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Real Estate Crowdfunding vs. Real Estate Investment Trusts (REITs)

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A real estate investor looks out over a city skyline.

Investing in real estate is an attractive venture for both seasoned and novice investors due to its stability and the potential for substantial returns. However, the traditional approach of purchasing property isn’t the only way to add real estate exposure to your portfolio. Real estate crowdfunding and real estate investment trusts (REITs) are two popular methods of investing in property. However, if you’re weighing real estate crowdfunding vs. REITs, consider talking through your options with a financial advisor

How REITs Work 

REITs are entities like corporations, trusts or associations that own and curate a portfolio of real estate properties and mortgages. They unfold within a unique legal and financial structure, getting noteworthy tax considerations and serving up a potentially high yield to investors. They act somewhat as a channel, conveying the income generated by their real estate holdings to shareholders as dividends. In fact, they’re required to distribute at least 90% of their taxable income to shareholders every year.

Primarily, REITs churn out income through the rent they collect from their properties. REITs may own commercial properties like shopping malls, office buildings or residential properties like apartment complexes. Also, because REITS typically hold a significant number of individual units, the entity isn’t reliant on a single property, thereby reducing risk.

Lastly, REITs may have minimum investment requirements as low as $1,000, making them a potential option for a range of investors.

How Real Estate Crowdfunding Works 

Real estate investors meet to discuss a potential investment opportunity.

Real estate crowdfunding involves a group of investors pooling their resources to collectively finance a real estate project. This approach is typically facilitated via online platforms that connect investors with real estate opportunities. 

Crowdfunding platforms typically provide detailed information about each project, including its location, expected returns and the development team involved. Investors can review these details before committing to an investment.

There are two primary real estate crowdfunding models: equity crowdfunding and debt crowdfunding. For the equity option, investors acquire equity shares in a property or a portfolio, and their returns hinge on rental income and price appreciation. Meanwhile, debt crowdfunding involves investors lending money for a real estate project and earning interest revenue, promising lower yet predictable returns.

Pros and Cons of Investing in REITs 

Investing in REITs has several selling points. They offer a high dividend yield because of the legal requirement to distribute most of their taxable income. Further, they may provide diversification and reduce risk by spreading investments over various real estate assets. Lastly, the ease of converting such investments to cash surpasses conventional real estate investments since REIT shares can normally be bought and sold like any other stock on major exchanges.

However, REITs are not fully insulated from risks. Market risk, or the chance for a general real estate market downturn, hovers as a persistent concern. Rising interest rates, another risk, disproportionately burden REITs by escalating borrowing costs and possibly thinning out profitability. There’s also management risk, reflected in poor choices by the REIT’s managers that could dent returns negatively.

Pros and Cons of Investing in a Crowdfund for Real Estate 

Crowdfunding offers investors access to a diverse range of real estate opportunities that can generate regular income through rental yields or interest payments. Further, it avails access to distinct projects and provides investment entry points that require less capital. This approach has democratized real estate investing, opening doors for people to join deals that, on their own, might be out of reach.

But, risks do persist. The failure of real estate projects or an underperformance against expected returns is a concern. Liquidity risk is pertinent too, as offloading the investment in need might prove problematic. Crowdfunding platforms also may charge fees for their services, which can impact your overall returns.

Real estate investments are generally less liquid than stocks or bonds, meaning it can be challenging to access your funds quickly. Lastly, there’s always the risk that the crowdfunding platform goes out of business or faces other financial hardships that could impact the investor base negatively. 

Which Investment Is Right for You? 

Investors can invest in residential properties via REITs and real estate crowd funding platforms.

Selecting the right investment often depends on personal financial aspirations and risk tolerance. If you seek a steady income and have a low risk appetite, REITs might suit you. On the other hand, if you pursue higher returns and can stomach the increased risk and illiquidity, real estate crowdfunding could be the better option. Remember, due diligence is required before making such decisions.

In choosing between REITs and real estate crowdfunding liquidity needs, minimum investment, control level and diversification come into play. While REITs offer higher liquidity and potentially lower minimum investments, real estate crowdfunding may present you with more control and project-specific investment options.

Bottom Line 

Both real estate crowdfunding and REITs offer unique investors the opportunity to gain exposure to real estate investments without having to own or manage a property. REITS are entities that own, operate or finance income-generating real estate, and can be traded like stocks. On the flip side, real estate crowdfunding is a more networked approach where investors coalesce their funding online to hitch their fortunes to individual real estate properties.

Tips for Investing in Real Estate

  • Beyond REITs and crowdfunding, there are a number of ways to invest in real estate for retirement income. Rental properties, real estate notes and real estate partnerships are all ways to generate income for your golden years.
  • A financial advisor can help you leverage your real estate investments to meet your financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/PKpix, ©iStock.com/ArLawKa AungTun, ©iStock.com/tanukiphoto

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