How to get into real estate investing if you can’t afford the price tag?

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Rent is my favourite form of quasi-passive income: it is steady, there’s an asset of inherent value behind it that usually rises with inflation and it can be very hands off and passive with the right tenants. That’s why it forms a core part of my portfolio. However becoming a landlord isn’t for everyone as the the initial capital outlay is extremely high. With the property price averaging above £250,000 in the UK, even a 10% deposit down payment can prove to be prohibitive for most people.
 
What if I tell you that you can reap all the benefits associated with owning a property without its downsides? Even better, you can have these benefits without even needing the large sum of capital and mortgage required to jump start your dream of being a property tycoon?
Welcome to collective investment vehicles!
These are funds where many investors contribute a level of funds that they feel comfortable with and the funds are pooled together to purchase assets such as stocks, bonds and you guessed it, properties! Today I will look at 2 particular property-related collective investment schemes you can readily access: REIT and Property Partners (PP).
 

What’s a REIT?

REIT stands for Real Estate Investment Trust. They are mainly US companies with preferential tax treatments (exemption from corporation tax) in exchange for distributing at least 90% of the annual profit to shareholders as dividends. Consequently they normally purchase properties, lease them out to tenants, collect rents and pass them onto shareholders as dividends. Investors normally owns shares in the company which in turn owns many different properties.
 
There are thousands of REITs being traded on the NYSE, covering many different sectors and geographies. For the purpose of this blog, I will be referencing to a REIT called Realty Income Corporation because I am a shareholder in that REIT and thus understand its mechanism well. However what I have learnt can be easily applied to other REITs.
 

What is Property Partner (PP)?

Property Partners is a UK startup that pioneered the peer-to-peer crowdfunding real estate investment platform. The company sets up a special purpose vehicle (SPV, essentially a fancy way of saying a sub-company). Investors buy shares of the SPV which then in turn buys a particular property. Investors thus own shares of a company that owns a property.
 
There are equivalent companies in other countries that provide almost identical offerings, such as RealtyShares in the US which has been covered extensively by Joe Udo at RetireBy40 and BrickX in Australia, which is run by a friend of mine.
 
For the purpose of this blog, I will be referring to PP most of the time although the principles and mechanisms are applicable to other companies too.
 

How do REITs differ from PP?

Well as far as I can tell, the operating model of REITs and PP are identical:
  • Both are collective investment schemes
  • Both work by pooling investor funds together, purchase properties and then collect rent
  • In both cases, investors are shareholders in the companies that own the property rather than being direct owners.
The only difference I can detect as that by purchasing REIT shares, you become a shareholder in a company owns many propertied whereas by investing in PP (and other crowdfunding property platforms), you are a shareholder of a company (the SPV) that usually only owns 1 property and thus an investor will need to become shareholders in many SPVs if he wants to his diversify holdings. You would never become a shareholder in the investment platform (i.e. Property Partners).
 

Which platform is better?

Rather than a simple one or another, I will look at a variety of factors that impact an investor’s investment experience and reach a verdict at the end.
 
1. Barriers of entry is lower at Property Partners.
REITs
Because they are traded on stock exchanges, you can only buy them if you have a brokerage account, which means you will need to register and open an account with your stockbroker. This is usually an easy process requiring you to provide a copy of ID and proof of address. The only obstacle is that most REITs are traded on US-based exchanges, therefore unless you are a US Person using a US-based broker, you will need to complete a W8-BEN form before being allowed by buy US securities.
 
Property Partners (and other crowdfunding RE investment platforms)
I found the registration process to be super easy at PP as it took less than 5 minutes to complete. The platform was extremely user friendly and all documents could be electronically uploaded and verified, almost instantly. Unsurprising for a technology-driven start-up.
 
Verdict: REIT 0; PP 1
 
2. REITs have lower costs.
REITs
Because these securities are treated and traded like a conventional stock, the only cost associated is the commission during buying and selling. The average size of my investment is in increments of £5,000 and Hargreaves Lansdown (HL) charges £11.95 per trade, representing a transaction cost of 0.24%. As the commission is fixed, the transaction cost as a % of your trade decreases as the size of your trade expands.
 
There are no ongoing platform fees or management fees by holding REIT if you choose the right trading platform (e.g. iWeb or Interaction Brokers).
 
Property Partners
This is my main beef against PP because it is super expensive. Buried somewhere 3/4 down their Terms and Conditions page (you know, that blob of text that you hope you will never ever have to read) is the Fee Schedule. If you’d like a more concise version, Neil from P2P Blog has written a good overview.
 
The initial trading cost is 2% of the total investment amount, which is at least 8 times more expensive than my REIT investments. Then there is an ongoing 12.6% annual management charge on your investment income, which is infinitely higher than my 0% holding cost of REIT.
 
Verdict: REIT 1; PP 0
 
3. REITs offer superior return due to lower management fees and stronger track records.
Property as an asset class offers returns in 2 ways: ongoing rental income (yield) and capital appreciation. REITS and PPs are no different.
 
REITs
I’ve held Realty Income Corporation for over a year. This company owns over 5,000 industrial, agricultural and commercial units across 49 states in the US. It is currently yielding at 4.9% per year (so if I invested $10,000, I would receive $490 of dividend income per year). The unusual aspect of this company is that it prides itself in paying out the dividend (or rental income) on a monthly basis rather than the industry convention of quarterly. This is super attractive to investors who seeks a monthly income from their investments.
 
In terms of capital appreciation, REITs in general had a pretty dismal 2017 compared to the general stock market. However historically Realty Income tends to outperform the market on an compounded annualised basis therefore I’m fairly OK with the short-term dip.
 
Property Partners
Rental yield on PP had historically been averaging at the 3-4% mark as it used to focus in southern England where property prices had been high, thus eroding yield. However lately I’ve noticed it venturing up to the north of the country as well as branching out into Purpose Built Student Accommodation (PBSA) and most recently, their first commercial asset. This means the yield has been increasing to the 4-5% mark, which is on par with Realty Income and other similar REITs in the US.
 
Capital appreciation on PP is tied much more directly with the overall real estate market in the UK rather than the stock market as the none of the properties are publicly trading. Instead it has its own trading platform where it matches individual investors who wish to buy and sell shares in the property, thereby creating a virtual property exchange. Given that the platform has been in business for less than 5 years, I don’t feel appropriate to be commenting on its performance. However one thing I have noticed is that whenever I tried to sell my holdings, the bid price (what people are willing to pay for) is always lower than the price that I bought them at.
 
Verdict: REIT 1; PP 0
 
4. Property Partners has a higher liquidity risk than traditional REITs.
The key risks with property investing are:
  1. Credit risk – tenants stop paying the rent
  2. Capital risk – market events leading to permanent loss of value on the investment
  3. Interest risk (only if the property has a mortgage) – interest rate rise leading to increased monthly mortgage cost
  4. Liquidity risk – inability to quickly convert the asset into cash without significant reduction in asset value
With both REITs and PP, I found that #1-2 can be easily mitigated through diversification. Liquidity risk however is much more acute in PP than in REITs.
 
REITs
The nature of REITs is that it invests in multiple properties (often hundreds or even thousands) across different sectors and geographical locations, with many different types of tenants. This level of diversification is extremely helpful in mitigating credit risks and market downturns and the associated capital risks. You can also purchase REITs that are not heavily geared (using debt / mortgage to purchase properties) like Realty Income, thereby mitigating interest risks. Furthermore because REITs are publicly traded securities, liquidation is instantaneous most of the time (without significant erosion to the value of your holdings) should you wish to sell your units.
 
Property Partners
Similar to REITs, you can diversify your holdings on PP by investing in different properties, thereby spreading your credit and capital risks. You can also choose properties that are not geared, thereby eliminating the interest risk. However I found that properties on PP are predominantly English residential, thereby limiting the sector and geographical reach. Furthermore each property needs to be purchased individually rather than the bundling effect of REITs, thereby increasing transaction costs.
 
The real risk with PP is liquidity.
 
Property trading volume is very thin on PP as a quick snapshot of the last 24 hours indicates a trading volume of around £10-20,000 per hour vs $3.75m per hour for Realty Income alone! Such low volume directly restricts liquidity and can lead to the imbalance between the bid-ask price, which means people who wants to sell cannot sell at the desired price whilst people who wishes buy do not want to buy at the proposed price.
 
The absence of liquidity often translates into lowered asking price, which if left unchecked will manifest into price drop and value loss, as indicated by the Average Traded Price being lower than Buy Price on all the trades above. I think this is a major drawback of the PP platform.
 
Verdict: REIT 1; PP 0
 

Wrap up

All in all, REITs score better in 3 out of the 4 categories outlined above compare to PP as they are:
  • Cheaper to buy and manage
  • Offers better yield and capital appreciation after-cost
  • Provides greater liquidity should you wish to exit and convert your holdings into cash
Have you had experience with the likes of Property Partners and REITs? What are your thoughts? Please comment away!