Real Estate Crowdfunding vs. Private Equity Firms
There are more ways than ever to invest in real estate assets. REITs, real estate company equities, fractional ownership through crowdfunding, and private equity firms all offer varying levels of risk and reward and present innumerable opportunities for retirement savers to use real estate to generate returns while diversifying their investment portfolios.
Often, when presented with too many choices, many of us suffer from decision fatigue- but don't worry- in the following article, we will take an in-depth look at two of those categories: real estate crowdfunding and private equity funds- and help you decide if one of them may help you achieve your investment or retirement goals.
What is Real Estate Crowdfunding?
Real estate crowdfunding is a simple concept. Investors purchase fractional shares in real estate development projects or assets alongside other investors to benefit from the subject property's cash flow, appreciation, or to flip the property to generate immediate returns. Crowdfunding real estate deals have existed since the birth of the modern real estate markets, but really came into their own after the passage of the 2012 Jumpstart Our Business Startups Act, or JOBS Act.
That legislation widened the pool of eligible investors for crowdfunding projects, as well as streamlined the process for developers/financial managers to solicit crowdfunded capital. These regulatory changes, alongside the rise of digital crowdfunding platforms, has led to an explosion in the popularity of crowdfunding projects among accredited investors.
Why Choose Real Estate Crowdfunding?
Real estate crowdfunding offers investors the ability to benefit from the myriad cash flow, appreciation, and tax benefits of real estate investments, without many of the hassles that come along with acquiring, maintaining, and managing commercial properties. In addition, the process for investing in crowdfunding projects is significantly more streamlined than traditional real estate investment- many crowdfunding sites act as "one-stop shops" that provide investment listings, due diligence relevant to the property and the region in which it sits, as well as other related services to help investors find the investment that works for them.
In addition, crowdfunded real estate projects allow investors to take advantage of economies of scale, without having to deploy the capital necessary to make large-scale property acquisitions, for example, buying a fractional share in a large office tower rather than having to purchase or finance that building alone. Crowdfunding may also allow investors to diversify their real estate holdings by the individual property, region, property type, or any number of characteristics, which is much harder to do when investing in individual properties. Rather than deploying all of their capital in a single investment in a single area, retirement savers can invest across properties and regions using crowdfunding shares.
What is Private Equity Real Estate?
Private equity is a real estate asset class that is comprised of pooled public and private investment in commercial properties. Investors deploy capital in private equity real estate by acquiring, financing, and managing real property within a pooled investment vehicle. Private real estate equity funds first gained a significant following in the early 1990s, as the property market saw a contraction, which led many institutional and retail investors to group together to attempt to pick up these assets at a discount. Over time, they have become a significant force in the property markets, as well as the global financial market as a whole, with over 900 billion in capital invested in private equity funds in 2018.
When investing in private equity real estate, investors should have both significant capital access ($250k or more) as well as the ability to hold on to the investment for a longer-term than traditional equities. In addition, private equity real estate offers less liquidity than other investment classes, due to the typical capital commitment window, which can often be multiple years long. Lock-up periods are also a key feature of private equity investments- these terms can range as high as twelve or more years until that capital is accessible. Investor distributions tend to be paid directly from the property's cash flow, rather than liquidating the asset, which makes them smaller and slower than other forms of investment income.
Why Choose Private Equity Real Estate Investments?
Although these assets restrict flexibility and have low liquidity, for investors willing to sacrifice these qualities, there are substantial potential returns on investment for private equity real estate assets. As time passes, these properties generate income from rents as well as possible price appreciation when the asset is sold at the end of the holding period. These investments are not for everybody- the vast majority of private equity real estate investments are made by institutional (large-scale) investors like pension funds and nonprofits, or financial managers acting on behalf of large financial entities like banks or hedge funds. Private accredited investors and high-net-worth individuals are also regular investors in the private equity sphere.
Returns for private equity real estate investment range between 6 and 8 percent for core strategies, and go all the way up to 8 to 10% for core plus investment strategies. Value-added or market-specific strategies can outpace even 10% annually, which is typically higher than many other real estate investment sectors. With this additional return potential also comes risk- the wrong investment can lead to a loss of capital, which is also not as common among lower-performing, lower-risk real estate assets.
Crowdfunding and Private Equity- Which is Better?
Both of these investment avenues have their benefits and downsides. Crowdfunding investments tend to be more accessible, especially for those with less experience in the property markets. They tend to offer more diversification potential than private equity and offer a measure of control over the investment that is harder to achieve (though not impossible!) with private equity investments.
Private equity investments provide substantial returns and often have the benefit of professional financial management at the highest level- but their risk profile, alongside long holding periods, makes them less ideal for many investors-especially if you are looking at a short-term investment horizon and need liquidity within your investment. As with any investment, retirement savers need to take into account their risk profile, desired returns, and liquidity needs before deploying capital in either crowdfunded or private equity real estate investments.