You may be wondering, if I really want to enter the commercial real estate market as an investor why would I use crowdfunding to invest? After all there already exists a great way for me to invest and gain equity exposure in commercial real estate in the form of REITs.
REITs are an acronym for Real Estate Investment Trusts. These are basically investment companies that pool together investor money and invest in a portfolio of various types of real estate investments. So what is the difference between buying a share of a REIT and owning part of an actual property through crowdfunding?
Well from an investor perspective there are a few main differences. Depending on your goals and investment horizons these may be the determining factors in which investment tool to choose.
Diversification and Risks
In terms of diversification a REIT will hold a portfolio or share of numerous properties. As an investor in the REIT you will have your money spread over the entire portfolio instead of in one property. If one property loses value or rents decrease, something needs repairs etc. the loss on one property can be offset by the gains on another property. Whereas if you crowdfund in a real estate project your entire investment is tied to one property. This makes your investment riskier as a loss to the property will no doubt translate to a negative return as there are no other properties to offset those losses. Consider this similar as owning a share in a Mutual Fund versus owning the stock of a single company.
On the other hand the diversification costs money. It costs more to receive the type of diversification that REITS offer. Unlike stocks which are relatively easier to buy and sell and create a diverse portfolio buying and selling real estate isn’t as simple which makes the costs associated with that diversification greater. As an investor you pay for that type diversification which means your yield overall will be less. Although some may claim that the yields are lower simply because it is a diverse portfolio and as there will always be some winners inevitably there will be losers which will negatively impact the yield, I don’t think this totally explains yields of 3%-3.5% that REITS are returning compared to high quality income producing commercial real estate projects that you can invest through crowdfunding paying 10% yields.
Figure out how much time you are willing to tie up your money for. If you invest in a publicly traded REIT and decide you need the money in a few months all you need to do is logon to your online broker and sell your shares. When it comes to crowdfunded real estate your money is basically tied up for the duration of the investment which may be a number of years. The lack of any secondary market makes it almost impossible to sell your shares and pull out your money.
Valuation and Secondary markets
Although there exists no secondary market on which to sell your investment this may actually prove in many cases to be beneficial, especially if you don’t need your capital back in the short term. When the REIT’s shares are traded in the market it makes the valuation of your investment dependent on market factors which may not at all reflect the real value of your investment. Take for example a REIT that invests solely in properties in NYC they own Billions of dollars of commercial real estate and they have great tenants all paying rent. The yields are at 8% a year and all of a sudden there is a huge crash in real estate prices now this crash doesn’t have any real effect on property valuations in NYC as those prices keep going up. It would be hard to imagine though that the shares of your REIT would not see a sharp drop in price. This is totally based on market sentiment and not on reality but that is how the market works and any asset traded on the market is subject to the same volatility. So despite the fact that you have a 8% yield your overall return could very well be negative. The beauty of crowdfunded real estate is to give an alternative investment opportunity which is specifically not market tied. This in fact gives great deal of diversification as an asset which is part of a greater portfolio of stocks and bonds.
Although they both offer investments and exposure to the commercial real estate sector REITs and crowdfunded real estate offerings vastly differ. If you have clear goals in your investment strategy crowdfunded real estate can add an entirely new dimension to a diversified portfolio that a publicly traded REIT simply cannot offer.