Both types of investing have their benefits – but real estate crowdfunding offers the best of both worlds.
There are many roads to positive returns in the world of real estate investing. Typically, investing in real estate takes two major forms; active and passive investments. We’ll examine both of these and then turn our attention to real estate crowdfunding, the modern way to get the best of both worlds.
Active real estate investors purchase and manage properties for rental income, or renovate them to flip the properties for a gain. Active investors can even build new homes for sale. These investors are involved in every part of the deal, from selection, to obtaining financing, to personally guaranteeing the loan and managing the investment. Basically, the investor is hands-on, actively participating in making the investment pay off.
Obviously, active investing is a significant undertaking. House flipping is essentially a full-time job, while renting out property may require less time, especially if the investor hires a management company or uses a building superintendent. Investors who are handy and have the time, though, can actively manage properties to maximize their profit margins.
The main benefit of active investing is control, including specific deal selection. The investor selects which properties to buy, based on their preferences for type, location, budget and other factors. Investors can choose between single family homes, multi-family houses, large apartment buildings, commercial/mixed used properties or industrial properties, or even a mix of different types. Budget concerns, though, may limit active investors to one or a few single-family homes, preferably clustered relatively close to each other.
The downside of active investing is the headache factor – complaining tenants, plumbing leaks, routine maintenance, marketing of rentals, etc. Active investing also requires a rather sizeable investment, even for the smallest properties. A purchase of an investment property typically requires at least a 20% down payment and a personal guarantee on the loan. With a median U.S. home price of $219,400, even purchasing just one modest home will require at least $40,000 out of pocket, before factoring in transaction costs, any needed repairs, and ongoing upkeep.
Investors can also passively invest in real estate through real estate-related mutual funds and real estate investment trusts (REITs). Wealthier investors can participate in a real estate syndicate that accepts private placements, or in a real estate private equity group. The common feature is that someone else is managing the investment. This places few demands on investors’ time, but gives them little or no say in the organization’s investment policies.
The minimum investments required for passive investments can vary widely. Investors can purchase publicly traded REITs from online brokerages for as little as a few thousand dollars, while many private placement offerings will require minimum investments of $50,000 or $100,000.
Some funds are specialized for commercial or residential properties, and private syndicates can be very specialized with regard to location and property type. Other alternatives include investing in mortgage-backed securities, buying property liens, buying the stock of home developers and investing in mineral rights. But as a general rule, the only control passive investors have is to buy or sell these investments.
Real Estate Crowdfunding
Crowdfunding is the brave new world of investing, and this extends to the real estate markets as well. Currently, only accredited investors can take part in crowdfunding real estate ventures, but new SEC regulations will very shortly allow the average investor to invest modest amounts without having to meet any wealth tests. A crowdfunded real estate investment is mediated by a portal that brings together investors and sponsors. In some ways, this resembles active investing in that investors can choose the exact properties in which to invest. The portal performs due diligence on the properties and the sponsor, and completely handles the transaction. Investors also have control over the size of their investment, and can invest as little as $5,000 in a specific deal (and soon, into certain funds).
Real estate crowdfunding provides the benefits of passive investing, in that the property is professionally managed and investors don’t have to lift a finger to collect profits. Beyond that, they also don’t need to spend a lot of money to get involved, and can diversify into several crowdfunded deals to spread their risk. Investors also can select properties in their own communities to help boost the local economy. Crowdfunding allows investors to enjoy the benefits of both active and passive real estate investing.