The global real estate market is persistently changing just like any other industry. Nowadays, you will find several investment vehicles in every economic concern. In real estate, it started with the conventional way of directly purchasing a property. With time the conventional method has lost taste, and many investors are looking into real estate crowdfunding and real estate securities (REITs).
Why Many Investors Have Abandoned Direct Real Estate Investing (DREI)
This method of real estate investing got difficult with some global markets including Singapore setting quite high prices. This development caused domination of the real estate business by wealthy individuals thereby curtailing retail investors. Some of the challenges met by an average investor include high transactions costs, restrictive regulatory regime, and inadequate capital. There are also investors who dislike owning properties as they find properties management a challenge.
Therefore, direct real estate investing proves only affordable for the Ultra High Net-worth Investors (UHNI). What happens then to the average investor who still has interests in investing in the real estate market? This hiking of real estate business was the genesis of REITs and real estate crowdfunding.
What is Real Estate Crowdfunding and Real Estate Securities?
Real estate crowdfunding is the pooling of resources to invest in a viable real estate project. Multiple investors contribute each small amounts of money to fund a purchase collectively. Real estate crowdfunding becomes effective with a crowdfunding-platform and a developer. The developer has interests in constructing a commercial property bat has insufficient funds.
On the other hand, the investor has insufficient capital and also doesn’t want to maintain a building. The crowding platform comes as an intermediary between the developer and the investor. The developer benefits from the pooling of money from investors and the investor become a shareholder in some properties project. Any profits that the real estate properties generate is passed on to the investor.
REITs on the other hand, are companies that own or finance income generating real estate assets. Such companies trade in a stock exchange and offer benefits to real estate investors. To investors advantage, the law requires that REITs distribute a minimum of 90% of their profits to shareholders. This makes it a big and guaranteed reap for investors.
An investor owns shares in the total holding and thus cannot know the direct underlying asset he or she owns. If you don’t know what you own, it’s hard to assess your risk. For instance, let’s say your REITs invest in one market area and the value in that sector declines. This essentially means you may not establish your level of risk. And, this locks you from seeing the need for diversification.
Which is More Sustainable: Real Estate Crowdfunding or REITs?
Firstly, we can endorse that both kinds of investments come as a solution to the challenges investors face in DREI. The goodies investors enjoy from both include:
- Any investor can invest in commercial real estate something that could be difficult to attain
- Investors enjoy more returns than would be possible with DREI
- They off-load the burden of managing properties
- Investors easily acquire financial support that would be hard to get from financial institutions.
Let’s now address the question of sustainability. Sustainability is directly relative to the risk. What level of risk can we associate with each of the kinds of investments? If we start with REITs, we can advocate that they exhibit transparency as they trade through the stock exchange. Investors can know the size of total holding as well as performance.
The exposure of the activity itself is key to preventing misappropriation of funds which can lead to loss of investments. Another thing is that this investment is highly liquid. You can sell your shares in the stock exchange and any future loss suffered will not affect you. This is because cash holdings are resistant to market conditions.
Investors in REITs are covered by statutory law which requires 90% of profits to be distributed to investors. REITs are not like other stock exchange stocks in that they suffer lower volatility. It is because management expenses and rental income are predictable both in short and long-term. Predictions for REITs performance can be accurate.
A reliable fact about REITs is that they don’t have a direct correlation with other classes of assets. Therefore they will not replicate stocks and bonds. This makes them useful for portfolio diversification. The only risk you can associate with REITs is the hefty maintenance cost involved. It is the single aspect that can hurt this investment and make investors get a lower rate of return.
Real estate crowdfunding, on the other hand, becomes reliable if an accredited crowdfunding platform undertakes it. If the crowdfunding firm decides to sink with investors money, that becomes the end of their investment. In this real estate investment vehicle, investors can invest in different properties. Therefore, they can reap the benefits of diversification.
The shortcomings of the crowdfunding option include:
- Majority of the platforms are local, and so people can’t diversify out of their country or in another currency.
- Operators of crowdfunding platforms are technical people who just build the platform but may lack substantial credibility that enable them to verify good markets or projects
- The platform is just for facilitation of transactions. The platform managers can’t determine what will happen if some projects are not performing. Neither can they predict what will be a long-term performance
- The platform operators can set fees which are quite high and eat into investors’ return
- Not all markets will provide conditions favorable to use the blockchain
- Feasibility of these platforms relies hugely on the availability of regulations. Absent of which can make investor suffer
From the above points, I believe that REITs are more sustainable that Real estate crowdfunding. Nevertheless, both options are attractive and have proved feasible. What matters is your risk appetite. As the rule of the thumb, the higher the risk, the higher the return. What you must remember is both options can empower you to invest in real estate.
Here are more articles you should read:
(By Racheal Muriithi)
- Pros and Cons of Turnkey Real Estate Investment
- Sharing economy in real estate: Implications of Airbnb for European property investment
- Japanese real estate: forecasting the next 10 years from historical cycles