Rental property investing has been around forever and is a tried-and-true way of making money in real estate. Real estate crowdfunding is the relative new kid on the block, but is taking the real estate investing world by storm.
Which is better?
Real estate crowdfunding is the better investment strategy if you want a passive, easy to set up, and low-cost real estate investing option that offers plenty of diversification. Rental property investing is the superior strategy if you prefer reliable cash flow, strong ROI potential, greater control over your investment, and access to your equity without restrictive holding periods.
We will go into each of these reasons in detail below, there may be some readers who are unfamiliar with these two investment strategies, so we’ll cover some introductory information about them first.
If you want to skip ahead the the actual comparison of the two strategies, click on this link to jump to the first comparison category of “Cost.”
The information contained in this post is for informational purposes only. It is not a recommendation to buy or invest, and it is not financial, investment, legal, or tax advice. You should seek the advice of a qualified professional before making any investment or other decisions relating to the topics covered by this article.
What Is Real Estate Crowdfunding?
Real estate crowdfunding is a method used by companies to raise money for real estate investments from a broad range of investors. These companies typically operate online platforms where investors can review real estate investment options.
If the investor finds something that they like, they can choose to invest in it.
Investments can span across a wide range of real estate, including individual houses, apartments, shopping centers, and office buildings. The offerings can be structured in a variety of ways, but are typically structured as equity or debt deals.
In other words, you can get an ownership stake in the property or you can get paid by funding a loan that is being offered in connection with a piece of real estate.
Some real estate crowdfunding platforms offer REITs, which are funds that hold income producing real estate.
Because these online platforms have access to a large population of investors, they can collect a lot of money for investments even if each investor only invests a small amount individually.
They use these large pools of money to buy high-end properties that would normally be out of reach for an individual investor.
Getting Started With Real Estate Crowdfunding
The easiest way to get started in real estate crowdfunding is to go to one of the many crowdfunding sites out there and sign-up. If you are eligible (in some cases, you must be an accredited investor), then you can select the investments you are interested in and start buying shares of that investment.
An accredited investor is someone who has a net worth of at least $1,000,000 (individually or jointly with a spouse) or makes $200,000 per year individually (or $300,000 jointly) for the last two years, with an expectation of earning at least that much in the current year.
Some of the most popular real estate crowdfunding sites are Fundrise, Crowdstreet, Realty Mogul, Modiv (formerly richuncles) and Yieldstreet.
I like Fundrise and invest with them personally. They have really low minimum investment requirements. As of the date of this article, their starter package only requires a $10 investment.
If you join them via this link, you can be part of their “refer a friend” program where you (and I) can receive $50 worth of bonus shares for signing up. If you want to help support the blog and also get some free shares, it’s something you may want to consider.
What Is Rental Property Investing?
Rental property investing is the purchase of real estate for the purpose of renting it out for profit.
Getting Started In Rental Property Investing
There are six basic steps to getting started investing in rental properties.
- Get your financial house in order (get a down payment, get your credit in shape)
- Find a great real estate agent
- Select your market
- Analyze potential rentals (and start mortgage application process)
- Make the offer
- Navigate the post-contract process and close the deal
If you want to learn more, I go into each of these steps in my complete guide to start investing in real estate.
Ok now that we have that introductory stuff out of the way, let’s jump into the comparison!
Cost
For most investors, cost is going to be a deciding factor in choosing an investment option.
Real estate crowdfunding is tough to beat here. Some of the lowest cost options only require a $10 minimum investment. See Fundrise as an example.
But many platform require much higher minimums, so you should be aware of that.
Related reading: If you want to learn which crowdfunding platforms become available at every price range, see my article on real estate investing by price range. It doesn’t just cover crowdfunding options, it includes all of the major real estate investments available to you along key price points (e.g., under $1,000, under $10,000, etc.).
On the other hand, rental property investing can be expensive. If you want to buy an investment property, you are usually going to need a down payment equal to 15% of the purchase price.
There are also closing costs, which could run into the thousands of dollars. Finally, you will need money to cover ongoing costs, such as maintenance and repairs, as well as money to cover future vacancies, etc.
The good news is that there are some low and no money down options that you can pursue. If you want to learn more about them, I wrote an article providing 15 no money down strategies that you can use to buy rental properties.
Even with these options, the start-up costs for rental property investing are probably going to be higher than the minimum investment amount for a low-cost crowdfunding investment.
Based on that, I think real estate crowdfunding takes this round.
Ease of Getting Started
Getting started in real estate crowdfunding is pretty easy. We covered this topic a bit already. You simply need to sign up, find an investment you like, and fund it.
As we covered, you may need to qualify as an accredited investor for some platforms or certain investments within a platform, so getting started is not a slam dunk.
That being said, rental property investing is far more involved.
As we discussed, you need to save for a down payment, get your credit in order, obtain financing, find the right property, enter into contracts, and navigate the closing process. Then you have to find tenants and manage the property.
When it comes to the ease of getting started, real estate crowdfunding takes the prize.
Cash Flow
Some crowdfunding investments offer monthly or quarterly payments based on rents received or profitability.
Source: fool.com
But many crowdfunding investments choose to reinvest earnings, so you may not get a monthly or quarterly payout. You will need to read the offering memorandum for the investment you are interested in to learn details around distributions.
Rentals on the other hand are known for their steady monthly cash flow. If buy in a great neighborhood and find great tenants, you will have rent checks coming in every month like clockwork.
The edge in terms of cash flow goes to rentals because not all of your crowdfunding investments may pay with the same regularity that a rental property will.
Return on Investment (ROI)
ROI is always going to vary by investment but here are some averages that I collected for the top real estate crowdfunding platforms:
Fundrise: in 2019, Fundrise produced a total net platform return of approximately 9.47%.
Source: Fundrise
Crowdstreet: Crowdstreet claims a 17.7% internal rate of return (IRR).
Source: Crowdstreet
Realty Mogul: Realty Mogul does not seem to provide a lot of information about average returns on their various individual real estate investments, but they have two REITs where there is some return information.
Their Mogul REIT I has an annual distribution rate of 6%. Their Mogul REIT II, which is more of a growth fund, has paid a 4.5% annualized distribution to investors.
Source: Investingsimple
Yieldstreet: Their IRR is 11.54% for the last quarter of 2020. If you want the latest numbers for them, check out their statistics page here.
Seems like ROIs are all over the place for real estate crowdfunding, but I think you can get a sense of the possible returns. Remember these are averages: your returns may vary.
Rental property returns are also going to vary. Much will depend on the property you buy, the neighborhood’s trajectory, the tenants you attract, and your ability to manage the property efficiently and in a cost-effective way.
That being said, if we want to talk averages, the average annual return for residential rental properties is 10.6%.
Source: Mashvisor
That seems within the ballpark to me. If you are an experienced investor, you may do better.
When I look at the returns of my nine investment properties, their performance is as follows (as of 12/31/2020):
|
Property # |
Annualized ROI |
|
Property 1 |
12.07% |
|
Property 2 |
12.23% |
|
Property 3 |
23.85% |
|
Property 4 |
11.96% |
|
Property 5 |
18.30% |
|
Property 6 |
11.59% |
|
Property 7 |
17.51% |
|
Property 8 |
13.65% |
|
Property 9 |
20.43% |
So that works out to an average ROI of 15.73%
Why the variation in returns for my properties? Three of them I bought through my self-directed IRA, so I needed to put much more down (around 50%). Hence the lower (but still pretty good) ROI.
Others were purchased more recently, so they had less time to appreciate.
So who wins the ROI match-up? I would say if you are an experienced rental property investor, you will on average be able to get a superior ROI than you would through a crowdfunding investment.
But if you don’t have that experience, you may want to take advantage of the professional sponsors in the crowdfunding space to find and manage investments for you.
Since most people are not experienced rental property investors, I will give a slight edge to real estate crowdfunding.
Control
I think rental property investing takes this one.
You have complete control over every aspect of your investment when you buy rental properties. You choose the property, you market it, you set the rent, and you select the tenant. You also have full control over how you manage the property. All of these play a huge role in the success of your investment.
When you are investing through a real estate crowdfunding platform, you are giving up that control to the crowdfunding platform (to evaluate each deal) and to the sponsors (who will manage the individual real estate investments).
You also have limited due diligence opportunities. You usually just get an offering memorandum. That is not enough to fully understand the risks and benefits of a particular real estate investment.
And most people don’t know how to properly evaluate the deal even with the offering memorandum. Pile on to that the fact that most investments are going to be in locations you aren’t familiar with. That’s a lot of uncertainty and lack of control.
You have to trust that the platform has vetted the investment thoroughly and the sponsors know what they are doing.
Passivity
You really can’t get more passive than real estate crowdfunding, so I think it wins on this score.
You just select your investment and wait for the returns to come in. Doesn’t get easier than that.
Rental property investing will definitely be less passive. You will need to find and buy the properties, obtain financing, find and manage the tenants, maintain the property, remedy vacancies, etc.
But if you develop the right processes and have the right teams in place, rental property investing can become semi-passive.
You can make your rental property investing even more passive by automating many of the tedious property management tasks and processes. My article on automating rental property management gives your some great tips on how to do this, including the specific tools I use to automate my rental business.
Of course, you can outsource many of those tasks to a property manager and make the investment almost completely passive, but that will hurt your returns (and you will still need to manage the manager).
Risk of Loss
This is a tough one to judge.
There is definitely risk of loss for both investment strategies.
Real estate crowdfunding is risky because you can get defrauded. The crowdfunding platform could be a sham and just take your money. Or they could take a big chunk of your money and invest only a small portion of it into the investment and allocate the rest to personal expenses.
The SEC obtained judgments against two people running a real estate crowdfunding platform (iFunding) in 2019 who did just that.
Source: SEC
There have also been many lawsuits alleging fraud that were filed in connection with the collapse of Prodigy, a real estate crowdfunding company that collected over $690 million from people and is now defunct.
Source: The Real Deal
How do you avoid this?
There are no guarantees, but some of the more established and reputable crowdfunding sites that we already discussed may be less risky.
Another obvious risk of loss comes from making poor investment choices. You may select a real estate project that fails.
How likely is that?
Hard to say. These platforms are supposed to vet the investments that make it onto their website. It is certainly in their best interest to do a good job. Nothing will kill a platform faster than a lot of investments that don’t pan out.
But even if the platform does its best to screen for solid investments, you can still make poor choices because you have limited information other than what is in the offering memorandums they provide. We already discussed the limitations of those documents.
But there are ways to mitigate this risk.
You can protect yourself by diversifying your investments (more on that later). You can also choose a platform that has a strong record of performance. Of course, past performance is not an indicator of future returns, but there is a reason why all of these platforms tout their past returns.
Rental property investing also comes with risk of loss. Your property’s value could go down if your neighborhood deteriorates. You could get a bad tenant that trashes your place or fails to pay. You could be hit with repair costs as things break down. Or you could be facing a long vacancy after a tenant moves out.
There are ways to mitigate against these things happening, like buying a property in a neighborhood that is stable or growing and that attracts desirable tenants.
You can also assemble a team of contractors that can quickly and affordably take care of repairs and maintenance issues. Or you could hire a superb property manager who will professionally manage that stuff for you.
Ultimately, your risk of a huge loss in rental property investing (assuming you buy a high-quality property) is pretty remote because you still own the underlying property, which has intrinsic value and can be sold for a lot of money.
For that reason, I give the edge to rental property investing.
Liquidity
Speaking of selling for a lot of money, let’s discuss liquidity.
Neither option is great here.
Most real estate crowdfunding investments have multi-year investment horizons. Normal holding periods are between 3-10 years.
Source: fool.com
Some allow you to get out of your investment early, but they are usually careful to avoid making guarantees that there will be a market for your shares if you want to sell them.
Rental properties are also not very liquid, but they are more liquid on average than crowdfunding investments. You are not constrained by holding periods. You can sell whenever you want.
It may take a few months to complete the transaction, but you should be able to liquidate your investment without much fuss if you bought in a desirable neighborhood (as you should).
Diversification
Real estate crowdfunding is the clear winner here. Due to its lower minimum investment requirements, you can spread your money across a variety of real estate assets.
In addition to investing in different properties within an asset class (like apartments), you can invest across asset classes (invest in an apartment, shopping center, office building, etc.). This can further diversify your portfolio and reduce your risk.
In contrast, with rental property investing you are usually buying one property at a time. That gives you very little diversification. Of course, you will be able to diversify as you acquire more properties, but that usually takes some time.
Conclusion
So that concludes our comparison.
Who won?
They tied in the number of categories they won, so I think the answer is going to turn on what factors are more important to you.
If you want convenient, low-cost, passive investing, and the ability to easily diversify your investments, then real estate crowdfunding is the clear choice.
If you want more control over your investment, reliable cash flow and profits, and direct ownership of your real estate without any restrictions, then rental property investing may be the better choice for you.
