If you’ve been reading up on the latest developments in the commercial real estate industry, then you’ve most likely come across the concept of crowdfunding as a real estate investment option. It’s definitely an industry buzzword right now and has caught the eyes of many an investor, especially those who are new to the game. But, is it really a better option than traditional commercial real estate investments with tangible assets? In this article we take a look at some facts and fallacies about these two very different ways of getting involved in the commercial real estate game.

Crowdfunding

Let’s begin with crowdfunding, since it’s one of the more talked-about concepts in CRE lately. What is crowdfunding? In a nutshell, crowdfunding platforms allow small investors to directly invest in real estate deals, without having to purchase any physical property.

Platforms such as Fundrise, CrowdStreet and RealtyMogul have enabled developers to raise money to acquire and develop real estate, and it enables individual investors to invest directly in real estate deals.

This makes it easier for the newbie or small investor to obtain diversification in their portfolio. Projects are ready-made and managed through various real-estate agencies or platforms like those mentioned above. Pricing, market analysis, and associated research is done by all of the parties looking to raise funds, so the investor doesn’t have to do any of that work, as would be required for investment in a physical property on one’s own. In addition, the investor doesn’t have to work to find tenants, maintain or supervise the property. It’s quite a hands-off, passive investment.

From a risk and cost perspective, crowdfunding lessens the risk for the investor by allowing them the ability to spread their capital over several properties than in just one. Often, the buy-in is significantly lower, some as low as a $5000 initial investment.

That said, there are some drawbacks to CRE crowdfunding. For example, not having the responsibility of finding tenants and overseeing the property itself means that the investor has less control over how the property is managed. The investor must trust the developer/operator to do that successfully.

Another major risk of crowdfunding that also differentiates it from traditional REITs is the fact that the investments are illiquid and not traded, which may come as a surprise to some. So, it is nearly impossible to cash out of an investment quickly. Additionally, there is significantly less regulation among crowdfunded real estate investments, such as requirements for how much rental income is disbursed to investors.

Crowdfunding may sound like an ideal opportunity for someone looking to add real estate to their investment portfolio, and in truth it is ideal for some. However, when looking to invest in this manner, it’s important to do your due diligence and have a thorough understanding of your minimum investment, what returns you are guaranteed and what your exit options are.

Tangible Commercial Real Estate

Actually purchasing a commercial real estate property is quite different than investing in crowdfunding or REITs. It offers different benefits and opportunities, but along with that, unique risks.

Commercial property offers the investor the ability to enjoy faster appreciation of asset value and cash flow. This is because commercial real estate tends to appreciate more quickly than other investments due to factors such as supply and demand imbalances. Additionally, an investor can make improvements to the property that increase its value and desirability. This is one key difference from crowdfunding, where the investor has no control over the physical asset itself.

Additionally, owning a physical property gives the investor a tangible asset. While there may be ups and downs in valuation, the property will always be there. When investing in a crowdfunded property, an investor runs the risk of a development project not being completed, or experience a loss based on mismanagement of the project by those raising the funds. Again, the control is not with the investor when it comes to crowdfunding.

Owning a physical property also enables the investor to regulate his/her own earning potential through the tenants of the property. Whereas in a crowdfunding situation, the fundraiser determines the payout of the investment, when an individual purchases a property, he/she can control exactly how much revenue is obtained.

Another huge benefit of owning tangible property are the tax advantages. A rental property has the benefits of depreciation, enabling it to generate positive cash and a tax loss at the same time. Additionally, rental properties can defer capital gains taxes through a 1031 exchange – something that is not available through crowdfunding investments or traditional REITs.

One may argue that to own a property means being actively involved in the day to day functions of the property, thereby making it less of a passive investment. However, with the abundance of property management companies in the industry, an investor is sure to find one suitable for handling the day-to-day operations.

With all of the benefits of CRE, there are still some risks and challenges. When purchasing a property, the investor must do much of the research him or herself. Many factors need to be explored, such as the history and condition of the property itself, the local real estate market, price fluctuations and future plans for the area.

There is also a bigger investment risk than a diversified portfolio one would have with crowdfunding or REITs. A large portion of one’s money is invested into one property. Typically, having more investments equals lower risk. On the flipside, however, is that lower risk usually enjoys lower returns.

Regardless of what type of investment an individual chooses to pursue, the fact of the matter is that one must be very clear about his/her goals with the investment, and what he/she can actually afford or manage. Each type of investment has its benefits and drawbacks, so due diligence is critical to achieving success with either option.

What are your thoughts about crowdfunding vs. tangible investments? Share your thoughts in the comments below!