Real Estate: A little bit of history
Real estate investment has been one of the greatest wealth generators in the history of the last century, thanks to the economic boom. Although we are no longer in the roaring 70s and 80s, we may still consider real estate as part of a portfolio strategy. Also we usually think of real estate investing in terms of residential properties. But commercial real estate may offer even greater investment potential.
It’s not hard to see why commercial real estate is such a popular choice, especially for large scale investors. Over the 25 years 1994-2019, commercial real estate has delivered an average annual return far higher than S&P 500. Not only does commercial real estate yield slightly more than equities, it also offers an opportunity to diversify into an entirely different asset class.
But we have to look into the correlation between REIT and U.S. Stocks.
Depending from the period it varies from 0 (Dot.com Bubble) to more than 80% (2008 crisis).
In any case for most of the time the correlation is positive. It is due to the fact that Real Estate grow more during expansion economic cycle. And the same does the stock market. So they are positively correlated.
On average 0.45.
Other than buying commercial property yourself, there are two ways to invest in commercial property.
The most common are Real Estate Investment Trusts (REITs). But a new class of commercial real estate investments has emerged rapidly over the past decade. Commonly referred to as real estate crowdfunding. This is an investment method that allows you to invest in individual properties, offering greater investment choice. All is correlated with the potential for even higher returns than those offered by REITs.
Let’s take a closer look at REITs versus real estate crowdfunding.
What are REITs and how do they work?
REITs are public companies that own and operate commercial properties. These may include office buildings, retail spaces, warehouse facilities, hotels, apartment complexes, retirement homes and student accommodation, industrial spaces and other properties. Some REITs specialize in a specific type of commercial property, such as office buildings or large apartment complexes.
REITs fall into three general types: mortgage REITs, equity REITs, and hybrid REITs. A mortgage REIT invests in commercial real estate-backed mortgages. An equity REIT invests directly in commercial properties, and a hybrid REIT does both.
REITs raise funds from investors through the issuance of shares and use these funds to purchase, develop and manage commercial properties. Investors in REITs receive dividends based on the cash flow generated by the rentals. In case of selling of the properties the funds the managers will invest in other buildings or share them with investors. Moreover, the properties appreciation held by the REIT can raise the value of the REIT shares . One of the main advantages of REITs is their liquidity, REITs shares can be easily bought/sold on stock exchanges.
What is Real Estate Crowdfunding and how does it work?
Real estate crowdfunding is an investment method that allows investors to participate in specific real estate projects without having to buy the entire property. Essentially, investors contribute relatively small amounts of money to finance real estate projects, such as the purchase of a commercial building or the development of an apartment complex. A real estate crowdfunding platform connects investors with project sponsors, who are responsible for managing the project and distributing returns to investors.
There are two mainly models of real estate crowdfunding, including equity crowdfunding and debt crowdfunding. In equity crowdfunding, investors become shareholders in the project and participate in the profits and losses of the property. In debt crowdfunding, investors provide a loan to the real estate project and receive interest on their investment. Either way, investors can profit from selling or leasing the properties once the project is completed.
REITs vs Real Estate Crowdfunding: Pros and Cons
Now that we have a basic understanding of what REITs and real estate crowdfunding are, let’s look at the pros and cons of both investments.
Pros of REITs:
- Diversification. With REITs you can diversify among different buildings both at geographic and industrial level.
- Liquidity. REITs are publicly traded and therefore are very liquid, allowing investors to easily buy and sell their shares.
- Affordability. REITs are also accessible to investors with smaller capitals, as shares of REITs can be purchased for minimal amounts.
- Professional Management. REITs are managed by real estate professionals with experience in the management and operation of commercial properties.
Cons of REITs:
- Dependence on the stock market. Because the shares of REITs are publicly traded, their value may be affected by stock market volatility. Bear market could affect also them and lead to losses in the value of the shares of REITs.
- Unsecured Dividends. Dividends distributed by REITs are unsecured and could vary depending on the cash flow generated by the properties held by the REIT. If you are looking for stable dividends also during a recession, this could not be the right investment.
- Fees and Expenses. REITs may involve management fees and other expenses that could affect investors’ returns. Take a look on them.
Pros of real estate crowdfunding:
- Diversification: Investors can select different real estate projects to diversify their portfolio and mitigate risk. Differently from REITs Investors pick one by one all the buildings they think are worthy to enter in their basket.
- Affordability. Same as REITs. Also in this case there is the possibility of investing in real estate projects even with minimal amounts. Then making it accessible even to investors with smaller capital.
- Control. Investors can have more control over the projects they invest in and in some cases participate in management decisions. In this case investors can pick the best opportunity from different type of projects.
- High Return Potential. Real estate crowdfunding can offer the possibility of generating slightly higher returns than REITs. This is due mainly by the fact that the Investors take the risk of choosing the right project in which invest into.
Cons of real estate crowdfunding:
- Risk of loss. Investment property always carries a certain degree of risk, including the possibility of losing some or all of the invested capital, as projects may not be successful or unforeseen events may occur.
- Lack of Liquidity. Real estate crowdfunding investments are usually less liquid than stocks of REITs. I suggest you to search platform with second-market in which to resell the acquired properties. In any case, there could be liquidity problems in a time of real estate panic.
- Dependence on project management. The performance of the investment depends on the project management skills of the sponsors. It could be difficult to evaluate the different levels of experience and expertise in property management.
- Regualtion. Real estate crowdfunding may not be regulated uniformly in all jurisdictions, which could pose legal or compliance risks
REITs and Real Estate Crowdfunding: My opinion
In conclusion, both REITs and real estate crowdfunding are real estate investment options with their own pros and cons. REITs offer diversification, liquidity and professional management, but are subject to stock market volatility. Real estate crowdfunding offers affordability, control and high return potential, but also carries risks of loss, lack of liquidity and dependency on project management.
Also, it is important to consider diversifying your investment portfolio. Investing in real estate through REITs or real estate crowdfunding should be part of a portfolio strategy. Diversifying your portfolio can help mitigate overall risk and maximize potential returns.
Having said all this I prefer REITs. As I’ve always said, I don’t really like active investing and the additional alpha of crowdfunding investing doesn’t cover the additional liquidity risk.
Furthermore, I don’t have the time and desire to study the various individual projects to arrive at the same degree of diversification given by the REITs. That said if you are really good at choosing investments and want to be more of an active investor then part of your portfolio can be in real estate crowdfunding or a mixture of the 2.
I think a real estate investment could take up to 10% of my portfolio in the future. I would focus especially on those areas of the world that are expected to grow a lot (Asia and Africa). On the other hand it is also true that they could still face speculative bubbles (like China), which seem to affect all fast growing economies. In any case, I still have no idea when to enter decisively. For now they remain monitored. REITs ETFs I’m also considering, although large REITs already diversify enough. And you know that too much diversification diminishes returns.
I leave you an interesting article on Seekingalpha about REITs and Real Estate Crowdfunding.👇