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So far, we’ve covered the 5 ways to make money in real estate, we showed how residential real estate is an effective inflation hedge & portfolio diversifier, we talked about the real intrinsic value that real estate offers, & we dove into all the risks associated with a rental property.
We’ve come to the final part of this 6-part series on residential real estate investing. The final consideration for a prudent investor is the % of your portfolio that should be allocated towards an investment & which avenue you prefer: Physical, crowdfunded or REITs.
Summary
- Buying physical properties yourself is quite expensive & can be risky
- Only you, or someone who intimately understands your personal financial situation & goals, can determine the right allocation to real estate for you but 10-20% is reasonable for most people.
- You’d need $1.25-2.5M in assets for a single $250k investment property to make up 10-20% of your portfolio
- Otherwise, you could be over exposed to real estate & a single property at that
- 2 main ways around this
- Crowdfunded real estate investment platforms
- Real estate investment trusts (REITs)
- They both allow you to access the real estate market without the huge upfront costs
- There are many pros & cons though so make sure you do your due diligence
Here comes the cop out…I can’t say what is right for you because:
- I’m not you
- I don’t know your financial situation
- I don’t know your required rate of return to meet your financial goals
- I don’t know anything about your ability &/or willingness to take risk
This is a decision you’ll have to make, but like I said in my intro into alternative investments article, I think 10-20% is appropriate for most people. Especially for real estate due to its long track record & true intrinsic value.
Physical Real Estate
Having said that, buying physical real estate presents one major challenge when it comes to deciding on an allocation %.
Because houses are so expensive, a single investment property immediately becomes a very large portion of your portfolio.
For example, if you have $50k in assets & you buy a $250k investment property, real estate immediately becomes an 83% allocation in your portfolio.
If you have $100k in assets, it’s still 75%, & at $500k it’s 33%.
You’d have to have assets of $1.25 – 2.5M for it to meet the 10-20% range.
The good news is there are a couple ways around this: crowdfunded/shared real estate platforms & REITs.
Shared/Crowdfunded Real Estate Platforms
Platforms such as Fundrise & Realty Mogul pools money from many different investors which allows each investor to contribute a much lower amount compared to buying the whole property yourself.
This makes it much easier to meet your desired allocation % to real estate.
Pros & Cons of Crowdfunded Real Estate
Pros
- Lower initial investment which means less risk
- More control over your allocation to real estate
- Potential for better diversification
You can invest in multiple properties for the same cost of the down payment on a single property that you finance yourself
- You don’t have to deal with the usual landlord duties
- Much less paperwork & time requirements as they handle all that for you
And you can do everything from the comfort of your own home.
- The due diligence on a property has been done for you
Of course, you should always do your own due diligence but the crowdfunding site can distill the information down for you, & provide a few key metrics to review. This way you can quickly decide which offering works best for you.
Cons
- No legal ownership of any part of a property
You simply own shares in an LLC or special purpose vehicle which owns the property. You only have a claim on the cash flows & the proceeds from the sale of the property.
- Illiquidity
You may not be able to get your money out for several years. If a platform does offer a way out of the investment before the end of the contract, you’ll pay fees out the nose to get out.
- Management & advisory fees
- You don’t have any say so into the management of the investment/property
- Many platforms work with accredited investors only
To be accredited, you have to have a net worth over $1 million (excluding your primary residence) or an income over $200k per year ($300k with your spouse).[2]
The platforms that offer investments to non-accredited investors include Streitwise, Fundrise & Groundfloor.
Real Estate Investment Trusts (REITs)
With REITs you’re investing in the stock of a real estate firm that buys the physical real estate & manages it for all the shareholders.
You make money from REITs in 2 ways:
- Changes in the price of the shares of the REIT
- Dividends
Most REITs pay a dividend yield higher than the average stock because they get tax benefits if they pay out at least 90% of their taxable income.[1]
Pros & Cons of REITs
Pros
- Easier & better diversification
The options are much greater than with the crowdfunding platforms. You can invest in residential, commercial, industrial, medical & many more types of real estate. [1]
Additionally, each REIT will own dozens, if not hundreds, of properties across multiple states or even countries.
Lastly, you can invest with tiny amounts of money which increases the variety of properties you own & limits your potential capital loss.
- Much higher liquidity
They trade like stocks so the liquidity is much higher than many of the crowdfunding platforms which can require you to stay in the investment for several years or pay a hefty fee to get out.
- The potential for much higher returns
Most REITs are publicly traded securities so along with the nice dividend yield, you could recognize a 20%, 30%, 50%+ increase in the share price. This is nearly impossible with a crowdfunded property investment.
- low fees, usually
Usually you are charged a % of amount invested just like a mutual fund or ETF. From my experience the range from 0.3%-1% of assets but pay attention because some charges fees as high as 2%.
Cons
- They are funds
This creates a situation where you can lose money when other investors sell their shares even if the price of the underlying real estate stays the same. This is less of a possibility with crowdfunded sites where you buy a portion of the actual real estate. And it is eliminated entirely when you own the whole property yourself.
- They’re highly leveraged
Because buying physical property is so expensive, REITs have to use a ton of debt to finance their investments & operations. This exposes investors to a ton of market & interest rate risk that can easily blow up.
- Dividends are taxed as income rather than at the long-term capital gains rates
- You need to learn about new financial & performance metrics like funds from operations (FFO), adjusted funds from operations (AFFO) & more.
- There can be high fees if you don’t pay attention
Depending on your goals & your desire for liquidity, it’s up to you to decide which method of real estate investing is right for you. I prefer the physical real estate route myself because of the ownership of the actual property & the access to large amounts of leverage to amplify your returns.
Now that you have all the information around the benefits & risks of real estate investing, you are equipped to make an informed decision on this topic. If you need a refresher on any of the topics we’ve discussed, you can go back & read the 1st 5 articles in this series.
5 Ways to Make Money in Real Estate
Is Residential Real Estate an Effective Inflation Hedge?
Can Residential Real Estate Help Diversify a Stock Portfolio?
The Intrinsic Value of Real Estate
The Risks of Real Estate Investing
Otherwise, get out there and find an investment property, start building your financial wealth & move closer to financial freedom.
Or not.
Whatever you decide, I wish you the best on your journey.
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Leif Mullican
Leif is a 18 year financial services professional with expertise in finance, economics and financial/business analytics. His passions are his children, drums and healthy living. He started Adaptable Wealth to provide basic financial education while promoting a holistic view of wealth that includes your money, your health & your time. Too many people prioritize their money over their health & their time, & regret this decision once it's too late. You can reach out to him through LinkedIn, Twitter & YouTube by clicking the social platform links listed throughout this post. You can also email him at AdaptableWealth@yahoo.com
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