REITs Vs. Real Estate Crowdfunding

by: Jussi Askola

Summary

Real estate crowdfunding has in the recent years gained in importance and many today consider it a substitute to REITs.

While looking for comparisons between both online, I mostly found highly biased reviews written by crowdfunding companies.

I believe that, in most cases, REITs should be favored to any form of real estate crowdfunding investing.

REITs are less risky, more liquid, better diversified and have a long track record of outperforming private real estate investments.

In the recent years, real estate crowdfunding has experienced significant growth and is now often compared to REITs as a superior alternative for the small investor. For the ones that are unfamiliar with real estate crowdfunding companies, simply put, they are online platforms that allow investors to directly invest in certain specific real estate deals. On the other hand, REITs are most often publicly traded companies that invest in real estate and as such, by buying shares of REITs, investors can participate in the return of large real estate portfolios.

When searching for 'REITs versus Crowdfunding' on Google, one can quickly find many different Crowdfunding websites trying to sell their product in a very biased manner relative to REITs. The main arguments that they seem to make are always the same: REITs are not real estate, REITs are riskier, and REITs are therefore less attractive than real estate crowdfunding investments. I disagree with all these points and will aim to explain why REITs offer in fact much superior investment characteristics compared to any crowdfunding platform.

MYTH #1: REITs are not real estate

Crowdfunding websites make sure to quickly point out that REITs are traded in the form of stocks to try to scare investors away from these supposedly "highly volatile and risky" investments. On the other hand, crowdfunded real estate investments are independent of the stock market and are hence pure real estate.

While this is true, it is in my opinion very unreasonable to assume that REITs are less of a real estate investment than crowdfunded deals simply because of how they are traded. This is the equivalent argument to saying that Exxon (NYSE:XOM) or Chevron (NYSE:CVX) do not provide exposure to oil and gas markets because the firms are publicly traded. The argument that REITs, which own nothing but real estate, are not real estate, is nonsense.

In fact, research from Cohen & Steers (NYSE:CNS) shows that over full market cycles, the returns of REITs and private real estate are almost perfectly co-integrated.

Again, this should not come as a surprise since the dividends and the long-term capital appreciation of REITs is directly tied to the underlying properties that it owns. Disregarding REITs as stocks, rather than real estate is thus not a valid argument.

MYTH #2: REITs are riskier

This second myth goes hand in hand with the above one. Since REITs are perceived to be stocks, they must be riskier since the stock market is famous for its high volatility relative to real estate assets.

On the other hand, since crowdfunded real estate investment are insulated from the volatility of the public market, they may offer lower volatility and lower risk. This is wrong. Not only are crowdfunded real estate investments much riskier than REIT investments, they may also be more volatile in the short term.

REITs offer the opportunity for investors to invest in broad and widely diversified portfolios of properties in a liquid and cost efficient manner. Crowdfunding websites, on the contrary, allow you to invest in a concentrated, illiquid and often cost inefficient manner with potentially higher conflicts of interest between sponsor and investor. How is this supposed to be less risky? I agree that theoretically investing in an individual property could lead to higher returns, but it is also clearly much riskier compared to a large and well-diversified portfolio.

Crowdfunding investors are also able to diversify by investing small sums in multiple deals. But this will never achieve the same scale as investing in REITs, which (often) own thousands of properties across different property types and geographical locations.

Furthermore, I would also disagree that being traded independent from the stock market makes the investment less volatile. In fact, some research shows that REITs are not any more volatile than real estate, despite being traded on the stock market. In an analysis by Brad Case, PhD, CFA, it was concluded after adjusting for leverage, return calculation methodology and liquidity, private real estate come up as more volatile than public real estate:

Is it believable that public real estate is actually less volatile than private real estate? It's not just believable, it's to be expected. Volatility is a measured of uncertainty regarding asset values. Think of a crisis: people trade assets at lots of different values because they have so much uncertainty regarding the factors that determine the asset values: the future stream of earnings, and the appropriate discount rate. A market in which more transactions give investors greater information about those underlying factors-that is, a market that is liquid and information-efficient, such as the stock market in which listed equity REIT stocks trade-SHOULD be less volatile than an illiquid, information-inefficient market such as the market for properties or (worst!) the market for private equity fund shares. Brad Case

MYTH #3: Crowdfunding is superior to REIT investments

Finally, many of the comparisons available online state that crowdfunding has the big advantage that it permits an investor to cherry pick the best properties and to only invest in those to earn higher returns. After all, why would you invest in a large portfolio that may contain some good and some bad properties if you could sort out the less attractive ones?

This statement is true but very misleading, especially when targeting individual investors. Think of the following: If you are not a professional real estate investor with the expertise and resources that go with it, how are you even supposed to evaluate individual real estate investment deals on a crowdfunding platform? You cannot.

You are at the mercy of the deal sponsor and pure luck. Real estate is a local business and if you are not actively involved in the local market, you simply cannot assess an individual property investment. You need to be able to analyze the macro and micro location, the surrounding infrastructure, the growth trends, the demand and supply factors, etc.

This is the beauty of REITs: You do not need to know everything; you have a professional management team taking care of all the operational work. You directly invest in a large portfolio that is managed by people that have the resources and expertise to make the right decisions.

The historic track record of REITs proves this point:

Over the last 40 years, REITs have returned more than 13% per year to investors according to NAREIT.

EPRA also notes that REITs have outperformed private real estate investments over the last many decades:

This is how I would summarize this comparison:

  • The main selling points of real estate crowdfunding are flawed.
  • REITs are less risky due to much stronger diversification and higher liquidity.
  • REITs have a very strong track record of outperforming private real estate investments due to structural advantages.
  • Crowdfunding investors must make individual property investment decisions without having the expertise or the resources to do so.

My conclusion: If you are not a professional real estate investor, forget any form of private real estate investing including crowdfunding. And even if you are a professional investor, you might be better off investing in REITs as demonstrated by the above graph.

Final Thought

Investors very often like to criticize the stock market for its volatility and look for alternatives that are independent from it. What they however fail to consider is that despite not being daily quoted on a market place, the private asset may still be fluctuating in value just like stocks.

Volatility will always be low if you only value an asset twice a year and everything is a diversifier if you don't value it properly. David Prescott

In this sense, real estate properties are also constantly changing in value; the information just isn't publicly quoted on a daily basis. Thus, REITs are not any riskier just because they are traded as stocks.

Opposite of that, being traded on the stock market is a POSITIVE, not a negative. It provides liquidity and lowers transaction cost.

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Disclosure: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer. Readers are expected to conduct their own due diligence or seek advice from a qualified professional.

Sources: Brad Case Research, Cohen & Steers, NAREIT, EPRA.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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