Trust Deed and REIT investments are seemingly similar at first glance. They both utilize crowdfunding type platforms that open the door to commercial real estate investments at a lower “buy-in” than your typical real estate venture (i.e. rentals, fix-n-flips, etc.); and offer a steady stream of passive income. There are some key differences that you should be aware of when deciding which investment vehicle is best for your portfolio and for your tolerance for risk.
If you are unfamiliar with these types of investments or just a bit rusty, here is a brief synopsis on both. There are many different types of REITs, equity, mortgage, or a combination of both (hybrids), that can be publicly traded, non-traded, or Private. Here we are going to focus on the most common, the publicly traded equity REIT; where the REIT fund managers purchase multiple properties to lease the space and collect rents. These properties are bundled into a fund where you purchase shares on the stock market exchange, and that rental income is then distributed as dividends to you as a shareholder. Trust Deeds are a debt investment. Commercial brokers, such as Ignite Funding, work with real estate developers to broker and fund short-term loans for individual projects (i.e. acquiring land or a property, developing raw land, and/or construction) with hard money lending. You along with many other investors are lending your money to these borrowers, earning a return on interest negotiated by the broker.
Fixed vs Fluctuating Form of Income:
When you invest in Trust Deeds with Ignite Funding, you will earn an annualized 10%-12% return paid out to you monthly. This form of income is more likely to be steady because borrowers have a better incentive to continue making payments. Borrowers that wish to maintain the success of their business and continue to receive lending for future projects will not tarnish their reputation by frequently defaulting on payments, and they know that a hard money lender will foreclose and take the property back in a heartbeat if necessary. REITs only pay dividends on a quarterly basis, with annual dividend yields averaging around 3% to 8%. That is contingent upon all properties retaining paying tenants who have less of an incentive to pay consistently or stay on the property. Any one of the properties failing to perform can be detrimental to the life of the fund, causing fluctuations and making this form of income less reliable.
Trust Deeds are less liquid than REITs because of the nature of a debt investment versus an equity investment that’s publicly traded. The trade-off for liquidity in Trust Deeds is the property encumbered by the loan is collateral to your investment because your name is on the deed of trust and title insurance. With the guidance of the broker, investors get to decide how to proceed if the borrower goes into default and can even foreclose and sell the property if necessary. This helps mitigate the amount of principal you risk losing in the process. In a REIT, there is no such collateral protecting your investment and you do not have a say in how things are managed if property performance declines. You must hope that you aren’t selling your shares at a lower market value than you bought in, cutting into your principal and earnings. If the REIT altogether fails, you stand to lose all your principal.
The Ability to Diversify:
Very few REITS have a mixed portfolio of property types, most tend to specialize in a specific real estate sector. They are either composed of all apartment buildings, all health care facilities, all hotels, etc. You are also relying on the REIT’s fund managers to choose profitable properties to fold into the fund. When investing in Trust Deeds, you are in control of which project you are lending your money on. This creates the opportunity to diversify across borrowers, product type, and geographical area. If one area of the market slows down, a diversified portfolio will contain other investments that should continue performing while the other works itself out.
In order to maintain REIT status, government requirements mandate that they must payout a minimum of 90% of income back to investors which does not leave much for the fund managers to work with. In order to make up for this lack of capital they can charge base fees, performance fees, acquisition and divestment fees, digging into your overall earnings. When you invest in Trust Deeds, the broker is paid through the extra brokerage points paid by the borrower and does not hinder the return on your investment.
Whether you are investing in Trust Deeds or REITs, you should always perform your due diligence on the company or fund manager you are looking to invest your hard-earned money with. Look at the management team, their performance track record, and question if their interests are in line with your own as an investor. You should also question yourself and what type of risk you are willing to face, like with any investment there are no guarantees.