As of this past December, buying is still more affordable than renting in 58 percent of U.S. housing markets, while rent prices outpace weekly wage growth in 57 percent of markets. (Realty Trac) These statistics, while painting an undesirable picture for renters in certain parts of the country, illustrate a golden opportunity for real estate investors expecting home values to appreciate. With the internet creating more investment outlets than ever before, investors such as yourself face several questions, including:
- How should I invest in real estate?
- How can I achieve high ROI with a minimum of risk?
- Do I need guidance on my portfolio or do I want to invest with greater autonomy?
Direct Real Estate Investing
Real estate investors often purchase homes or condos that a real estate company has “turned over”, meaning already renovated and rented out to tenants. The general process is simple enough: You identify an area where you plan to purchase property, and then contact a company for a listing or for guidance on available or soon-to-be-available renovated homes in the area. Due diligence is an important part of the process—visiting and assessing the neighborhood, property, and the development company itself when possible for extraneous risks. After vetting a property, you advance straight to the closing process. The arrangement often includes ongoing management, so you can sit back and collect your cash flow.
Crowd investing, commonly called “Crowdfunding”, harnesses the power of the internet to fund real estate projects. In previous blog posts we examined Crowdfunding in general, as well as for investors and real estate companies. Though the idea of Crowdfunding may intimidate more traditional investors, the best Crowdfunding platforms streamline their processes for ease-of-access. Moreover, an unprecedented amount of investors are inclined to embrace online investing on a mass scale in the very near future.
Diversity of Options
Direct Real Estate Investors could feasibly buy any type of renovated, tenant-ready building. The most common turnkey investments, however, are single-family homes or small-to-midsized apartments.
Crowd investors choose from many different kinds of real estate projects—single-family or multifamily homes, apartments, large and small commercial buildings—most of which are awaiting construction or renovation. Some platforms host projects locally and globally. Most offer equity and debt investments, with minimum investments as low as $1,000. And while certain platforms only permit “accredited investors” to invest, there are increasing opportunities for all investors—especially among platforms that have filed under Reg A+ exemptions and/or upcoming SEC Crowdfunding exemptions. These new rulings permit nearly anyone in the world to invest.
Guidance & Diligence
Direct Real Estate Investors do much of their due diligence themselves—non-local investors especially rely on local property managers, real estate agents, and internet sources for precise diligence on properties. Real estate investment companies help you complete and manage your investments; however, their diligence effort is less robust and far-reaching than that of Crowdfunding platforms.
Crowdfunding platforms usually do a substantial amount of diligence on companies and projects while Crowd investors can tap into a vast Crowd base to gather stronger diligence (imagine 99 investors capable of doing and sharing diligence with each other). Platforms encourage you to ask questions and voice concerns through email exchanges and phone calls.
Although Crowdfunding platforms cannot advise you on individual investments, they help mitigate risk by requiring real estate companies to facilitate project reporting, in addition to their own diligence.
Risk is inherent to all forms of investment. With Direct Real Estate Investing, risks may include anything from unexpected tenant vacancies, turnovers and maintenance issues. Direct Real Estate Investors can most effectively mitigate risk by hiring a good property management company and diversifying their portfolio.
Crowd investors face risks related to real estate company incompetence, the location of projects, and the project itself. Platforms offer no guarantees that any project will succeed, i.e. will be successfully renovated, turned over, and will generate returns. Preferred debt investors earn monthly interest regardless of how a project performs, but equity investors risk losing their investment entirely—especially if the real estate company defaults on a project.
Crowd investors can help mitigate risk by doing their own diligence, asking other investors (those familiar with the project’s location) pertinent questions, and by familiarizing themselves with all documents, which should outline unfamiliar risks and liability concerns. Of course, platforms can help mitigate risk on their end by providing quality diligence and scrupulously vetting companies.
Direct Real Estate Investing is a methodical, long-term investment. Tenants provide you with monthly income while a property’s value appreciates over many years. Additionally, depreciation allows you to recover the renovation/maintenance costs. Profit results from patience, diligence, and strong property management.
Notwithstanding development risks, most Crowdfunding platforms offer above-average returns on residential and commercial projects. Because funds are deployed on a short-term basis, market fluctuations have a minimal or no effect on returns. In most cases, you benefit from value-add price increases rather than appreciation on your investments. Additionally, many projects include a waterfall option in which debt investors share in the overall profits.
Whether Crowdfunding or Direct Real Estate Investing, some properties generate higher returns than others. However the profit margin for both types of investing is comparable, albeit measured over different lengths of time.
As a recap, let’s sum up the general pros and cons of Direct Real Estate Investing and Crowdfunding.
Direct Real Estate Investing
- You own the asset.
- Tenants pay down your mortgage.
- The asset is tangible (you can leverage it or live in it).
- Appreciation over time: In thirty years, for example, an asset bought with $50K downpayment could appreciate 900%, yielding a $450K return on your investment.
- Starting capital is more substantial—usually at least $20K.
- Illiquidity: Assets cannot be easily or quickly liquidated; usually takes end of the lease plus 60 days.
- Fewer opportunities for portfolio diversification among mostly single-family assets.
- Must rely on property management company for ROI.
- Professional due diligence supplements your own.
- Starting investments as low as $1,000.
- Greater diversification: With $20,000, for example, you can diversify among 20 assets.
- Fewer post-investment fees.
- Opportunities for global investments.
- The asset does not belong to you.
- Lower rate of appreciation means less opportunity to earn returns over greater length of time.
- Limited opportunities for depreciation.
The debate between Direct Real Estate Investing and Crowdfunding should center around you, the investor: your level of confidence, experience, risk tolerance, desired ROI, and life circumstances. Crowdfunding represents a new opportunity for diversification and liquidity. Direct Real Estate Investing is a tangible, long-term investment. Neither method is inherently superior to the other, but each serves different interests. Direct Real Estate Investing and Crowdfunding are durable methods to profit from real estate in your neighborhood and well beyond. So why not invest in both?