If you can’t beat ‘em, join ‘em.
Single-family homes and vacation rentals may be out of reach due to high prices and limited supply, partially driven by Wall Street investors buying up properties. But in one of the great ironies of the housing market, some organizations exacerbating the shortage are also offering a solution to would-be homeowners: the chance to become investors through a direct participation program (DPP).
DPPs are limited partnerships or REITs composed of investors who pool their money to buy real estate or energy commodities as a long-term passive investment. DPPs don’t trade on a public exchange and are considered illiquid investments because these non-traded securities have a shelf life of approximately five to 10 years.
When DPPs are organized as limited partnerships (LPs), investors become limited partners. A general partner is in charge of the venture and invests the pooled funds in a target project. As that project produces income, it’s passed on to the limited partners. While the general partner manages the investments, the partner investors don’t have any management responsibilities. They can also enjoy pass-through tax benefits, which means the investor is only taxed at their own individual rate for ordinary income, which can be derived through dividends from real estate rental payments, mortgage payments, or other income streams associated with the DPP’s business. Their original investment isn’t available until the term of the DPP is over, at which point their money is distributed back to them, plus any gains that haven’t been previously paid out.
DPPs are investment vehicles that aren’t traded on stock exchanges, yet they fall under the accredited investor rules of the state and the Securities and Exchange Commission (SEC). This means that qualifying participating investors have the “income, net worth, assets, governance status, and experience” to make investments in securities not closely regulated by the SEC. The reason is that DPPs aren’t liquid, which means the investor has to meet financial and experience bars so their investments aren’t a financial hardship.
Accredited investors must have an annual income for at least two years exceeding $200,000 or $300,000 if married and have a net worth exceeding $1 million, not including their primary residence. Applicants can also become accredited investors if they’re general partners, executive officers, or directors of the DPP. A business development entity with assets exceeding $5 million can also be an accredited investor.
An exception to DPP rules is the non-traded REIT. Real estate investment trusts (REITs) were created in 1960 to give smaller investors a chance to invest in funds as part of the exploding post-war growth in office buildings, shopping centers, industrial parks, apartment buildings, high-rise office buildings and so on. REITs have a simple business model—buy properties, collect rents, and distribute rents as dividends to shareholders.
Public non-traded REITs are not listed on a public exchange, but they are regulated by the SEC and required to submit regulatory filings, including quarterly and annual financial reports. They operate similarly to REITs with the mandate to return a high proportion of income back to the REIT investors as dividends. They also have a finite maturity date at which time they can either become publicly traded on a stock exchange or liquidate, returning remaining profits to shareholders. The advantages to investors are that non-traded REITs don’t require large capital investments, they’re transparent about financials, and investors can avoid the daily volatility of stock market investments. The downside is that non-traded REITs often charge higher fees, and their illiquidity makes it difficult for investors to redeem their funds if they want to cash out.
Public traded REITs are SEC-registered and regulated and therefore more volatile by nature, but they’re also more liquid, allowing investors to retrieve their funds more easily. Then, there’s the private non-traded REIT. These are REITs not listed on a major exchange and they’re not subject to most SEC regulatory requirements because of their accredited investors/founders. The investments are illiquid, and profits are tied to the individual rent amounts gained from the properties and the final market value of the properties when they’re sold. This differs from a public non-traded REIT where the value is in the fund’s shares, not in the appreciation of the properties being held.
And that brings us to single-family and vacation rentals purchased by eREITs like Arrived and Fundrise. Arrived operates as a “modern kind of private REIT,” says the website. Boasting some of the most famous founders in publicly traded companies, the Arrived Single Family Residential Fund is “redefining the traditional real estate investment trust landscape,” allowing smaller investors to participate without the burden of becoming landlords and collecting rents themselves. Like other REITs, returns come from rent payments and property appreciation, but because the founders have satisfied the SEC standards for accredited investors, individual investors like you can jump in with as little as $100—like a mutual fund. As the fund expands, you make more returns across a number of homes in multiple diversified markets.
Fundrise was crowdfunded in 2012 to allow entry-level investors to participate in commercial and residential real estate, venture capital, and tech funds for as little as $10. Their flagship Fundrise Real Estate Interval Fund invests in commercial and residential real estate debt and equity. The Fundrise Income Real Estate Fund is designed for cash flow by investing in commercial and residential property equity and real estate loans.
The beauty of private non-traded REITs is the platform to invest in real estate without buying a whole property or acting as a landlord. The idea is to think long-term, at least five years, and before you choose an account, it’s prudent to learn the minimum investment you can make and if your investment can be redeemed before the fund liquidates, and if its redeemable with or without a penalty. Most eReits will offer several tiers of investment levels for beginners to accredited investors with the choice of distributions categorized as fixed income, growth, or long-term risk with potential for higher reward.
Keep in mind that DPPs offer direct ownership in specific projects, potentially yielding higher returns but with greater risk, such as investing in an individual property, explains RanchInvestor.com. REITs pool investments into diversified real estate portfolios, which offers more liquidity but lower returns. If you’re interested in investing in fractional real estate ownership, weigh the risks and rewards before choosing between a DPP or traditional REIT.
