Hands-on investors may be interested in crowdfunding
If you have even a little bit of investing experience, you probably know what a REIT (real estate investment trust) is. They’ve been around for decades, and many are sold on major stock exchanges. However, even some experienced investors may not be entirely sure how real estate crowdfunding differs from REITs. This is understandable, given that the equity crowdfunding industry is only a few years old. As is obvious from the names, both REITs and real estate crowdfunding are types of real estate investments. There are several critical distinctions between the two that investors should be aware of, though.
A REIT is a company that owns (and usually operates) a portfolio of income producing real estate. REITs own varying types of commercial real estate, including office buildings, shopping centers, and hotels. REITs were originally intended to be the real estate equivalent of mutual funds, and are required to pay out nearly all of their taxable income to investors via dividends. Over 200 REITs are traded on major U.S. stock exchanges, with a combined equity market capitalization of $719 billion as of 2014.
Real estate crowdfunding platforms like PeerRealty, by comparison, are the new kids on the block. Crowdfunding is the practice of raising money through contributions from many individuals, instead of just a few. In 2012, Congress enacted the JOBS Act, which gave certain investors the ability to directly invest in crowdfunding projects in exchange for equity. After a lengthy delay, the SEC implemented Title II of the JOBS Act in 2013, allowing accredited investors to invest in equity crowdfunding projects. Title III of the JOBS Act, which would give certain non-accredited investors the ability to invest in equity crowdfunding, has yet to be implemented.
So what are the main differences between real estate crowdfunding and REITs? The most obvious difference is scope. When you invest in a crowdfunding offering, you’re in control of what you want to invest in. You can invest in a property across the street; or one halfway across the country. REITs, in contrast, own a array of properties across the country. Some investors may prefer owning a piece of a larger portfolio, while others may want the ability to invest in individual properties in their own backyard.
There is also a major difference in scale. REITs are large entities that generally own larger-scale commercial properties. While some real estate crowdfunding platforms offer these types of investments, they also offer many niche investments, such as smaller retail centers or multi-family buildings. This gives investors the opportunity to invest in properties that have previously only been available in private transactions.
Real estate crowdfunding investments also offer greater transparency than REITs. Some REITs own hundreds of large commercial properties, so it is simply not practicable for them to provide investors with information regarding each individual property. Real estate crowdfunding platforms allow investors to individually select properties to invest in, which gives investors the opportunity to research properties and location. Again, this is a matter of personal preference. Some investors prefer to invest in real estate passively, and do not want to spend time researching individual properties. More hands-on investors, though, may enjoy the control over investment selection and location that real estate crowdfunding offers.
REITs have long been billed as offering diversification benefits for a portfolio. However, in recent years publicly traded REITs have been sensitive to market volatility, and have tended to move in tandem with the broader market. From 2007 through 2013, stock performance or REITs correlated with the stock market nearly 80% of the time, up from 47% between 1980 through 2006. Private real estate, by comparison, utilizes appraisal-based valuations, and is less sensitive to short-term market volatility. Obviously, the real estate market is not unaffected by broader market trends, but real estate crowdfunding gives investors an opportunity to further diversify their portfolios by acquiring assets that are not necessarily correlated to stock market returns.
Finally, REITs also receive different tax treatment than real estate crowdfunding deals. Dividend distributions to REIT investors are taxed at “ordinary” income tax rates rather than as capital gains. While every real estate crowdfunding deal is different, the structure of most deals offer the potential to reduce investors’ tax liability. Crowdfunding attorney Anthony Zeoli notes that investors can take advantage of “pass through” benefits available through the limited partnership or limited liability company structure. Depreciation and interest benefits can be passed through to individual investors, reducing their overall tax liability.
Of course, it goes without saying that each investor should consider their own investment profile. Different investors have differing goals, differing time horizons and differing risk tolerance. No investment, including real estate crowdfunding, is perfect for everybody. However, investors seeking a real estate component to their portfolio who desire a more hands-on approach than REITs can offer may find that real estate crowdfunding is right for them.