Taking a Passive Approach to Real Estate Investing
Discover ways to create wealth in real estate, including branching out to other types of property or owning real estate through REITs and crowdfunding.
A notion often attributed to Andrew Carnegie is that 90% of millionaires created their wealth through real estate. Whether or not the industrialist and philanthropist uttered such a thing, real estate—in various forms—has been a key wealth creator for investors over the past two centuries.
Today, most individual investors associate real estate investing with owning rental property, but there are more ways to create wealth in real estate, including branching out to other types of property or owning real estate through REITs and crowdfunding.
Pros and Cons of Real Estate Investing
The benefits of investing in real estate are well known. This asset class acts as an inflation hedge, provides regular income through rents and leases, offers a diversification benefit and, generally, price appreciation over time.
Like any investment, however, there are potential downsides. Investing directly in real estate means the investor owns hard assets, as opposed to a traded stock. While property prices tend not to zig and zag with daily market fluctuations, illiquid hard assets can tie up capital for years. Meanwhile, owning such assets managing the property, covering the maintenance, taxes and other expenses.
All of that said, there are ways to invest in real estate today that alleviate some of the downside, leaving the investor with an investment that is easier to manage and offers more liquidity.
REITs Offer Access and Liquidity
Owning real estate through REITs, or, real estate investment trusts, takes away the burden of managing properties and introduces a market model with which many stock investors are already familiar.
REITs are traded like stocks, making them liquid real estate investments that often have relatively low correlations to the broader stock market. Investors tend to seek safe harbor in REITs when high-flying tech stocks cool, which adds diversification to an overall portfolio—plus dividend income to boot.
One knock against REITs is that investors don't directly participate in capital appreciation—though their value does reflect the market's view on the prospects of the underlying property. REITs are structured to return 90 percent of income to investors, so no meaningful amount gets reinvested to grow the portfolio. REITs don't have the same tax-advantages as owning real estate directly and then can entail high fees for management and transactions.
While many REITs own diversified portfolios of properties, they increasingly make it possible for investors to access specific segments of the real estate market, including health care facilities, warehouses, and timberland. Two segments that offer a different take on real estate are data centers and self-storage.
Every time we turn on a TV, a computer or a smartphone, we are using data. With the growth of always-on smart connected household appliances, data is, even more, a hot commodity. International Data Corporation predicts that global data will more than triple by 2025.
All of this data, however, needs to be processed and stored somewhere. Data centers are being built across the globe to accommodate the quickly growing demands for data. The data center construction market was valued at $20.1 billion in 2019 and is expected to reach a value of $32.5 billion by 2025, with a combined annual growth rate of 8.34 percent.
The argument for investing in data centers is that their growth is not tied to consumer spending, and they offer access to a unique segment of the market that continues to grow.
Low maintenance and high returns. Self-storage is a real estate play without most of the challenges associated with managing rental homes and tenants. They are simple steel sheds that are rented for low monthly rates and with low risk. If a storage tenant doesn’t pay rent, the owner can seize and auction the contents of the unit. Demand is based largely on life events such as marriage, divorce, renovating, relocating and downsizing.
While some high-net-worth individuals opt to buy self-storage units outright—in part because they don’t require a great deal of maintenance—self-storage REITs have an added diversification benefit since managers can own units across many markets.
Crowdfunding Real Estate
Crowdfunding real estate is a newcomer that has shown lots of potential for real estate investors. Crowdfunding is a web-based system that allows investors to pool their assets to invest directly in property.
The segment is small but growing, with the World Bank predicting that global crowdfunding will grow to $93 billion by 2025.
Like REITs, crowdfunding allows individuals to invest in multimillion-dollar commercial deals they wouldn’t have access to otherwise; minimum investments can be as low as $5,000. But investors in crowdfunding real estate act more like small private equity investors for the developer of one property and can earn rental income plus ownership payout in the sale of the building.
The advantages of crowdfunding real estate is that it allows investors to take positions in single properties based on their risk profiles and investment objectives. In some cases, the small scope of each project provides direct access to the business plan and developer behind the deal. The potential for short-term cash flow and longer-term capital gains is different than owning a REIT.
Crowdfunding in real estate is still seen as a relatively illiquid investment. You can be stuck in so-called target investment periods of three to five years and make no income until the end of that period.
In any form, real estate investments can be a key component for preserving and growing wealth. While owning property outright is one way to gain exposure, new avenues have opened up, making this asset class more accessible.