Ask middle-class Americans their thoughts on diversifying into real estate, and many dismiss the question. Some say “I already own real estate: my house.” Others say “I already own shares in a real estate investment trust (REIT) through my brokerage account.”
That’s all well and good, but neither does you much good when it comes to diversifying your portfolio. Your home is a single asset in a single market. And REIT shares move far too synchronously with stocks because they trade on the same exchanges.
It’s precisely why many investors have increasingly turned to alternative real estate investments like Fundrise and Roofstock in recent years.
How Do You Want to Invest in Real Estate?
Let’s be clear: Fundrise and Roofstock offer completely different services for investors.
Fundrise primarily sells shares in private REITs. These investment funds combine direct ownership of apartment buildings with loans against other investors’ properties.
You invest money with Fundrise, and they use it to add more investments to their portfolio funds. It’s a completely passive way to invest in real estate, requiring no work on your part.
In contrast, Roofstock offers a platform to connect rental property buyers and sellers. Roofstock doesn’t own the properties themselves (with a few exceptions) — they simply provide the platform for direct transactions between buyers and sellers.
Think eBay, but for assets worth hundreds of thousands of dollars. Investors buy rental properties directly and become landlords. That’s a far cry from owning shares in a fund.
Fundrise vs. Roofstock
Because the two investing models are so different, the pros and cons reflect the types of real estate investments more than these specific companies.
It’s worth noting that Roofstock does offer a “shares” investing model called Roofstock One. Investors can buy shares in individual rental properties, which Roofstock has itself purchased. However, it’s only available to accredited investors, and a side service compared to Roofstock’s rental property sales platform.
Income Yield
Rental properties can earn investors excellent cash flow, in the 6% to 15% yield range. Or they can lose you money every year if you don’t know what you’re doing as a landlord.
Properties listed on Roofstock typically offer cap rates — a stand-in for annual yield, albeit a simplified one — in the 4% to 8% range. You can find properties with cap rates over 8%, but usually in lower quality neighborhoods.
That’s the tradeoff when you buy turnkey properties that need little or no work on a publicly available platform rather than going out and finding off-market deals or buying fixer-uppers.
I have a little money invested in Fundrise, and I’ve earned an income yield of 5.18% with them to date. I currently have my money in their “Supplemental Income” plan, which emphasizes dividend yield over appreciation.
Disturbingly, Fundrise has removed its return estimates for each investment fund from its public website. But my dividend income to date is in line with what they advertised previously.
Appreciation
Real estate investors don’t just benefit from cash flow. Over the long term, they also earn a return through their properties appreciating in value.
Usually, anyway. Properties don’t always go up in value, as anyone who lived through the housing bubble and Great Recession remembers all too vividly.
Still, investment data group Black Knight points out that U.S. single-family homes have averaged 3.9% annual appreciation over the past 25 years. When added to 5% to 15% in annual cash flow, that makes buy-and-hold properties a tempting investment.
Fundrise shares also appreciate in value, based on their funds’ underlying property values. Depending on which fund strategy you choose, you may see anywhere from 1% to 6% in appreciation, at least according to their previous marketing materials.
I’ve earned around 1.65% in appreciation in my own investments with Fundrise, but again, I chose the more income-oriented investment option.
Leverage
When you buy a rental property — on Roofstock or anywhere else — you can leverage other people’s money to cover most of the purchase price, in the form of a mortgage. You only come up with 10% to 30% of the purchase price, but you own the asset in its entirety.
When you buy shares in a Fundrise fund, you can’t take out a mortgage to do so. You invest with your own cash and earn a return on only that amount.
Diversification
It’s hard to diversify when each individual asset you buy costs you $25,000, $50,000, $100,000 in down payments and closing costs. Each rental property you buy on Roofstock requires a huge investment of cash, even when you leverage other people’s money.
By contrast, you can invest $1,000 in a Fundrise fund, which spreads your money over dozens of real estate projects. That includes both directly owned and managed properties and real-estate-secured loans.
While Fundrise focuses on residential use properties, many of their properties are large multifamily buildings, which qualify as commercial real estate.
Note that Fundrise requires a minimum investment of $1,000. They do allow non-accredited investors, unlike many real estate crowdfunding investments. Regardless of your net worth, you can invest in Fundrise.
Labor Required
Buying, maintaining, and managing rental properties takes far more work than the average person thinks. Try it yourself before criticizing landlords for getting rich without “earning” it.
Buying shares in a fund, whether an ETF or a private REIT like Fundrise offers, requires no work whatsoever. You spend five minutes creating an account and transferring money into it, and voila! You have a completely passive source of income. You can even automate your transfers and investments each month.
Investor Control
Rental properties allow far more control than most investments.
You can predict returns accurately, at least for cash flow. You know the purchase price, you know the closing costs and any required renovation costs, you know the market rent, and you either know or can forecast all ongoing expenses.
Plus, you can pick and choose the best cities for rental investing, the best neighborhoods, and the best properties on Roofstock.
You also control how you manage the property. With aggressive tenant screening, semiannual inspections, and lease enforcement, you can mitigate most of the risks that come with rental properties.
Funds don’t offer any control whatsoever. You buy at one price, then cross your fingers that the fund pays you the dividend yield you expected and appreciates in value as you expected. Once you buy in, you have exactly one play: sell your shares — which you can’t easily do with Fundrise, by the way.
Liquidity
Real estate in general comes with poor liquidity. It typically takes months from the time you decide to sell to the time you actually walk away from the settlement table with a check.
Which says nothing of your marketing and sales costs. Expect to pay around 6% of the sales price in real estate agent commissions alone. This is true using Roofstock or in any real estate transaction.
Selling Fundrise shares isn’t a cinch either. If you want to sell your shares, you have to contact Fundrise to request it. You don’t get your money immediately, and if you’ve owned your shares for less than five years, you can expect a penalty.
Tax Implications
Rental properties found through Roofstock and Fundrise shares are taxed similarly.
The IRS taxes rental income at your regular income tax rates, although you can take advantage of the many tax benefits of owning investment properties. Meanwhile, Fundrise dividends are taxed like any other dividends.
When you sell an investment property or shares in Fundrise or any other fund, you pay capital gains tax on the profit. However, with directly owned investment properties, you can defer capital gains taxes using techniques such as a 1031 exchange.
Fundrise does offer an IRA option as an easy way to invest in a tax-sheltered retirement account. It’s much harder to invest directly in real estate using an IRA, requiring you to set up a self-directed IRA.
Platform-Specific Fees
Roofstock’s fee structure is extremely transparent. They charge sellers a fee of 3% of the purchase price, and buyers a fee of 0.5% (with a minimum fee of $500).
As a fund selling shares, Fundrise’s fee structure isn’t quite so simple. They charge an annual advisory fee of 0.15% of your account balance, and a 0.85% annual asset management fee (1% total annual fee). But having been scammed myself by property managers, I know firsthand how many ways they have to nickel and dime investors under “expenses.”
Fundrise could theoretically charge investors for any number of property management-related items, and simply list them under “Expenses” rather than including them under the management fee.
For instance, they could list their in-house maintenance team’s billing expense at $100/hour when they only pay the workers $20/hour. Or list a “site visit fee” every time their property managers visit a property.
I’m not saying they do any of that — I haven’t the slightest idea. Which is precisely the point: We as investors don’t know what kind of mathematical magic they do or don’t engage in to shift costs around, so all we can go on is whether we like the bottom-line returns they generate for us.
The Verdict
So how do you decide whether to buy a rental property on Roofstock or buy shares in Fundrise?
Invest Through Roofstock If…
Investors who want the control, tax benefits, and potentially high returns that come with direct real estate ownership should explore buying turnkey properties on Roofstock.
You can predict the returns accurately if you know what you’re doing, and you can leverage other people’s money to build your own portfolio of income-producing assets.
But that raises an important point: Only invest directly in rental properties if you’re prepared to learn how to do it properly. It requires knowledge and skill to buy rental properties and earn a reliable profit.
If you only want more real estate exposure in your asset allocation, invest through more passive means.
See our full Roofstock review for a complete breakdown of their pros and cons, if you’re intrigued by the idea of buying a turnkey rental property.
Invest Through Fundrise If…
Do you just want to sit back and earn a passive return with a diversified portfolio that includes real estate? Fundrise lets you do so.
No skills or knowledge necessary. No labor or property due diligence necessary. Within five minutes, you can set up your account and start investing in real estate.
Of course, you also don’t get some of the perks, such as tax deductions, control over your returns, and leveraging other people’s money.
For the average person just looking for some initial diversification into real estate, Fundrise makes a great place to start. You can invest with as little as $1,000, and you don’t have to do or learn anything new.
Start with Fundrise, and if you develop an interest in real estate investing akin to a hobby, start learning about rental investing. Build some expertise before you go out and buy your first rental property.
Final Word
Friends of mine ask me all the time about buying investment properties. Most of them like the idea of diversifying their investment portfolio to include real estate, and many are seduced by the notion of owning a vacation rental property, or a rental property they could downsize into one day.
I ask them all the same question: Are you interested in making real estate a genuine hobby, in learning about real estate investing as a side business, or do you just like the idea of owning some real estate investments and passive income?
Because there are easier ways to earn passive income and diversify into real estate. Ways like REITs and real estate crowdfunding platforms like Fundrise.
Only those truly passionate about building a side real estate investing business should buy rental properties. It takes a great deal of work, from learning all the skills you need to finding a good deal to networking with lenders and contractors to screening tenants and beyond.
I’ve enjoyed my real estate investing career — but it has definitely been a career.
