Most people make a living based on the physical work they do, earning a paycheck every few weeks in exchange for that work. Regardless of whether you get paid an annual salary sitting at a desk with a computer or are paid by the hour standing on a factory floor, at the end of the day you are making a living based on what you produce with your time. This is called active income because you must actively continue to work in order to maintain that income stream.
If you stop working, whether it’s due to an illness, a layoff, or just because you are reaching the age of retirement, that income stream ends.
Meanwhile, sophisticated investors have learned that the key to financial stability is through passive income. Passive income is the ability to earn a steady income stream and grow your wealth even when you are not working. Most individuals acquire passive income through investing.
The most widely known and prevalent form of investing is owning stock in publicly traded companies through the stock market — but there are more effective ways to earn money without actively working. While the average investor only invests in publicly traded stocks and bonds, high net worth investors tend also to invest in private assets to diversify their income streams, understanding that diversification is the most likely way to mitigate risk and maximize returns.
One of the most common differences between a wealthy investor’s portfolio and the average investor’s holdings is that wealthy investors tend to own more private real estate investments.
Real estate as an investment has been a top performing asset class for decades because it can provide both consistent income from rents as well as the potential for long-term appreciation. Real estate is also scarce, as there is only so much land. As Mark Twain once said, “buy land, they aren’t making it anymore.”
Food and shelter (i.e., real estate) are the two most fundamental material human needs. They have intrinsic value, which means they can act as a hedge against inflation. Moreover, as cities grow, demand for real estate increases, since more people need more places to live, work, eat, and shop. This is why real estate has historically appreciated in value over time and produced wealth for those who own it. Ironically, passive income is usually taxed at a lower percentage rate than active income, especially sheltered income from real estate.
The quality of real estate as an investment is why I decided to start my company Fundrise. We aim to democratize access to this largely inaccessible, high value asset class. I’ve spent 18 years investing in commercial real estate, and until Fundrise, my investment partners were typically billion-dollar private equity funds and insurance companies. It never made sense to me that people could not invest in real estate the way they can invest in stocks. Buildings are all around you, and yet most people do not own any property — not even a fraction of one — except maybe their home.
While the potential for high returns in real estate has been made self-evident over time, very few people are familiar with real estate investing or know where to actually begin when attempting to build their own passive income stream from it. Most wealthy investors have a variety of choices to invest in real estate including private equity funds, real estate investment trusts (REITs), and direct investment properties.
Meanwhile the everyday investor has historically had limited options and so has been forced to pay large upfront fees to various middleman and traditional financial gatekeepers. These high costs and barriers to entry reduce the latent, underlying strong returns from property.
Take for example the most common option available to you, the publicly traded REIT. Publicly traded REITs are professionally managed pools of real estate that offer the benefits of being traded openly on an exchange, giving investors the ability to easily buy and sell. However, REIT prices are set not in the private exchange of real property, but rather in the much larger, more competitive public markets, where fierce bidding dynamics drive up prices of easily traded shares and lower long-term returns.
Plus, the option to sell at any time isn’t free — this added liquidity premium, typically priced at a hidden 20-30% markup in the cost of the shares you buy, translates into lower relative returns. For long-term investors whose aim is to hold their investments for several years, this premium can be excessive and unnecessary.
To illustrate the magnitude of this premium, imagine if you were buying a $300,000 house and were given the option to pay 30% more — $90,000 — in order to have the option to sell it back the next day. Would you pay it? If you were planning on living there for several years, it wouldn’t seem worth it.
The smart millionaire understands this liquidity premium and only pays it when necessary.
In addition to these pricing premiums, publicly traded REITs tend to be highly correlated to the broader market, meaning that REIT prices may fluctuate in tandem with the stock market, regardless of whether the fundamental property values have changed. For a long-term buy-and-hold investor, frequent price swings in the near term may not present an issue. However, the high correlation of public REITs to the stock market means lower overall diversification, higher beta, and potentially lower portfolio returns in the long run.
Today, because of technology and new federal regulations, the potential for a truly cost effective and simple way to invest in real estate has been realized. Any investor, regardless of their income or net worth, can now invest directly in private real estate online with low fees and low minimums.
At Fundrise, we’ve given individuals the ability to invest like institutions — without the public market retail markup. What was previously only attainable for the wealthiest investors with the right relationships can now be purchased online by any investor through a financial technology platform.
And, we are just beginning to scratch the surface of what is possible.
Technology can do for real estate investment what it did for media, travel, and ecommerce: lower costs, increase transparency, and drive better performance. Online direct real estate investment has the potential to not only revolutionize real estate capital markets, but also broader financial markets, by democratizing access to a more sophisticated investment portfolio with higher return potential and by providing an actual alternative to the stock market.
Ben Miller is Co-Founder and CEO of Fundrise. With over 18 years of commercial real estate experience, Mr. Miller is an innovator and champion for the everyday investor, focusing on the Fundrise mission to democratize access to real estate investing. Stay up to date with the latest from Fundrise through their social channels: Facebook, Twitter and LinkedIn.
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in partial or total loss. While the data we use from third parties is believed to be reliable, we cannot ensure the accuracy or completeness of data provided by investors or other third parties. Neither Fundrise nor any of its affiliates provide tax advice and do not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Neither Fundrise nor any of its affiliates assume responsibility for the tax consequences for any investor of any investment. The publicly filed offering circulars of the issuers sponsored by Rise Companies Corp., not all of which may be currently qualified by the Securities and Exchange Commission, may be found at fundrise.com/oc.