Real estate crowdfunding vs. REITs – Top differences

Investing in real estate is a good idea for most people. On the other hand, rental properties aren’t a good fit for all investors. By introducing this idea, people now have access to a plethora of investment opportunities in which they do not have to handle property management but still share in the profits. Real estate investment trusts (REITs) and real estate crowdfunding, a relative novelty, are two of the most popular methods. Read the article to learn more!

What is real estate crowdfunding?

Real estate crowdfunding, like regular crowdfunding, is a method of supporting the development or renovation of real estate. Many small investors combine their funds to make larger real estate purchases. Crowdfunding sites like Crowdbase make it simple for anybody to discover and put money into promising real estate projects without considering such factors as the size of their initial investment, the cost of repairs, or the potential for rental income.

The premise behind crowdfunding is that many individuals are prepared to invest a small amount, and when they do, significant sums of money can be obtained relatively fast.

Historically, a large sum of money—in the tens of thousands or more—was needed to start real estate investing. That’s why high-net-worth individuals can only afford to invest in this potentially lucrative asset class. Crowdfunding has made it possible for even a small sum of money to be invested in the real estate market. In crowdfunding, potential backers are found and contacted online and through various social media platforms, including Facebook, Twitter, and LinkedIn.

Crowdfunding in the real estate industry is booming, and it’s especially common for projects with novelty and social impact. A wide variety of initiatives, such as those involving renewable energy, sustainable infrastructure, and the preservation of historic structures, fall under this category.

How does real estate crowdfunding work

With mortgage rates near record lows, buying an investment property is a regular and extremely popular activity among individuals trying to accumulate or enhance their wealth. Still, a mortgage from a financial institution like a bank or credit union is usually necessary for would-be homeowners to acquire real estate. As a result, these financiers may need to lay down a sizable sum of money all at once and find a way to pay for continuing costs like groceries and utilities. Property owners have ongoing responsibilities, including annual property tax payments, repairs, and utility costs for investment properties.

As an alternative, real estate crowdfunding encourages investors to combine their resources through the use of fintech or crowdfunding platforms to finance real estate ventures with the hope of generating either a one-time or reoccurring return. Most web-based investment services require only a few hundred dollars to start. Financial resources are frequently invested in REITs and other similar financial vehicles, which act as holding corporations for various real estate assets. Homes, apartments, condos, stores, malls, hotels, office buildings, and other commercial and residential spaces are all examples of real estate. Investments made through crowdfunding platforms, on the other hand, are often not open to the public. REITs often regularly distribute a portion of their dividend income to shareholders.

Crowdfunded real estate companies may be able to give investors entry to private market property assets that would usually be off-limits. Also, similar to private equity funds, they typically offer more significant returns than publicly traded REITs. However, as with any private investment holding you would contemplate putting money behind, you should study and analyze beforehand and avoid going into debt. Crowdfunding in real estate isn’t a primary means of wealth creation but rather a means of diversifying and growing an investor’s stock, bond, and equity holdings.

Keep in mind that anyone can invest money in crowdfunding projects. Some may only accept funding from “accredited investors,” defined as those with a $200,000 or more annual income or a $1 million net worth.

Real estate crowdfunding vs. REITs

Liquidity

Compared to real estate crowdfunding, investing in REITs is more liquid because they can be bought and sold as readily as stocks. An investor can, for instance, buy shares of a REIT in the morning and sell them in the afternoon if they so choose. This is helpful for people who want to keep their cash on hand for future expenses like tuition, a vacation, a house, etc. Because of REITs, people can put their money into the real estate market without worrying about their money being stuck there for a long time. For those who would rather own a commercial property outright but can’t seem to find a suitable deal, REIT investments can be an excellent way to get exposure to the market while waiting for the right time to make a purchase.

Regarding crowdfunding, there is less money available for real estate. Typically, investors have to commit to a deal for a certain number of years, anywhere from three to five but often longer. Many advertisers feature an early termination option but beware of potential fines and fees.

Minimum Investment

The initial sum you put into a REIT is entirely up to you. An investor can purchase a single share of a REIT at the market price at any time. Although the average price of a share of a REIT is in the hundreds of dollars, there are a number of REITs that trade for far less than $20 per share. Investors interested in real estate but lacking the funds necessary to participate in real estate crowdfunding or purchase the property outright may find the REIT route appealing.

Crowdfunding may be a good option if you’re looking to invest at least $5,000 in real estate. While the minimum investment on certain platforms is only $100, most deals require far more capital. Some crowdfund syndicated deal promoters even demand a $25,000 or $100,000 entry-level commitment. Even though this is greater than the cost of purchasing a single share of a real estate investment trust (REIT), it is still much less than purchasing a commercial property outright.

Portfolio vs Individual Asset

First, it’s important to note that there isn’t a single model for either REITs or real estate crowdfunding. The following is an oversimplification based on our experience with most REITs and crowdfunded initiatives. A real estate investment trust, or REIT, is a company whose stock is owned by a collection of properties. As a result, the value of a shareholder’s REIT share is not tied to the success of a single asset. The REIT’s portfolio risk is thereby reduced.

To a greater or lesser extent, most real estate crowdfunding ventures have investors purchasing a stake in a piece of commercial real estate. For instance, the sponsor could seek financing via crowdsourcing to transform an old strip mall into a trendy lifestyle center. The investors know much more about each initiative, but their money is still tied to how well each project does. Greater danger lurks in fewer places.

However, crowdsourcing is also utilized to acquire a group of properties at once. It’s not uncommon for crowdfunding platforms to have their own funds holding a curated portfolio of transactions, and it’s also uncommon for sponsors to set up funds where investors can put money into various properties to reduce their overall exposure to risk.

Profit Sharing

The legislation mandates that REITs distribute at least 90% of their yearly income to their shareholders as dividends. Regarding real estate crowdfunding, there are fewer rules governing how profits are distributed. In the second case, it is up to the individual sponsor to determine how much money will be made, considering factors like preferred returns and waterfall splits. Distributions to shareholders (investors) may not occur in a crowdfunded real estate syndication until years after the project’s inception, whereas REITs may make distributions regularly.

Management Experience

Experts often manage REITs with many years of commercial real estate sector expertise. This is a welcome development for those who prefer to minimize their financial exposure to risk. As was indicated above, they are more likely to garner the interest of independent, third-party analysts whose reports can be used by investors as part of the due diligence process.

Crowdfunding for the real estate industry is rife with managers of varying experience levels. While there are some highly qualified project sponsors, there are also many more just starting out and seeking to secure funding. Before participating in real estate crowdfunding, investors must conduct their own research on the sponsor (and, relatedly, on the platform presenting the deal). Expertise at the helm is crucial to the success of any commercial real estate transaction or portfolio.

Investors can learn more about seasoned, professional sponsor teams and their value offer by perusing the websites of these firms. These firms will make substantial educational materials available online regarding their investment philosophy, background, and experience.

Real estate crowdfunding vs REITs – Which is the better investment?

Trying to figure out whether real estate crowdfunding or a real estate investment trust would be a better fit for your portfolio? Neither option is inherently better; as we’ve seen, both have their drawbacks, and either could be a good fit for an investor’s portfolio.

However, investors who fear losing their money can consider purchasing shares in a real estate investment trust (REIT). Those looking for a slightly riskier investment opportunity with the potential for increased returns may wish to investigate real estate crowdfunding. Minimum investments vary by REIT and each crowdfunded project. Thus, a person’s financial situation will play a role in their final decision. Below are some points to consider when considering any of them;

Returns

The returns on investment for either choice are through the roof. Long-term investors who put their money into REITs have seen returns of 12-13% on average over the past 20+ years, beating the returns of even the best-performing stocks. In principle, crowdfunding for real estate could yield even larger returns than REITs due to, first, far cheaper fees and, second, higher leverage (which means that a higher portion of the total capital is invested in real estate, thus potentially increasing the expected returns). According to some projections, returns may go as high as 14.6% (more cautiously, between 11 and 15%). The data on real estate crowdfunding, on the other hand, is neither as credible (much of it is merely informed estimates) nor as long-term as the statistics on REITs (only a few years is the best we can hope for in most cases).

Volatility

Peer-to-peer lending and crowdfunding aren’t as closely related to traditional asset classes as other investments, which can help a portfolio become more diverse. Even when stock markets are volatile, real estate crowdfunding may be a lucrative investment. However, real estate investment trusts (REITs) have a stronger relationship to the performance of the stock market than does the value of the underlying real estate. Thus, they are subject to somewhat high volatility following the stock market ups and downs (they are stocks, after all). This would be bad news for you if you were hoping to hedge your stock market risk with de-correlated real estate investments.

Transparency and control

A REIT is called a “blind” trust because investors get some diversification but don’t have much say in how the trust is run or what decisions are made. This isn’t always terrible; some prefer not having to deal with their money directly and instead leaving it in the hands of experts. If you’re not one of them, though, you might find that real estate crowdfunding is a better fit; with it, you can research and select the properties you’re most interested in, then participate in its management and ultimately become a partial owner.

The Bottom Line

While real estate investments can be lucrative, most people would rather not deal with the hassles of owning the property themselves. The management of rental properties is a job that, for some, becomes their primary source of income. Tenant problems can be a headache, and negative returns are possible if you don’t do it right. Crowdfunding and REITs eliminate many of these concerns, making real estate investment accessible to more people. Both investment choices have favourable terms. The level of danger you’re willing to take determines the answer. Always remember that proportionally more risk also results in a proportionally greater return.