Most people will benefit from having some of their portfolios in real estate. But most investors aren't suited to own rental properties. This concept has opened a whole world of investments where someone else manages the properties, but individuals can invest in them and reap some of the rewards. There are a few different ways to go about investing in real estate, the two biggest are through REITs and a newcomer to the game: Real estate crowdfunding.
- REITs purchase commercial properties and distribute the rental income to shareholders as dividends.
- Crowdfunding allows entrepreneurs to raise capital for projects from a large group of individuals.
- Investors can purchase shares of REITs through mutual funds or ETFs.
- If you don't want to buy property, you can invest in a crowdfunding company that specializes in real estate.
What Is a REIT?
Real estate investment trusts, commonly known as REITs, have been around since the 1960s, and allow investors to make investments in real estate without having to actually buy any property. How do they do this? It's fairly simple. A REIT purchases different properties—condominium complexes, large apartment buildings, hotels, office buildings, storage centers, retail outlets, and other similar properties—and leases or rents them out to tenants. Investors buy shares in the REIT. The rent collected by the REIT is distributed to investors in the form of dividends.
How REITs Work
REITs are actually tax breaks for corporations. That's good news for you, the investor. In order to qualify, REITs must distribute at least 90% of their profits back to their shareholders as dividends. This helps the corporation qualify for some lower taxation while helping the investor to reap a larger portion of the profits than they otherwise may have been able to.
Investing in REITs
REIT investors are generally institutional investors. That's because they are complicated investment tools that may be hard for the average, individual investor to understand. If this kind of investment really piques your interest, there are alternatives. You can invest in REITs through mutual funds. This strategy helps gather the gains that can be made from investing in real estate, without all of the risk. You may also want to consider looking into REIT exchange-traded funds (ETFs), which you can purchase through a broker.
REITs trade like stocks, while crowdfunding can be conducted through a website or social media platform.
What Is Crowdfunding?
Crowdfunding is nothing new. But it has reached new heights with the rise of social media. The term refers to the raising of capital from a large pool of individuals in order to finance an entrepreneur's project, idea, business, non-profit, or invention. This allows people to reach a new group of potential investors beyond the usual suspects like family, friends, and venture capitalists.
How Does Real Estate Crowdfunding Work?
Crowdfunding has opened up new avenues for people who want to start their own business or project, but don't have the money to do so. They may not necessarily have the best credit score either, which automatically disqualifies them from getting a loan through traditional avenues. There are many different sites out there that a person can use to help raise funds. These crowdfunding sites are a great way for someone to get the investors that they need, without the hassle of going to banks or venture capitalists.
Real estate crowdfunding works in a similar manner. If someone wants to invest in real estate, but doesn't want to own or maintain a building, they can become a shareholder through a crowdfunding company. Any profits directed to the real estate venture—profits that come from rental income or flipping of the property—are passed on to the investor.
Which Investment Strategy Is for You?
The idea behind both REITs and crowdfunding is that you get a piece of the pie without all of the risk. But there are pros and cons to each.
REITs: Pros and Cons
Because they pay out dividends, REITs provide investors with guaranteed income, and they trade relatively easily, just like stocks. They help diversify a portfolio, providing investors with exposure to real estate without the hassle of having to deal with the headaches that comes with owning properties.
The biggest drawback that many people have with REITs is that they generally include higher expenses. These are portfolios that are generally difficult to manage, as real estate can come with some hefty maintenance costs. There are profits to be reaped by those who run the companies, which sometimes means a lower rate of return for the investor.
Crowdfunding: Pros and Cons
One of the biggest advantages of investing in crowdfunding for real estate is that you can commit a lower amount of capital for your investment. You can find a number of different projects that may only require as little as $500 or $1,000. Another benefit of going through this route is that there are generally no investment fees, unlike the additional costs you would be expected to pay with traditional real estate investments such as closing costs or realtor commissions.
The downside to investing with crowdfunding is that for most of these projects, you have to be an accredited investor. That means you have to meet some specifications that are set forth by the Securities and Exchange Commission (SEC), and many people do not meet those guidelines.
The Bottom Line
Real estate can be a great investment, but most people don’t want to worry about owning the actual property. Managing rentals can end up being a full-time job. The stress of renters can be a nightmare and the rates of return can be negative if done incorrectly. REITs and real estate crowdfunding take away a lot of those nightmares and open up real estate investment to anyone. Both investment options are attractive. It all depends on how much risk you wish to take. Remember, higher risk generally translates into higher reward.