New crowdfunding platforms aren’t the first to offer passive access to real estate - but they may be the most transparent and cost efficient.
REITs and TICs have historically been the most accessible vehicles for individual investors searching for passive real estate exposure. Undeniably, these vehicles have greatly improved the ability for individuals to easily diversify. However, these traditional avenues for real estate investment also involve high fees and low transparency.
A REIT, or a Real Estate Investment Trust, is a company which makes investments in and owns incoming generating real estate properties. Investors buy shares of the REIT and the REIT uses that money to make investments. The REIT then typically earns income from rent payments or interest on real estate debt.
Although there are publicly traded REITs which must be registered with the SEC, there are also non-traded REITs and private REITs which do not need to be registered. Instead, they are structured as Regulation D private placements, which are exempt from SEC registration.
Non-traded private REITs are in many ways similar to TIC (Tenants In Common) structures, which have become popular over the past few decades. TICs purchase the same types of commercial real estate that REITs purchase. However, unlike REIT investors, who buy equity stakes in a company that purchases and manages real estate, TIC investors directly purchase a fractional ownership of a property, each with a right to the use and possession of the property.
Although the term “Tenants In Common” can be used broadly for a family purchasing an asset together, it is also used professionally to refer to a securitization (a pool of ownership in different real estate assets).
Typically, in a TIC, the property is managed professionally by a third party and each owner receives a portion of the net income based on their ownership share. TICs advertise the structure as an effective way of avoiding capital gains tax due to their compatibility with Section 1031 of the Internal Revenue Code of 1986, which serves as a method to defer taxes on real estate sales and subsequent purchases. This has been a primary driver of the growth in investment in TICs.
Despite the potentially tax efficient nature, TICs suffer a myriad of problems, and one study showed that the high cost of investing more than outweighed the TIC tax deferral. In one particular TIC, the authors found that upfront fees alone totaled 22% of the gross offering proceeds.
The study reads: “Although the marketing material for TICs emphasize that TIC investors earn a steady income stream on the untaxed proceeds of their Section 1031 exchanges, much of the tax deferral benefit is lost in upfront fees paid to the entities involved in the offering. The remaining tax deferral benefits, if any, are offset by the TIC’s annual fees and additional expenses.”
On top of the highly inefficient cost structure, many TIC owners encounter major setbacks as a result of the inefficient nature of the ownership structure: when something goes wrong, a unanimous decision by the owners is often required to take action. For a TIC with many owners, a unanimous decision can be difficult - if not impossible - to achieve.
Although REITs and TICs achieve the objective of passive real estate exposure, in many cases, the expenses outweigh the benefits. The Fundrise eREITs were created to offer passive exposure to diversified pools of commercial real estate directly to investors online, without any brokers or selling commissions.
And, as always, whether you are considering a REIT, TIC, crowdfunding platform, or direct investment, a thorough evaluation of the sponsor, fee structure, and liquidity constraints should be conducted before adding any investment to a portfolio.