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Picking the ideal investment tool: value-added, REIT or crowdsource investment?

Property investors in Western economies have been witnessing a trend of ROI being squeezed over recent years. As such, they are looking for other ways to boost their investment income, whether it be trying to add value to the properties that they already own or purchase new properties with a view to taking on value-added projects; investing in Real Estate Investment Trusts; or tapping into a relatively new and up-and-coming investment tool – crowdsource investment (crowdfunding).

So where should you place your funds to make the most of them? Let Tranio.com give you a walkthrough of the advantages and disadvantages, in addition to the risks that placing funds in these three investment tools entails, so that you can make the right decision for your investment.

Value-added property investment

The most traditional way of investing in property is to purchase property yourself. Many opt for buy-to-let, but with yields falling and investors looking to make a quick profit on their investments, more and more investors are turning to value-added projects. Such projects involve the renovation of property in order to increase its value, with the property then being placed back on the market for resale. The obvious advantage of making this kind of asset purchase means you are the direct owner and so you are able to control every aspect of the project; many find the idea of leaving their day job to pursue a value-added real estate project appealing. However, many underestimate the time and effort needed to complete such a project, as well as the costs involved with employing competent firms to undertake the work for you.

Not only are the aspects concerning the renovation of the property time consuming, but, as Managing Partner of Tranio.com, George Kachmazov, notes: “Owning a property outright means managing its upkeep, rentals and renovation, in addition to closing the purchase and sale. This all takes time”. This length of time may go way beyond expectations due to hidden pitfalls that set the project back. Imagine, for example, your builder not responding to your calls.

Sometimes value-added projects apply to those thinking more long term. For example, a region is identified as promising due to its rising student population, or the early stages of gentrification in the area have been identified. Forward-thinking investors may then decide to purchase property in the hope that their forecasts come true and will subsequently hold onto this investment until their ROI target is met. However, problems may be faced regarding the tenants residing in the property when the owner comes to sell. Such problems may include the tenants’ failure to inform of repairs which need to be completed, or just a general lack of care taken of the property during their tenancy.

Additional risks related to property asset purchasing with a view to creating value-added also include:

  • paying too high a price for the property initially;
  • the cost of repair exceeding expectations;
  • the property selling for too little or sitting on the market for a long time, which will also negatively affect the price.

In the cases highlighted above, time is needed to complete the work necessary and, ideally, experience to get the job done properly wouldn’t go amiss. In such cases, we are talking about experienced property developers who have time and experience, and probably have thought about ways to mitigate risks, namely by having an adequate equity reserve.

So, if you are relatively inexperienced, lacking the cash and time to pursue a value-added project, and don’t want the hassle and hazards which it entails, you may want to assess other options at hand. This also goes for more experienced investors looking for higher yields elsewhere and, with value-added taking too much time, aiming to delegate responsibility to investment managers. This makes placing funds in REITs a great alternative.

REITs

A real estate investment trust is a company that seeks out many different individual investors who are seeking to invest in real estate. the trust then combines the funds from each investor and allocates parts of the aggregate amount into a diversified portfolio of commercial real estate. as such, REITs provide a way for investors to profit from commercial real estate without necessarily having to set aside large amounts of funds, nor having to purchase commercial property outright.

REITs must adhere to strict requirements, which include distributing a minimum of 90% of its taxable income in dividends to investors (in order to avoid paying federal income tax) and having to develop real estate with a view to manage the properties, instead of selling them. This means that the equity class brings higher yields since the business model is based on perennially increasing capital from equity and debt markets to broaden its portfolio of revenue generating properties, translating into dividend growth. Let’s not forget that, generally speaking, yield growth coupled with dividend growth results in share price increases.

REITs can be divided into two categories: public and private. Unlike Private REITs, Public REITs are traded on the open market, meaning they are very liquid and so investors can easily cash out. The downside of this, however, is lower yields, since share units tend to be correlated to stock market instruments, thereby making them more susceptible to market swings. Moreover, although the entry price for Public REITs can be low, with the minimum investment being just a single share, buying and selling shares involves commissions, and the impracticability of buying and selling a single share makes this route unfeasible.

Conversely, a Private REIT’s value is tied to the property portfolio’s underlying value and is not based on a market-traded price. This means that increased market liquidity will not have the same effect on share price, unlike that of Public REITs. In addition, Private REITs entail minimum investment requirements that price out many but the “accredited investors”. This, in turn, affects the trusts’ liquidity.

So, are there any other options for investors looking for flexibility and a low entry threshold, but with room for personal input to choose which projects they would like to invest in?

Crowdfunding

Crowdfunding nowadays is all the rage, being a source of capital for a wide range of different projects, with real estate being no different. An investment tool for the suit-less digital age, crowdfunding appeals to a younger generation who are looking for minimal contact investment with small amounts of initial capital. Such projects can be simple ones or value-added, ranging all the way to crowdfunding becoming a Private REIT.

The relaxed regulation of crowdfunding for property in the US and relatively little regulation around the globe have led to an “Uber effect”: cutting out the many intermediaries that would normally take their share, whilst facilitating a faster and simpler form of investment using a credit card online. This minimal contact, share economy can mean faster turnaround for investment, with company reputability vouched for by users online.

Another notable advantage of crowdfunding is the diversification that it allows the investor. Due to the relatively small sums that can be used, an investor can broaden his portfolio across several platforms and a multitude of projects, distributing risk as they see fit. Additionally, investment in crowdfunding involves no personal involvement and takes place remotely on the internet.

“The main difference is that, unlike funds, in crowdfunding investors often choose particular projects themselves and do not make up-front commitments”, Alexander Chernov says.

According to the Cambridge Judge Business School, US investors placed 484 million USD in real estate crowdfunding platforms in 2015 alone, over triple that of 2014. The figure worldwide for 2016 is estimated at $3.5 billion after rising from an estimated $2.5 billion in 2015. “Most of the investment from crowdfunders comes from North America, Asia and Europe, but as more and more people become connected to the internet and find out about this simple investment technique, the potential growth for real estate crowdfunding will be exponential over the next few years”, says George Kachmazov.

Advances in computer technology are also set to play their part in boosting interest in crowdfunding platforms. As such, crowdfunding's attractive low investment entry level will be complemented by secure technologies such as blockchain, ensuring that investment is executed in line with the crowfunders’ wishes and significantly reducing the risk of investors in this model being defrauded, something that worries many when investing via an internet platform. Additionally, such technologies are likely to eventually erase the need for platforms as a whole, with smart-contracts executing transactions using crowdfunder investment. With trust issues overcome and additional commissions reduced by cutting intermediaries from the fold, the popularity of real estate crowdfunding is only set to rise.

However, one must note that the current lack of a secondary market limits options to sell shares held in crowdfunding projects (i.e. low liquidity). Furthermore, due to the lack of regulation, the risk of the property developers going bankrupt is higher for crowdfunding projects due to regulations being absent or with little regulation equating to low investment entry-level requirements. For these reasons, it may be unwise to rush into crowdfunding projects without carefully assessing their options and reading more about the market climate.

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    Tranio’s managers offer advice on buying real estate overseas
    Anna Boyarchukova
    Anna Boyarchukova
    Head of Residential Department
    +44 17 4822 0039
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