REITs vs. Crowdfunding

Real Estate Investment Trusts (REITs) and crowdfunding are both popular ways for investors to gain exposure to the real estate market without physically owning properties. REITs are publicly traded companies that own and operate real estate portfolios, allowing investors to purchase shares of these companies like they would any other stock.

On the other hand, real estate crowdfunding involves pooling funds from multiple investors to finance a specific real estate project. This allows individuals to invest in properties that they may not have access to otherwise, such as commercial real estate or large-scale developments.

When comparing REITs vs. crowdfunding, investors should consider their investment goals, risk tolerance, and preferred level of involvement. Both options have their advantages and drawbacks, so it's important for investors to do their research and consult with a financial advisor to determine which option aligns best with their financial goals.

Quick Comparison

What is a REIT?

A REIT is a company that owns or manages income-generating real estate. Most focus on a specific type of real estate like multifamily buildings, retail, hospitality, office space or industrial property. Some also focus on specific regions, investing only in properties located in the Northeastern United States, for example.

Congress established REITs in 1960 as a way for individual investors to invest in large-scale, income-generating real estate ventures that were previously only accessible to the very wealthy or institutional investors like banks and hedge funds.

For a company to qualify as a REIT, it must meet certain requirements, including:

• Distribute at least 90% of its taxable income to shareholders each year in the form of dividends
• Invest at least 75% of total assets in real estate and cash
• Derive at least 75% of its gross income from real estate-related sources such as rents or mortgage financing

As an individual investor, these criteria mean there is a fair amount of transparency about how your investment dollars are being used because it has to go toward real estate investments. It also means that REIT shares come with especially high dividend yields because, unlike other companies, it has to pay out at least 90% of its income to shareholders.

When you buy shares of a REIT, you’re investing in the company, not directly in the properties it owns or manages, so there are some key pros and cons that come with that. This means they technically fundraise from your investment, making you a backer of the portfolio they manage.

Pros of REITs

Here are the benefits of investing in REITs.

• High dividend yields and more liquidity: The average REIT dividend yield is about 5% for an equity REIT, compared to just 1.9% for the S&P 500. On the liquidity side, you are holding tradable shares, not physical property, so it’s easy to buy and sell as needed.
• Easier to defer taxes: While you technically can hold property in a tax-deferred account like an individual retirement account (IRA), doing so is complicated and comes with a lot of rules. With a REIT, you can just hold the shares in that tax-deferred account like you do with ordinary stocks.
• No management or financing responsibilities: As a shareholder, all you have to do is sit back and collect dividends. The company handles the work of finding investment opportunities, managing properties and securing financing.
• No minimum capital requirements: An investor can become a shareholder in a REIT for the price of a single share. This is much more affordable than saving to buy a property outright or to meet some of the higher minimum investment requirements of some crowdfunding platforms. It’s also easier to scale up at your own pace. You can keep buying new shares as your budget allows, earning interest and dividends on each new share immediately rather than waiting to save up enough money for your next property, meanwhile earning negligible interest while it sits in a savings account.
• Gain more exposure to the real estate market: As an individual, investing in real estate at a large scale may not be practical. Typically, you’re buying just one property at a time, and you have to personally manage each property you own directly so there’s a limit to how much real estate you can realistically manage. With a REIT, that’s no longer a problem. You’re instantly gaining exposure to a large-scale portfolio of multiple properties.

Cons of REITs

Here are some cons to look out for when investing in REITs.

• No direct control over decision-making: You’re close to the action and can choose a REIT that aligns with your investment priorities, but you won’t have control over which properties are added to the portfolio or how those properties are managed. For investors with little interest in actively managing real estate, that’s not a major drawback, but for those who want to be more hands-on, you might feel too limited by a REIT.
• Prices fluctuate like stocks: Because REIT shares are traded on public exchanges like other stocks, the price fluctuates according to market sentiment just like other stocks. While that won’t affect your dividend yield, it can impact the net worth of your investment portfolio — and it can also be a little nerve-wracking to watch if you’re risk averse.

What is Real Estate Crowdfunding?

Real estate crowdfunding is a newer option investors have for investing in real estate without the same barriers to access as direct real estate investing but offering a little more decision-making power than REITs do. Investors can go to one of the many real estate crowdfunding platforms that have emerged in the last few years and choose to invest in specific projects or deals.

Pros of Crowdfunding

A crowdfunding campaign might intrigue you for a number of reasons, but how does equity crowdfunding differ from buying REIT stocks? As an investor, going the crowdfunding route offers the following benefits:

• Direct ownership: As a crowdfunding investor, you become part of a pool of investors who directly own a property or development project. This typically translates into a much larger share of the total project. REIT shareholders don’t have this same ownership. Shareholders own shares of the company — not of the properties it owns.
• More transparency: Those who advertise projects or deals on a crowdfunding platform have to provide in-depth detail and clear parameters for what your investment will go toward and what you can expect in return. With REITs, you know most of its money is going toward real estate investments, but you won’t really know what specific decisions are being made or how the money is invested.
• Higher returns: The annual returns on a project you invest in vary depending on the investment but are usually somewhere around 15%. As a direct owner, you also usually get a higher proportion of that return because it’s being divided among a smaller pool of investors.

Cons of Crowdfunding

While crowdfunding gives you more control and ownership, it carries higher risks. Here are the main drawbacks of crowdfunding:

• Higher risk: Because you’re investing in a single property rather than a portfolio of hundreds or more, the potential loss if this project doesn’t pan out is much higher. As a shareholder in a REIT, performance might fluctuate from year to year, but the failure of a single property in the portfolio won’t cause you to lose your entire investment.
• Less liquidity: Because you’re investing more directly in real estate, you run into the same liquidity problems that come with that. Your investment will be tied up in this project until it’s completed, or the property is sold. Many projects also have restrictions around when you can withdraw your investment so it’s not possible to cash out early if you change your mind. It’s not the same as selling back assets on a stock exchange and moving on.
• Strict minimum requirements: While the 2016 Jumpstart Our Business Startups Act removed the requirement that you had to be an accredited investor to invest in real estate through a crowdfunding platform, many platforms still restrict access to accredited investors. Even when they don’t, many of the projects have higher minimum investments ranging from a few thousand dollars to hundreds of thousands of dollars. These requirements can make them less accessible to many individual investors.

Which Real Estate Investment is Better?

There’s no one right answer here as every real estate company is different. The best option is the one that aligns best with your interests and goals. A real estate asset is a fine investment, but how will you buy into office buildings, data centers and the like?

To make the best decision, you have to think about what your priorities are and how you see real estate fitting into your investment strategy. With that in mind, here are a few guidelines that can help you decide:

REITs Are a Better Option for Investors Who Prioritize

• Consistent, passive income from annual dividends
• A hands-off approach that doesn’t require extensive knowledge of the real estate market
• High liquidity so that your portfolio can be rebalanced as necessary
• The ability to hold your investment in a tax-deferred account

Real Estate Crowdfunding Is Better for Investors Who Prioritize

• A more hands-on approach that allows them to choose specific properties and projects
• Directly owning real estate
• The potential to earn a substantially higher return on their investments

This also doesn’t have to be one or the other decision. If you value having the steadier, more passive income stream of a REIT but you’re also drawn to the excitement and high return potential of crowdfunding, you can certainly do both. Incorporate some great REITs into your portfolio but reserve a little play money to put toward crowdfunding projects.

This asset class helps the real estate investor get closer to the action without buying properties outright. Plus, there are still shareholder dividends to be had. You just don’t make the real estate deal yourself.

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