There’s no shortage of ways to invest in real estate. In the past few years, technology-based investment models have taken shape, providing opportunities to a new class of investors — individuals who have either never dabbled in commercial real estate or never had access to an institutional network or the personal wealth required to participate.
Here we’ll break down the pros and cons of six different real estate investment models — including the very newest platforms, online REITs and Crowdfunding.
Direct ownership is the oldest form of real estate investing and the easiest to understand. An individual, partnership or company fully owns a piece of real, physical property. At its heart, that’s all there is to it.
Owning a tangible piece of property means you can personally see how your investment is doing and directly oversee what needs to be done to make improvements, such as renovations or leasing strategies. Decision-making at the property is straightforward, as the owners have direct access to all reporting materials and it’s easy to gauge how the property is performing.
Smaller properties in particular — a small apartment building, a strip center, or a single-tenant retail property — tend to require hands-on management from the owner due to small economies of scale. This can be time-consuming in the extreme, and requires a certain level of expertise to be successful. Whatever needs to be done to maintain the property or provide the tenants the services they are entitled to, the owner has to do it. That’s why an entire industry is devoted to property management, which usually only makes sense for larger properties or when several small properties are located in close proximity to each other.
In addition, the barriers to entry are high – i.e. it requires you have a significant amount disposable income. Money aside, unless you have access to an institutional network, have made real estate your profession or are constantly studying the market, it can be hard to find good real estate to buy.
Private Equity Funds
Private equity funds provide a source of investment capital, usually from high-net-worth-individuals or institutions, in order to gain equity ownership in a variety of assets such as commercial and residential real estate. Typically, private equity firms structure a limited partnership with investors. The firm, as the general partners, raises and manages shareholder funds with the expectation of providing favorable returns back to the investor.
With an experienced general partner, the main benefit of private equity funds for investors is high returns. The best private equity managers significantly outperform public markets.
Private equity funds tend to involve substantial entry requirements, perhaps in the millions of dollars. Also, such funds tend to be illiquid over the life of the fund, perhaps for five years or longer. An investor usually has no right to receive distributions early, and cannot have a say in which kind of properties to buy. That’s all in the hands of the general partners, so the vehicle is higher risk than many others.
A public real estate investment trust (REIT) is a very easy way to invest in real estate. A public REIT’s sole purpose is to own and manage real estate and return the profits to the shareholders (i.e. you, the investor). In that way, the structure is similar to any public company.
The main benefit is that no hands-on management is necessary, and an investor can sell anytime, so the investment is liquid.
Public REITs are only as good as their management and its expertise in real estate. Generally, REIT shareholders must defer to management in terms of what properties to buy and hold, and how to operate them.
A major con is that the value of shares fluctuates with the greater equities market. The risk of shareholders losing value in their investment is possible, even if the REIT’s underlying real estate property isn’t losing value.
As the name implies, private REITs are more exclusive than public ones. The legal structure is similar, but a private REIT is not traded on any of the stock exchanges or registered with the U.S. Securities and Exchange Commission (SEC).
Unlike a public REIT, market fluctuations do not typically impact the share value of a private REIT. This provides a greater measure of stability for private REIT investors.
The main drawback with a private REIT is the barrier to entry is higher than with a public REIT. Not everyone can invest in a private REIT. Investors who want to participate must be qualified under guidelines that management establishes – that often excludes those that are not high net worth individuals. Shareholders in a private REIT also have little say in what specific properties the management acquires.
The online REIT investment vehicle began in 2012 when legislation passed that enabled companies to use crowdfunding to issue securities, which was not previously permitted. As a relatively new structure for real estate investment, the online REIT is a public, non-traded REIT. The two are similar, but online REIT investments are made strictly electronically.
With an incredibly low $1,000 minimum investment, online REITs are an easy way to get into real estate investing. Similar to standard REITs, the online REIT’s value depends on the underlying real estate, but not as much on trading fluctuations.
Because online REITs aren’t at the whim of the markets, they are relatively illiquid compared with standard REITs. Investors in an online REIT can typically cash out only on a fixed schedule, often once a quarter. For investors that might need cash unexpectedly, online REITs are probably not the best option.
Similar to the other REIT models, there is very little transparency into what investors are putting their money into. This is essentially a blind spot for investors – because they don’t have a choice in what property they are investing in, they have no access to critical information about the quality of the deal.
Crowdfunded Equity Investment
Equity crowdfunding also found its roots in 2012 through the same legislation that made online REITs possible. It sources investment capital from online investors to establish a fund to buy a particular property or portfolio.
Crowdfunding has a low-to-medium barrier to entry. Because of its online structure, it makes investing easy and accessible. Moreover, most crowdfunding vehicles do not require large outlays of capital. That means investing in a property that might have once only been attainable to high net worth individuals is now possible for investors with more modest incomes.
Unlike public or private REITs, the crowdfunding investor can choose a particular property, and not blindly rely on management to do so. Investors also have flexibility. Instead of being committed to a single property type — as is the case with direct ownership and usually for REITs — investors have more flexibility to put their money in a diversity of real estate options such as multifamily or industrial assets. There is also a high degree of transparency, as crowdfunding investors typically have access to much of the same due diligence materials as the deal sponsors.
A potential drawback of crowdfunding is less liquidity, just as with online REITs. Depending on how a deal is structured, investors may have to hold their investments anywhere from 18 months to a number of years before they can cash out.
Many of the new crowdfunding companies that have sprouted are technology oriented. In other words, their experience leans more on building the online delivery platform than in real estate.
Whatever investment vehicle you choose, the most important factor is trusting that you’re getting the highest quality real estate that has the potential for the strongest returns.