Real Estate Crowdfunding vs REITs: Which one gives better returns?

REIT Real Estate Investment Trust money for home finance trusts

On its own, real estate has been known to offer tax breaks, cash flow, fair risk-adjusted returns, equity building as well as a hedge against economic turmoil and inflation. It can also boost your portfolio by lowering volatility through diversification.

Despite the benefits of real estate, most investors are not keen on owning rental properties or physical properties, instead of letting someone else manage the assets while they just invest and earn interest.

There are also different ways in which to invest in real estate using this concept, but the two biggest and most popular are through real estate crowdfunding and REITs.

Real Estate Crowdfunding

Figure: Real Estate Crowdfunding illustration

Crowdfunding is not new, but thanks to its explosive growth, it has reached new scales with the help of the rise of social media.

In a nutshell, crowdfunding is a term used to refer to the process of raising capital from a large pool of people to finance a project, business, idea, invention, or non-profit venture. This allows project owners to reach new strata of potential investors beyond the traditional venture capitalists and banks.

Real estate crowdfunding works on the same principle. If you want to invest in real estate but don’t want to maintain or own a building, you can become a shareholder through crowdfunding, and any profits generated from the property are passed on to shareholders like you.

There is a range of rules and regulations that protect real estate crowdfunding, but the project sponsor will determine part of the rules of engagement.

Crowdfunding allows you to choose the type of property you want to invest in without relying on someone else to select it for you.

Moreover, investors in real estate crowdfunding have more flexibility in terms of properties available to invest in, for example, industrial assets or multifamily homes.

The current global real estate crowdfunding market is valued at around $120.5 million but it is expected to rise to $368.9 million by 2027 according to Researchnester.com.

If you want to get into real estate crowdfunding, there are plenty of sites that can allow you to start investing straight away without any hassle.

Real Estate REITs

Figure: REITs (source: Wealth Management)

Real estate REITs can be defined as real estate investment trusts that allow investors to invest in real estate without the need to actually owning the property. It is a concept that has been around for decades.

A REIT buys different properties, be it office buildings, large apartment buildings, retail outlets, medical facilities, condominium complexes, storage centers, and other kinds of properties, and rents or releases them out to tenants.

If you buy the REITs shares, you will receive earnings through the rent received from the property in the form of dividends.

REITs are tax breaks for corporations, which is good news for investors. But not any company can qualify as a REIT, there are regulations in place that must be met, for instance, a company must distribute more than 90% of its earnings back to the shareholders in form of dividends in order for it to qualify as a REIT.

This rule help companies qualify for tax reliefs while allowing investors to reap a lion’s share of the profits than they may have otherwise been able to.

The difference between Real Estate Crowdfunding and REITs

These two share lots of similarities. For example, both enable investors to efficiently diversify portfolios while offering value from the property.

Also, both methods allow investors to pool funds to invest in a range of real estate properties without the hassle that comes with direct ownership.

However, there are differences two between the models of real estate investing. The main differences between real estate crowdfunding and REITs come down to transparency, access, and management.

Here are the differences:

  • REITs are easy to access (buy and sell), but they can be subjected to market volatility. On the other hand, real estate crowdfunding has a high entry barrier but is subject to less market volatility.
  • REITs take your money and invest it into real estate without your input while real estate crowdfunding offers you direct transparency into the property to invest in.
  • REITs and real estate crowdfunding have differing management levels of expertise based on REIT or crowdfunding platforms.

Comparison: Advantage & Disadvantages

Advantages of Real Estate Crowdfunding

  • Real estate crowdfunding offers potential for excellent returns due to higher leverage (6 to 14%).
  • Less volatile than REITs
  • More control and transparency

Disadvantages of Real Estate Crowdfunding

  • Because it is a single-asset in nature, real estate crowdfunding is riskier compared to REIT investing (but this can be solved by investing in several assets since many real estate crowdfunding platforms have the minimum investment amount per asset of only $50)
  • Income from real estate crowdfunding can be delayed, non-existent or unpredictable
  • Most crowdfunding deals require a higher minimum investment than REITs

Advantages of REITs

  • REITs tend to spread your investment over a portfolio of properties, thus diversifying your investment risk.
  • REITs are highly liquid compared to real estate crowdfunding, meaning you can easily buy or sell at any given time.
  • REITs are quite easy to invest in.
  • No minimum investment is required to invest in REITs

Disadvantages of REITs

  • REITs are usually oriented towards good returns and income rather than huge returns like crowdfunding real estate, which is high risk but highly rewarding.

Risk and Return

Risk

In real estate crowdfunding, there are no guaranteed returns on your investment. There are unseen factors that might affect your investment, including construction and market fluctuations.

On the other hand, the biggest risk to REITs is when interest rates fluctuate, reducing demand for REIT.

Even non-traded REITs have risks, such as lack of liquidity, high fees, and distributions.

Return

What can you expect from real estate crowdfunding? On average, investors can expect returns between 6% and 14%.

With that return, real estate crowdfunding is a pretty attractive investment option, especially if you consider stock/bond portfolio averages between 5% and 7% per year.

An actively managed REIT portfolio can generate 10.6% per year on average according to Cohen & Steers.

However, you will have to be patient with your investment since it takes a lot of time to market a property and there may also costs associated with maintaining an unsold property.

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