3 Reasons You Should Rethink Real Estate Crowdfunding Platforms
The stock market ended the year on hot terms but has cooled down this year so far. This leaves many beginner investors wondering what can be the next investment for the highest returns. Quite quickly, it’s easy to see a great next step is real estate: In fact, many of the richest people in the country have listed real estate as their rise to gaining, and keeping, their wealth safely. But for many of us, real estate is unattainable for the time being (Downpayments? Closing costs? Commissions? Gross).
In comes crowdfunding real estate platforms, like Fundrise, Realty Mogul, Yield Street, and many, many, others. They offer a simple solution: The rich have money to invest in real estate, why don’t we mass crowdfund and buy our own real estate properties, then divide up the profits?
These platforms have a lot of really good benefits, and this article isn’t meant to say you should never invest in any of these. However, it’s important to look at the cons, compared to other potential investments, before buying in.
Crowdfunding vs REIT’s and ETF’s
A crowdfunding platform pools funds together to let average investors participate in the real estate market that usually isn’t open to them.
A REIT, Real Estate Investment Trust, are companies that own real estate and often pay out profits through dividends. You can buy a public REIT on any brokerage, like you would a stock.
A Real Estate ETF pools together REITS or individual real estate companies into one basket that provides a safer option to invest in many companies and properties, rather than just a few.
The way crowdfunding platforms work for you, the investor, is through offering private REITS, meaning ones that are not available to the public and are not on brokerages, or by actually using the money you invested to construct, or buy, individual properties. Some only do private REITS, some only do individual properties, while many do both. However, they all have some important cons to look into compared to public REITS and real estate ETF’s.
1. High Start-Up Costs
It’s ironic that one of the biggest perks of crowdfunding platforms is the low start-up costs, yet it’s also one of its cons. Compared to a traditional property buying investment, yes, crowdfunding provides a lower startup cost. However, compared to buying a public REIT, which functions as buying a normal stock, crowdfunding platforms have a much higher barrier to entry. Take for example Fundrise, one of the largest crowdfunding real estate platforms, to get access to their BASIC plan, you need to put in $1,000. That’s their BASIC plan. For access to all their investments, you need to put in at least $100,000. That’s enough of a downpayment for an actual house!
Compare that to a REIT, like my favorite, “O” (Which invests in commercial properties worldwide), which costs only $70 as of January 8th. This means you only need $70 to start investing in real estate through a public REIT, compared to $1000 in Fundrise. Keep in mind Fundrise has one of the lowest minimum costs of crowdfunding platforms, which can go up to even $25,000 for basic plans.
2. Liquidity Issues
Liquidity is important for me. In simple terms, liquidity refers to how quickly you can cash in your investments for real cash. A house, for example, is pretty illiquid-If you buy a house and then an emergency pops up a few days later and you need money, it could take months (and in a not-so-hot market like today, even a year) to sell the house and get your money back. On the other hand, a stock like Apple (AAPL), is extremely liquid. You can easily sell an Apple stock and it’ll be bought up, for the market price, instantly.
I care about liquidity. As a young person, I’m still finding where I want to invest my money and exploring different options. I also move around a lot, which means that I could need money available at any moment in case of a moving emergency.
Crowdfunding platforms are typically illiquid, this means it can be hard to cash out your profits at any given notice. This makes sense for the platform, if they use your money to build a property, and suddenly investors are pulling out their money, the property may never be built and the rest of the investors will lose their investments. Fundrise, for example, only allows investors to cash out in specific times of the year without a penalty, meaning that you have to wait to be able to sell your assets for actual cash. Even with that, you have to find someone else on Fundrise, which has a lot of customers but not millions like a public market, to buy it off of you. This can be challenging, especially if everyone is trying to cash out at once (like a recession or pandemic, which is when you may try to cash out too).
Public REITS, on the other hand, are public and available to millions of investors. Larger and more popular ones, like O, can be sold in seconds. Liquidity is never an issue unless you specifically buy niche, low volume REITS on the stock market.
3. Expense to Gains Ratio
The two previous points would be fine if you ended up making more money on crowdfunding platforms than you would in a public REIT or Real Estate ETF. Of course, if you got higher returns for the cost of slightly less liquid assets and higher start-up costs, it would be worth it for me and I wouldn’t be writing this article. However, that isn’t the case.
Let’s take for example “AMT”, the American Tower Corporation REIT, and the largest REIT by market cap (typically means the highest volume and most investors), and Fundrise, the most popular real estate crowdfunding platform.
Over the past 5 years, according to Fundrise’s own website, the average return an investor would have gotten each year is 11.7% (taking each year’s profit added, then divided by 5 years). This is total annual return, which includes dividends and appreciation of the private REIT’s. However, Fundrise has an annual 1% “maintenance fee” that brings your total down a percentage.
“AMT”, on the other hand, grew 133% in 5 years, averaging 26.6% return every year. On top of that is the dividend, which REITS are popular for, which happens to have been an average of 2% each year. AMT does not have an expense ratio either for fees.
This means the total return, if you had just bought the most popular REIT rather than Fundrise, you would on average be making 28.6% to 10.7% a year, almost triple the amount.
Obviously, AMT is a special case, and while it is the most popular REIT (not just a random small REIT that nobody knows about), past performance doesn’t indicate future success because it is a single REIT. Other REIT’s have performed closer to what Fundrise has performed, but without the cons.
So, if you’re like me, and you care about liquidity and easy startup costs, think of buying a public REIT. They often perform better, have less costs and fees, and are easier to buy and sell than a crowdfunding platform.
