Commercial real estate investing can be an excellent way to grow your nest egg, although it’s not without risks. The big risk? Commercial real estate requires large amounts of upfront capital to purchase a property. In order to properly diversify your portfolio, you should own multiple properties, various types of properties (e.g., apartment complexes, strip malls, office space, etc.) and in multiple locations.
One avenue for the small investor who wishes to invest in commercial real estate is through a REIT (real estate investment trust). As you may know, a REIT owns and manages income-producing real estate.
By pooling the funds of many individual investors, the REIT can purchase a diversified mix of commercial properties — such as office buildings, shopping centers, hotels and apartments — the typical investor might not otherwise be able to purchase individually.
One type of REIT, an exchange-traded REIT, is available through any broker; as the name implies, their shares trade on the securities markets. Exchange-traded REITs have a few downsides, however. For one thing, their performance is heavily correlated with the broader stock market.
A lot of factors contribute to daily market ups and downs that have nothing to do with the value of the real estate assets the REIT actually owns, yet the value of REIT shares fluctuates with the market. If you’re looking to diversify your portfolio with real estate to insulate you from stock market risk, an exchange-traded REIT is not going to do the trick.
Non-traded REITs are also registered investments, and while they are subject to the same SEC requirements an exchange-traded REIT must meet, they are not directly correlated with stock market fluctuations. Two downsides: There isn’t the same liquidity since they are not traded on the markets, and front-end fees are even higher than exchange-traded REITs.
As you can see, the main differences between exchange-traded and non-traded REITS have to do with liquidity and fees:
|Non-Traded REITs||Exchange-Traded REITs|
|Not listed on a national securities exchange.||Shares trade on a national securities exchange.|
|Limited secondary market.||Exchange traded. Generally easy for investors to buy and sell.|
|Front-end fees that can be as much as 15%.||Front-end underwriting fee may be 7% or more plus brokerage commission.|
Front-end fees for both types of REITs are substantial — and that’s where Fundrise steps in.
Fundrise started out as a crowdsourced real estate investing service primarily for accredited investors but has recently changed its business model. They have developed and are offering a hybrid product, the eREIT™.
Fundrise’s eREITs are most similar to non-traded REITs. The difference is fees. When you invest in a Fundrise eREIT, you don’t go through a broker. You’re buying directly from the issuer. That allows Fundrise to dramatically reduce the fees. There’s no middleman, so there are no upfront fees or commissions. And rather than paying a front-end load of 7%–15%, Fundrise charges just a 1% annual asset management fee.
The minimum investment is just $1,000 for Fundrise eREITs, and you don’t have to be an accredited investor to participate. Shares of the eREITs are purchased exclusively online, and Fundrise members receive notifications when new assets are added to the eREITs.
As of August 11, 2016, Fundrise was offering two types of eREITs:
- Income eREIT™ – focuses on debt investments in commercial real estate assets, which are held for their steady cash flow. Returns are fixed and paid throughout the term of the investment. The Income eREIT paid an annualized dividend equal to 10% for the second quarter 2016, assuming a $10 per share purchase price.
- Growth eREIT™ – invests in equity ownership of commercial real estate assets and is inherently more risky, with a correspondingly higher anticipated reward. Returns are variable and are paid at the end of the investment term. The Growth eREIT paid an annualized dividend equal to 8% for the second quarter 2016, assuming a $10 per share purchase price.
For the launch of their eREITs, Fundrise offers an “accountability policy” that’s far from industry standard:
- As an investor in their Income eREIT, you pay $0 in asset management fees unless you earn at least 15% annualized return during the first two years of operation, until December 31, 2017.
- For their Growth eREIT, Fundrise will pay a penalty of up to $500,000 to investors if it earns less than a 20% non-compounded annual return.
Fundrise is not a newcomer to real estate investing, and their team has experience from many areas of the real estate marketplace. In 2015, they had $525 million in real estate assets under management and provided an average annual return of 13% net to their investors.
Each property goes through a rigid screening process, and only 2% of investments are approved for inclusion in their eREITs.
- Start With Little Capital — The minimum investment is $1,000.
- Low Fees — Fundrise charges a 1% asset management fee per year.
- Access to Commercial Real Estate in Small Investments — Commercial real estate is typically a high-dollar investment, whereas Fundrise allows you to invest with little money.
- Passive Investment — Unlike owning your own commercial real estate outright, Fundrise investments are truly passive.
- Quarterly Redemptions and Distributions — The Fundrise eREIT™ has adopted a quarterly redemption plan to provide periodic liquidity; however, distributions are not guaranteed.
- No Accreditation — Unlike competing firms, Fundrise, is open to any investor in the United States regardless of income or net worth.
- Fundrise Accountability Guarantee — Unheard of in the investment industry, Fundrise is offering to waive the asset management fee if investors don’t make at least 15% on their Income eREIT, and they’ll pay out up to $500,000 on their Growth eREIT if investors don’t gross 20% or more.
- Investment Liquidity — Once you make an investment, you are pretty much committed to the investment for the term. There is currently no secondary market to sell your investment to others; however, there is a quarterly redemption program whereby investors may be able to redeem their shares, subject to some limitations.
- Tax Consequences — Distributions are taxed as ordinary income, as opposed to the 15% tax rate on qualified dividends.
- REITs are Not Publicly Traded — REITs are best suited in tax-deferred accounts, whereas Fundrise might have advantages in taxable accounts.
- Real Estate Risk — There are risks associated with both the real estate market as a whole and any subset of the market where a particular REIT concentrates. While REITs as an investment class may help diversify your portfolio, putting all of your intended real estate investment into one REIT — including investments in different issuances or phases of the same REIT — can expose you to the risk of under-diversification.
Real estate as an asset class is a long-term investment. This includes REITs, whether they are publicly traded, non-traded or eREITs. The opportunities for capital appreciation, portfolio diversification and regular distributions are alluring; however, distributions are never guaranteed.
While not exactly the same as investing in real estate directly, it is much more passive and allows you to invest in properties outside your geographic location. Fundrise can be a way to diversify into real estate without the large amounts of capital or management headaches involved when doing it yourself.
While I am a real estate investor, REITs have never appealed to me for several reasons — primarily because of the front-end load and ongoing fees. Fundrise takes the sting out of those investing fees with its 1% asset management fee.
And their unique accountability guarantee is a breath of fresh air in the investment marketplace. Every investor I know would fully agree with this statement on their website: “Today’s model of investors paying large fees to investment managers regardless of their performance makes no sense.”