Real estate is one of the best performing alternative asset classes for investors who would like to diversify their portfolio or simply do not enjoy the volatile nature of the stock market. Contrary to popular belief, one does not need to be extremely wealthy to have interests in property. In the past, investing in real estate, especially large commercial properties, was something that was only reserved for high net worth individuals (HNWI) however the rise of online real estate crowdfunding platforms and publicly traded real estate investment trusts (REITs) have made it a lot easier for the average investor to get access to real estate investments.
Fundrise, for example, is one of the many online crowdfunding marketplaces out there that have pooled relatively small sums of money from everyday people and used those funds to assist property developers to finance their projects. To date, developers on the website have raised more than $10 million. Founded in 2012 by two brothers named Benjamin and Dan Miller, Fundrise recently made headlines when it announced the launch of the world's first online REIT, or as they call it "eREIT."
Earlier this month, Fundrise began processing subscriptions for their $50 million initial public offering (IPO), but they were quickly forced to temporarily discontinue selling shares of the eREIT due to high demand. On the first day of the offering, Fundrise received an average of $21,400 in subscription requests every minute. Investors were required to purchase a minimum of 100 shares at a rate of $10 per share. Although the Fundrise eREIT looks like it will be a very promising investment, it certainly is not for everyone. Here are three important things to ask yourself when determining whether or not an equity stake in Fundrise's eREIT would make sense in your investment portfolio.
Do You Mind Investing in an Illiquid Asset?
One of the main differences between Fundrise's eREIT and traditional REITs is the level of liquidity. Traditional REITs are traded on a stock exchange and are given a mark to market (MTM) valuation every minute of a trading day. This gives investors the ability to sell a portion, or all, of their REITs within a couple of minutes if needed. The Fundrise eREIT is not listed on an exchange, and as a result, units can only be redeemed at the end of each quarter. This can help to force an investor to take a long-term horizon, but it can also be a problem if an investor needs immediate access to cash for an emergency. (See also, Fundrise CEO Ben Miller On 'Why Pre-Funding Matters.)
Do You Need the Income?
Federal law requires that all REITs distribute no less than 90% of their annual income to their unit holders. Fundrise’s eREIT is not excluded from this requirement. As a result, the company intends to make a "high yield cash distribution" at the end of every quarter. This can be great for those investors who are looking to create an additional revenue stream. However, the eREIT might not be ideal for investors who do not immediately need investment income.
It is important to remember that unlike corporate dividends, that are taxed at a low rate, REIT distributions are taxed at the normal income tax rate. This is why REITs are often called tax-inefficient investments. Investors who own REITs tend to hold them in retirement accounts that have favorable tax treatments, like a Roth IRA, but it is not possible to do this with the Fundrise eREIT.
In some cases, an investor may end up realizing higher net returns, and a lower tax bill, by investing in a stock that reinvests the majority of earnings instead of distributing it to shareholders.
How Risk Tolerant Are You?
Fundrise’s eREIT is probably not suitable for your investment portfolio if you consider your tolerance for risk to be low or fairly moderate. As a new investment fund, the eREIT has no previous operating history to look at in order to determine how good the management team is. This also makes it hard to make calculated predictions on how well the eREIT will perform in the future.
When compared to the management teams of publicly traded REITs, the management of Fundrise’s eREIT lacks many years of experience. In the company’s offering circular that was filed with the Security and Exchange Commission (SEC), it was disclosed that the eREIT's initial management team consists of four members, the oldest of whom is only 39-years-old. Furthermore, the eREIT had no non-executive board members at the time of writing.
Depending on your age and overall goals, an investment in the eREIT might be worth the speculation. On the other hand, other investors might not feel comfortable with the risk associated with the startup nature of the eREIT. Publicly traded REITs might be a much more suitable alternative for conservative investors like retirees, who want a reliable flow of income while protecting their principal. (See also, 3 Ways Millennials Can Invest in Rental Properties.)
The Bottom Line
REITs and property crowdfunding platforms have made it extremely easy for the average investor to include real estate investments in his or her portfolio. Just this month, Fundrise, a crowdfunding website, launched the world’s first Internet REIT. Like traditional REITs, Fundrise’s eREIT will give its unitholders the opportunity to benefit from income-producing property. While eREits are similar to traditional REITs in that respect, there are a number of differences between the two. For instance, shares in Fundrise’s eREIT can only be redeemed at the end of each quarter, and as such may not be a suitable investment for many retail investors. Additionally, the eREIT might be tax-inefficient for young investors who could benefit much more by realizing capital gains rather than investment income. Conservatives investors should also note that Fundrise is a new player in the REIT business, and as such may be riskier than other REITs because of its unproven track record.