It is a fact that institutional grade commercial real estate assets are very expensive. In fact, they are so expensive that purchasing one outright is likely out of reach for all but the most well funded individuals. But, that doesn’t mean that investors can’t gain exposure to this asset class in other ways.
Fortunately, there are a number of investment opportunities that allow individuals to obtain fractional ownership of an institutional grade commercial property, two of which are known as REITs and Crowdfunding. In this article, the pros and cons of both are described. By the end, readers should have a good feel for the key differences between these options and how they compare to individually syndicated private equity deals.
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REITs vs. Crowdfunding: What is the Difference?
What is a REIT?
The term “REIT” is an acronym for Real Estate Investment Trust. These are specialized types of real estate investment companies that are formed specifically for the purpose of acquiring and managing commercial real estate assets.
REITs can specialize in specific property types (like office buildings or multifamily) and they can be publicly traded on major stock exchanges, or they can be privately held (NOTE: Private REITs are only available to Accredited Investors). For example, the largest publicly traded REITs include American Tower – which owns and operates cellular phone towers – and Prologis which is a major holder of industrial and warehouse space.
When investing in a REIT, an individual is not purchasing fractional ownership in a number of commercial properties. Instead, they are purchasing shares in the company that owns the commercial properties, which entitles them to a portion of the cash flow and income they produce.
What is Crowdfunding?
Crowdfunding isn’t so much a type of company (like a REIT) as it is a term that is used to refer to the way that investment capital is sourced. Real Estate Crowdfunding Platforms source investment capital through web-based offerings that pool investment capital from “crowds” of individual investors who want to gain exposure to commercial real estate assets. For the most part, crowdfunded opportunities are advertised on real estate crowdfunding sites (like Crowdstreet, Fundrise or Realty Mogul) on which real estate investors can browse the offerings and choose the one that is most suitable for their own investment objectives.
What Are The Key Differences Between REITs and Crowdfunding?
REITs and crowdfunding investment platforms serve a very similar purpose – to source direct investment capital for the purpose of deploying it into commercial real estate properties. However, there are several key differences between them (NOTE: The discussion below relates to publicly traded REITs).
Publicly traded REIT investments are very liquid, crowdfunded real estate investments are not. This is because publicly traded REIT investments are offered through major stock exchanges, allowing their shares to be bought or sold at will, quickly, and with minimal transaction costs.
An investment in a crowdfunded real estate deal typically requires a funding commitment of 5-10 years, during which time the interest in the property cannot be sold. As such, it is considered illiquid. This disclaimer is always listed in the investment property’s offering materials. Depending on the specifics of the deal, the investment manager may allow investors to liquidate their holdings prior to the end of the period, but only in extreme circumstances and typically at a large discount.
Because shares in a publicly traded REIT can be bought or sold on public stock exchanges, there is no minimum investment beyond the cost required to purchase 1 share. If the brokerage through which the shares are purchased allow for fractional shares, then the initial investment could be almost any amount.
In a crowdfunded deal, the minimum investment can vary, but it is often in the $25,000 – $50,000 range. Sometimes higher. In addition, they are only available to high net worth individuals known as “Accredited Investors.”
Portfolios vs. Individual Assets
A REIT investment is a purchase of a share of an entire investment portfolio of real estate assets/rental properties. This provides investors with a broad degree of portfolio diversification over which to spread their investment capital. However, real estate investors have no say in how investment capital is deployed. This decision is made by the REIT manager(s).
Crowdfunded offerings are typically for one individual property. This provides investors with detailed knowledge about the property to be purchased (tenants, real estate market, cash flow, etc), but it also exposes them to diversification risk since their investment capital is tied up in only one property. If it does not perform as expected, there are no other properties to offset this substandard performance.
In a REIT, the bulk of investment profits come from dividends paid to shareholders. In addition, the share price may rise (or fall) based on the anticipated growth of the REIT’s real estate portfolio and/or profits.
In a crowdfunded investment, the potential profit calculation is more complex. The specifics vary by deal, but investors are usually paid some sort of “preferred return” which means they have a first claim on the property’s cash flow until they earn a certain return on their investment. Above that, they split the profits with the transaction sponsor according to predefined parameters. This type of real estate investing return structure is commonly known as a “waterfall” and the details are usually outlined in the investment’s offering documents.
Both REITs and crowdfunded investments are managed by professional real estate companies. However, the accountability structure is slightly different.
Because REITs are publicly traded, they must adhere to a strict set of governance and oversight rules that are set forth by the securities and exchange commission. These rules include things like audited financial statements and public filings regarding investment holdings and performance.
Crowdfunded investments are private, which means that they do not have the same disclosure requirements as a publicly traded REIT. This can make information a little bit more difficult to come by, especially when performing pre-investment due diligence regarding the sponsor’s track record.
So, Which is The Better Investment?
It would be foolish to state that one real estate investment opportunity is objectively better than the other. Instead, it is more helpful to look at the individual characteristics of each and attempt to determine which is the better fit for an individual’s own preferences and return objectives.
In general, investors with a smaller amount of capital and a shorter time horizon may be a better fit for a REIT investment. At the other end of the spectrum, accredited investors with significant capital and a long term time horizon may find that a crowdfunded real estate investment is a better fit.
But, What About Private Equity?
REITs and crowdfunding are not the only options in the commercial real estate sector. A third, and equally viable, option is an investment with a private equity firm.
A private equity firm is also a specialized type of investment company that invests in and operates commercial real estate assets. However, they are structurally different from equity REITs and are not required to pay out a high portion of their income as dividends. Per rules outlined by the Securities and Exchange Commission (SEC), private equity investments are only available to accredited investors. For those that meet these requirements, a private equity investment combines the best elements of both a REIT and crowdfunded investment.
Like a crowdfunded investment, private equity firms offer investments in a specific deal – as opposed to an entire real estate portfolio – which allows investors to choose exactly what type of property, market, and tenant they want to invest in. Like a REIT, the private equity structure offers certain tax advantages and the private equity firm acts as the property manager. As a private equity firm ourselves, we believe that a private equity commercial real estate investment is an option worth considering as an alternative to both a REIT and a crowdfunded investment.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate (CRE) investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.