Which Is Best: REITs or Real Estate Crowdfunding?

If you’re seeking the benefits of investment real estate but not in the market for the expense and workload of buying and managing rental properties, real estate investment trusts and real estate crowdfunding are ways to become a landlord.

The REIT title act, signed by President Dwight Eisenhower in 1960, created REITs to give the average investor access to income producing real estate. Today, anyone with a few thousand dollars or less can buy a REIT exchange-traded fund or invest in a real estate crowdfunding platform.

[Read: Everything You Should Know About REIT Investing.]

Real estate is an asset class with high returns and a hedge against inflation. Since real estate is inversely correlated with conventional assets it can diversify your investments away from a volatile stock market. Since 1971, the average total annual return for the FTSE Nareit REIT index, which tracks the performance of all U.S. REITs, is 9.72 percent.

According to NAREIT, the center for REIT education and information, REITs are similar to mutual or exchange-traded funds that invest in real estate instead of individual company stocks. REITS come in many varieties and sectors including office, retail, lodging, self-storage, data center, mortgage and more.

For the minimalist investor, the popular Vanguard Real Estate Index Investor (ticker: VGSIX) mutual fund owns a cross section of the entire U.S. real estate market.

What is real estate crowdfunding? Real estate crowdfunding is the newest member of the real estate investing party and offers investors the chance to craft their own specialized real estate investment portfolios. “Real estate crowdfunding provides investors the ability to individually select each property they wish to invest in. This allows investors to be more selective on a project-by-project basis and build a custom portfolio aligned to their specific investment objectives,” says Matt Rodak, CEO of Fund That Flip, a real estate crowd- funding platform for residential real estate investors that matches investors and borrowers with funding.

Real estate crowdfunding gives individual investors the opportunity to invest in certain real estate markets that were previously off limits, such as commercial real estate, says Gilbert Trout, director of investment real estate at Trout Daniel & Associates in Maryland.

Even if you could scrape together $50,000 or $100,000 and invest in a $500,000 four-family apartment building, it’s unlikely that you’d be able to get funding for a $50 million apartment complex. And that’s where crowdfunding comes in. Companies such as RealtyShares, Fundrise and Fund that Flip open the previously closed door to a variety of real estate investments.

[Read: Pros and Cons of Real Estate Crowdfunding for Retirement.]

There’s a path to real estate crowdfunding investing for every type of investor. This infant industry offers a diverse menu of real estate investment options.

“Real estate crowdfunding platforms create access to other, smaller-types of real estate asset classes such as fix-and-flip loans or mid-sized apartment buildings, where there may be less competition and greater potential for higher returns,” Rodak says.

Who can invest in REITs and real estate crowdfunding? The best investors for REITs and real estate crowdfunding might not be the same. Joseph Hogue, chartered financial analyst and owner of Crowd 101, a crowdfunding website, says that although real estate crowdfunding is less work than direct investment in properties, it still involves more due diligence than REIT investing.

“Only investors willing to take the time to review property and investment documents should invest in crowdfunding,” Hogue says. “Those that want a more passive investment should elect to invest in REITs.”

Also, REITs are extremely liquid and are traded daily across the financial markets, while the crowdfunding investing option makes a quick sale unlikely. So, the ease of REIT investing is trumped by the customization opportunities in real estate crowdfunding.

What are the advantages and disadvantages of REITs and real estate crowdfunding? For hands-on investors, who want to customize their real estate investing, crowdfunding fits the bill, says Javier Benson, senior vice president of strategy and implementation at crowdfunding site RealtyShares. RealtyShares specializes in funding commercial real estate projects valued at less than $50 million, certainly not a market for the individual investor.

Benson summarizes the benefits of real estate crowdfunding: “lower fee loads, increased transparency and the opportunity to select individual projects.”

But both REITS and real estate crowdfunding have their drawbacks. The value of your real estate investment can go down as well as up. And REITs typically pay out 90 percent of their income to investors, and that can cause hefty tax bills, if held in a non-retirement account. Finally, some real estate crowdfunding sites such as RealtyShares are only available to accredited investors, with high incomes or net worths. Although, Fundrise and Realty Moguls are open to all investors.

[See: 7 REITs to Buy for Regular Income.]

Ultimately, in a rising interest rate environment, investing in real estate can be a smart move. Interest rates are rising because the economy is strong and that bodes well for the real estate sector. With so many available options, adding real estate to a stock and bond portfolio makes a lot of sense.