Discover alternative strategies for real estate investment in our comprehensive guide on indirect investments in real estate. Learn how to invest in real estate without buying property directly, explore crowdfunding platforms, REITs, syndications, and more!
Investing in real estate has long been viewed as a smart move for growing wealth and generating passive income. However, not everyone has the means, time or desire to deal with the headaches that can come with being a direct landlord. Fortunately, there are numerous ways to gain exposure to the real estate asset class without having to buy physical property. These alternative real estate investments provide investors with the benefits of real estate investing—diversification, income, appreciation—without the responsibilities and risks of owning the actual real estate. This post will explore some of the most common ways to indirectly invest in real estate.
Real Estate Investment Trusts (REITs)
Real estate investment trusts (REITs) make it possible for everyday investors to include real estate in their portfolios. A REIT is a company that owns, operates or finances income-producing real estate. Some focus on one property sector—for example, apartments, malls, office buildings, hotels—while others own a diversified portfolio. REITs are structured similarly to mutual funds. They allow investors to essentially buy shares in a portfolio of real estate assets. Like stocks, REIT shares trade on major stock exchanges and can be bought and sold daily.
Owning REITs provides a share of the income produced through real estate ownership without having to go out and buy, manage, and finance properties yourself. REITs also provide investors exposure to the potential for real estate appreciation. In exchange for these benefits, REIT shareholders bear a portion of the risks involved in real estate investing.
There are a few different types of REITs to consider:
Equity REITs – The most common type, they own and operate income-producing real estate. Most of the earnings paid to investors comes from rents.
Mortgage REITs – They provide money to real estate owners and operators either directly in the form of mortgages and loans, or indirectly through the acquisition of mortgage-backed securities. Their earnings come mostly from interest earned on mortgage loans.
Hybrid REITs – As the name suggests, these REITs use the investment strategies of both equity and mortgage REITs.
When assembled into a diversified portfolio, REITs can provide stable dividends, growth potential, and a hedge against inflation.
Real Estate Exchange Traded Funds (ETFs)
Real estate ETFs function much like REITs, but with some different nuances. An ETF is a basket of securities—such as stocks, bonds, commodities—that trades on an exchange like a stock. Real estate ETFs own portfolios of REITs and real estate stocks rather than direct ownership of properties.
The advantages of real estate ETFs versus investing in individual REITs include:
Increased diversification – Real estate ETFs hold a basket of REITs and real estate stocks spread across different companies, sectors and geographies. This helps reduce firm-specific and sector risk.
Lower expenses – Owning just one ETF that provides broad real estate exposure can be cheaper than owning multiple individual REITs.
Liquidity – ETFs trade throughout the day like stocks, whereas REIT shares only trade once a day after market close.
Simplicity – Analyzing and picking individual REITs takes time and real estate knowledge. Real estate ETFs provide exposure through one simple investment.
Some things to keep in mind are that real estate ETFs do not own actual property, they may occasionally track an index less efficiently than a REIT portfolio, and there are still expenses involved in ETF ownership. But for most individual investors, real estate ETFs present an easy way to gain diversified real estate exposure.
Public Non-Traded REITs
Public non-traded REITs are products that straddle the line between traditional publicly registered REITs and private real estate investments. Like publicly traded REITs, they must register with the Securities and Exchange Commission (SEC). However, their shares do not trade on national stock exchanges. You can only buy shares directly from the company, usually through a broker or investment adviser.
The illiquidity of public non-traded REITs allows the manager to take a longer-term investment view without worrying about daily public pricing. The manager is able to acquire assets, optimize the portfolio, and sell at opportune times. Daily share prices don’t fluctuate with market swings.
While public non-traded REITs provide portfolio diversification and a reasonably stable income stream, they also carry significant risks not found with publicly traded REITs. First, they have no public market, making shares difficult to value and sell. It may be years before the REIT undertakes a liquidity event. Investors often pay high upfront fees, and early redemption of shares is usually restricted.
Do thorough due diligence before investing in a public non-traded REIT. Make sure you understand the investment strategy, portfolio composition, risk factors, and the manager’s track record. Also research what timeframe the company intends to provide liquidity.
Real Estate Private Equity Funds
Real estate private equity funds are pooled investment vehicles that give accredited investors exposure to privately owned real estate assets. They allow individual investors to contribute money alongside institutions like pension funds and endowments to acquire large real estate properties or portfolios.
Private equity real estate funds come in two main structures:
Core – This lower risk strategy focuses on stabilized or slightly underperforming assets such as multifamily, industrial, office and retail properties. The goal is consistent income and slow, steady growth.
Value-added/opportunistic – These higher-risk strategies target repositioning underperforming properties through upgrades like renovations or better management. Returns rely more heavily on asset appreciation.
Basically, private real estate funds allow pools of individual investors to participate in institutional quality real estate deals that would otherwise be inaccessible. In exchange for capital, investors receive a stake in the fund’s performance.
Benefits of private real estate funds include portfolio exposure to privately owned real estate, diversification away from the public market, and potential for attractive risk-adjusted returns. Drawbacks are high investment minimums, fees, and extended lock-up periods. Investors have limited control over investment decisions.
Thorough due diligence is vital when investing in private real estate funds. Make sure the manager has a proven record over full market cycles. Look at their experience executing the stated strategy. Understand the expected holding periods, target returns, capital calls, liquidity options, and fee structure.
Real Estate Crowdfunding
Real estate crowdfunding pools money from multiple investors through online platforms. The capital is used to fund small to mid-sized real estate projects that historically have only been accessible to institutional investors and high net worth individuals.
Usually, a developer or real estate company will pitch an investment opportunity on the platform. Then individuals can browse active deals and contribute as little as $1,000 towards one they like. The crowdfunded capital is used to purchase or renovate a property. Investors receive a portion of rental income and a cut of proceeds when the asset is sold.
Compared to REITs and real estate funds, the benefits of real estate crowdfunding include:
Lower investment minimums – Open participation to non-accredited and small investors.
Pre-vetted deals – Platforms review and select opportunities on behalf of their investor network.
Transparency – View detail on each investment’s business plan, projections, property information and loan terms.
Simplicity – Browse and select investments through an easy online dashboard.
Keep in mind that crowdfunded deals are highly illiquid investments with 3-5 year holding periods. Conduct thorough due diligence on the sponsor’s background, performance history and current business plan. Make sure you understand the market fundamentals behind each deal and the risks involved.
Options for Indirect Real Estate Investing
The opportunities to invest in real estate without becoming a landlord or property developer have expanded greatly in recent years. Investors now have easy access to:
REITs – Gain exposure to portfolios of real estate by purchasing publicly traded shares. Choose between specialized or diversified strategies.
Real Estate ETFs – Provide a low cost, diversified basket of real estate securities through a single ticker. Index-based exposure allows for passive investing.
Public Non-traded REITs – Pool investor capital to purchase privately held real estate while offering daily pricing. However, shares have limited liquidity prior to major corporate events.
Private Real Estate Funds – Allow accredited investors to contribute to institutional quality real estate deals alongside major limited partners. Lock-up periods limit liquidity.
Real Estate Crowdfunding – Enables individuals to browse and invest small amounts into curated, pre-vetted real estate projects online. Offerings are illiquid but provide portfolio diversification.
Adding exposure to real estate can be a smart move for investors seeking diversification, income and growth. Thankfully, the options abound for gaining those benefits without having to directly buy or manage property yourself.
Key Takeaways: Investing in Real Estate Without Owning Physical Property
Real estate provides portfolio diversification along with potential for regular income and long-term appreciation.
REITs offer liquid, diverse real estate exposure without having to buy or manage property.
Real estate ETFs provide low cost access to portfolios of real estate stocks and REITs.
Private real estate funds allow pooling capital for institutional commercial real estate deals.
Crowdfunding opens real estate investing to small investors through online platforms.
Indirect investments provide many benefits of real estate ownership without the headaches of being a landlord.
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