfunding Companies.) Instead of needing a six or seven-figure bankroll to buy into a particular deal, it’s possible to invest in hotels, warehouses, office buildings, shopping centers and other commercial properties with as little as $5,000 to $10,000. That’s appealing to investors who want to add real estate to their portfolio but aren’t in a position to buy a property outright. Not only that, but real estate crowdfunding is less restrictive in terms of who can invest. In October 2015, the SEC finalized Title III of the JOBS Act, paving the way for both accredited and nonaccredited investors to pursue crowdfunded investments.           

Investors Aren’t Required to Be Hands-On

Crowdfunded properties also spare part-time investors many of the responsibilities that come with owning a commercial property –  for example, dealing with leaky faucets or tenants who are behind on the rent, if the property is an apartment building. You could hire a property manager ​to do the hard work for you, but his/her fee would reduce the income the property generates. For someone who prefers a passive investing approach, crowdfunding makes more sense.

When you invest in a commercial property through a crowdfunding platform, your ownership is limited to either debt or equity shares in the property. When you own debt shares, you own a stake in the mortgage loan on the property and your return comes from the interest paid on the loan. With an equity investment, you receive a percentage of the rental income. Either way, you’re not the one who’s responsible for dealing with tenants or maintaining the property on a day-to-day basis – a huge plus if you don’t want those kinds of headaches. (For more on debt and equity crowdfunding, read: Equity vs. Debt Investments for Real Estate Crowdfunding.)

Tax Benefits of Direct Ownership Still Apply

In addition to the income potential that commercial real estate provides, investors also get tax benefits. The IRS allows investors to deduct depreciation of income-producing properties they own, as well as depreciation of any capital improvements made in connection with the property. For someone who owns a large amount of commercial property or a property that produces a significant amount of taxable income, that deduction can be extremely valuable.

Real estate crowdfunding allows investors to snag these tax benefits in a streamlined way. Typically, crowdfunding platforms set up investments as pass-through entities, such as a limited liability company. Investors own their debt or equity shares through the pass-through entity and that structure creates a tax shelter. The value of deductions for depreciation or loan interest trickle down and are used to offset any positive cash flow from the investment. Again, the tax aspect is handled by the crowdfunding platform so you’re not having to bend over backwards to get these benefits.

​The Bottom Line

Commercial real estate investments have the potential to be highly profitable over the long-term, which is important for anyone focused on building sustainable wealth. Real estate crowdfunding is an attractive option for investors who have been unsuccessful in getting a foothold in the market or want to gain entry to this asset class without having to do a lot of legwork.

As you’re comparing crowdfunding platforms, pay close attention to the range of investments available and the fees that the platform charges. The goal is to make sure you’re striking the right balance between cost and value before investing in a commercial crowdfunded property.  To check out the another route to shared ownership of commercial real estate, see REITS vs. Real Estate Crowdfunding: How They Differ.