A real estate investment trust (REIT) is a way for everyday investors to own income-generating rentals through indirect investment. You own a piece of other rentals and get a percentage of the profits without doing any work.
The premise sounds foolproof, right? But some still doubt if REITs are a good choice because of lower yields, fewer tax benefits, and more.
The other option is the more traditional approach: owning a rental property yourself or with a partner.
Choosing the best investment for you is a major decision, and as a seasoned real estate investor, I’ve had the same dilemma. That’s why, in this article, I’ll share everything I’ve learned from my decades of experience with rental properties to give you the insight and guidance you need to make the best choice.
Let’s get into rental real estate investment, where I highlight the fundamentals and differences between REITs and rental properties.
- REITs offer indirect ownership of income-generating rentals, providing diversification and steady income for investors.
- They provide better diversification, lower risks, and liquidity through stock exchanges, despite potentially lower returns
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REIT vs. Rental Property: Advantages
There are several considerations if you are deciding between real estate investment trusts and rental properties.
REITs are investment vehicles that offer you the opportunity to buy into and have a diversified investment portfolio of real estate properties.
By pooling funds from several real estate investors, REITs give people access the benefits of owning real estate without needing direct property management or paying a property manager.
REIT: Diversification, Risk, and Steady Income
One of the significant advantages of REITs is the potential for better diversification across commercial, residential, and industrial real estate properties. This diversification helps lower the risks associated with a single property investment. Also, REITs provide investors with liquidity, as shares can be sold and bought on major stock exchanges.
Despite lower stock market performance, REITs had impressive operational results with record-high earnings during 2022.
While REITs offer attractive benefits, it’s important to note that they may have relatively lower potential returns compared to buying rental property. However, the stability and steady income streams REITs offer can appeal to investors seeking a more passive approach to real estate investment.
Rental Property: More Capital Appreciation and Hands-on
A rental property allows investors to own and control assets directly. They offer the potential for regular rental income and significant capital appreciation over time. But — owning a rental property also involves active management and maintenance responsibilities.
It means landlords must actively oversee property maintenance, tenant screening, rent collection, and addressing issues. By taking on these responsibilities, landlords can maximize the potential returns on their investment and build a long-term income stream.
The Comparison: Real Estate Investment Trust vs. Rental Property
Pros and Cons of REITs
Let’s dive a bit deeper into the pros and cons of REITs.
Advantages of REITs
Diversification: REITs allow investors to diversify their real estate portfolio by gaining experience in a wide range of properties and real estate sectors. This diversification can help mitigate risks and improve potential returns.
Professional Management: By investing in REITs, you benefit from the knowledge of property managers. These professionals have an in-depth understanding of the market and can make sound decisions regarding property acquisitions, leasing, and property management, optimizing the REIT’s performance.
Liquidity: Unlike direct real estate investments, REITs offer liquidity. This means investors can buy and sell shares of REITs on the stock exchange, providing them with the ability to adjust their investment portfolio as needed quickly.
Disadvantages of REITs
Lack of Control: REIT investors need more control over the management and decision-making processes of the underlying real estate properties.
Market Dependency: REITs are subject to market fluctuations and can be influenced by factors such as interest rates, economic conditions, and trends in the real estate markets.
Tax Implications: REIT investors may face complex tax considerations, including potential tax obligations on dividends received and the potential for double taxation at both the corporate and investor levels.
Pros and Cons of a Rental Property
Here’s a closer look at the pros and cons of owning a rental property (or properties) on your own or with partners.
Advantages of a Rental Property
Control and Flexibility: Owning rental property grants you control over decision-making, such as setting rental rates, selecting tenants, and managing property maintenance. This level of control offers flexibility in adapting to market conditions and optimizing your investment.
Potential for Higher Returns: Rental property can provide attractive returns on investment. Regular rental income can generate a steady cash flow, while property appreciation over time can contribute to long-term wealth accumulation. Since February 2023, when rents bottomed out at $1,936, prices are up nearly 5%.
Tax Benefits: Rental property ownership often comes with various tax benefits you can take advantage of. These may include deductions in mortgage interest, property taxes, insurance premiums, maintenance expenses, and depreciation. Taking advantage of these tax benefits can help maximize your overall profits.
Disadvantages of a Rental Property
Active Management Required: One downside of renting a property is the need for active management. Being a landlord involves finding tenants, collecting rent, and addressing maintenance issues. It needs time and effort for smooth operations and tenant satisfaction.
Lack of Diversification: Another drawback is the need for diversification. Investing heavily in rental property ties up a big portion of your wealth in a single asset class. Your investment may be at risk if the real estate market experiences a downturn. Diversifying your portfolio between different asset classes can mitigate this risk.
Illiquidity: Rental property is considered an illiquid investment. Unlike stocks or bonds that can be bought or sold easily on the market, selling a property can take time. This lack of liquidity can hinder your ability to access funds quickly when needed.
Another Option: Co-Invest Club
If you like the idea of a passive investment like a REIT, but you want the ability to evaluate actual properties yourself, you might consider exploring a co-invest club. I like SparkRental’s co-invest club because it’s training plus an opportunity to invest if you want. And the investment at $5k is lower than a rental property purchase (unless you do creative real estate financing).
Each month, the club reviews various real estate deals, allowing members to hand-pick their investments. If you want to learn more, here’s how:
Looking For An Easier Way To Invest In Real Estate?
Choosing Between Rental Properties and REITs
There’s a few things you should look at when deciding between a rental property and a REIT, including:
Financial Goals: Your financial goals also influence your investment strategy and desired outcomes. For example, if your goal is to generate passive income in the short term, a rental property can provide monthly rental income.
If your goal is long-term capital appreciation and diversification, REITs can offer the potential for growth through property appreciation and dividend distributions.
Market Conditions: Additionally, investors should consider market conditions. Analyzing the current real estate market and economic trends can help you make a better decision. For instance, investing in a rental property can be advantageous if rental demand is high and interest rates are low.
If the real estate market is experiencing a downturn or interest rates are rising, REITs may provide a more liquid and diversified investment option.
Debunking Rental Properties and REITs Misconceptions
Sometimes, people get ideas about what they think REITs and rental properties are and how they work. Let’s see if we can’t alleviate some of those concerns or false narratives. By addressing these misconceptions, investors can better understand the considerations and benefits of investing in REITs and Rental Properties.
Relies Heavily on Leverage – One common misconception about REITs is that they heavily rely on leverage. While it’s true that some REITs may use leverage to enhance returns, not all of them do. REITs can also generate income through rental properties, property management, and other real estate-related activities.
Inconsiderate Managers – Another misconception is that REIT managers solely focus on maximizing their profits without considering shareholders’ interests. However, reputable REITs have fiduciary responsibilities towards their investors and are committed to generating sustainable long-term returns.
Complex Tax Reporting – There are several tax-related misconceptions surrounding REITs. One of them is that investing in REITs will result in complex tax reporting. In reality, shareholders receive 1099-DIV forms that outline their taxable dividends, making tax reporting straightforward. REITs often pass on a big portion of their income to investors, resulting in potentially favorable tax treatment.
Returns Are the Same as a Rental – Some people believe that investing in REITs will yield similar returns to direct real estate investments. While both options can be profitable, they have different risk-return profiles. REITs offer the advantage of liquidity, diversification, and professional management, but their returns may not directly mirror the rental income generated by individual properties.
Rental Property Misconceptions
Easy to Manage – This is a misconception because some people might assume you simply buy a house and rent it out. However, managing a rental property can be full-time and requires knowledge of local laws and regulations, establishing and maintaining tenant/landlord relationships, and continual property maintenance.
Profitable from Day One – Real estate investing involves risks, and properties take time to appreciate their market value. Sometimes, developing strategies that maximize profits while minimizing costs can take some time. The economy, housing availability, and interest rates are just some of the many factors that property owners are subject to.
Requires a Big Investment – Many people think you need tens or hundreds of thousands of dollars to invest in real estate. This is a misconception because there are many creative ways to get started investing in a rental property without large amounts of capital.
Investing is the Same as Owning Your Home – This is a misconception because owning your own home means you have more control over renovations, repairs, and updates than renting out property does. Additionally, owning your own home requires long-term commitment, whereas a rental property involves short-term commitments.
Safety of REITs and Rental Property Investments
REITs offer several risk mitigation strategies that can help protect your investment. These strategies involve diversifying the portfolio, conducting thorough due diligence, and implementing proactive risk management measures.
Stability: REITs provide stability in market fluctuations. By investing in diversified assets, REITs can weather market volatility more effectively than individual real estate investments. This stability is precious during economic downturns when traditional investments may experience significant losses.
Professional Management: Another safety net of REIT investments is the professional expertise of REIT managers. Experienced and trained professionals with in-depth real estate market knowledge manage REITs. Their property acquisition, development, and management expertise allows investors to benefit from their industry insights and market intelligence.
Rental properties have safety and risk mitigation factors as well.
Long-term Stability: a rental property provides investors with long-term stability as they generate tenant income.
More Value Appreciation: as the area surrounding the property appreciates, so does the value of your investment when it comes time to sell.
Tax Benefits: Rental property investments may qualify for tax benefits such as deductions for maintenance costs or depreciation of the unit itself.
Even though there is risk involved with investing in a rental property, there are also many ways to mitigate those risks, the simplest being obtaining quality advice before making any financial commitments.
How to Find Opportunities in REITs and Rental Properties
Here’s how to spot opportunities that might indicate a good time to get into REITs or rental properties.
How to Spot Opportunities in REITs
Market Trends: Successful REIT investments require monitoring market trends closely. By thoroughly analyzing various factors like property demand, rental rates, and occupancy levels, investors can effectively identify and capitalize on potential opportunities that occur within the market.
Economic Factors Favoring REITs: Several key economic factors create a highly favorable REIT environment. One such factor is lower interest rates, which makes financing more affordable and attractive for investors. Additionally, population growth plays a significant role in driving the demand for real estate, particularly in areas where urbanization is rising.
Emerging Opportunities in the REIT Sector: Among the emerging areas of interest within this sector are healthcare REITs, which are gaining traction due to the growing demand for medical facilities and senior housing.
Sustainability-focused properties are also gaining popularity because of the focus on environmentally conscious and energy-efficient buildings.
How to Spot Opportunities in Rental Properties
Technological Advancements: Advancements in technology, especially in property management software and real estate analytics, can reveal hidden opportunities in rental properties and REITs. Technologies like AI and big data analysis can help predict market trends, assess property values, and manage properties more efficiently.
Demographic Shifts: Changes in demographics, such as an increase in millennials seeking rental accommodations or baby boomers downsizing, can indicate potential growth areas in the rental market. Understanding these shifts can guide investors toward properties that cater to these specific demographic needs.
Distressed Properties: Identifying distressed properties or areas undergoing revitalization can present unique investment opportunities. Investors can buy lower-cost properties in these areas and potentially reap significant gains as the neighborhood improves or market conditions change.
The Best of Both Worlds?
When it comes to securing your valuable real estate assets for the future, there are various strategies you can use, and I have discussed two of them: REITs and owning a rental property.
Is there any reason you can’t do both?
REITs offer the advantage of investing in a professionally managed real estate portfolio, which can provide steady income and potential capital appreciation. On the other hand, owning a rental property allows for more direct control and the ability to generate rental income.
By combining these two investment vehicles, you can benefit from the stability and diversification offered by REITs while enjoying the potential for higher returns and the ability to manage your rental properties actively.
Remember, it’s key to carefully evaluate and select both REITs and a rental property that matches your long and short-term financial goals and risk tolerance. Additionally, staying updated about market trends and seeking professional advice can further enhance your investment strategy.
Consider the powerful combination of REITs and rental property in your portfolio to secure your assets and set yourself up for real estate rental success.
Options for collecting income from rental real estate include both REITs and rental property. Both choices have their own advantages and drawbacks, making it key to understand the dynamic nature of the real estate market before making your decision.
REITs offer diversified real estate investment without property ownership, providing passive income and capital appreciation potential but with performance depending on market conditions and REIT management expertise.
A rental property offers direct ownership, control, tax benefits, and potentially high returns but requires more hands-on work.
Understanding the dynamic real estate market is critical when choosing between REITs and rental property. Consider market conditions, financial goals, risk tolerance, and investment timeframe.
REIT vs Rental Property FAQs
Here are the most-asked questions I get about REITs and rental properties.
What are the advantages of REIT investment over direct ownership of rental properties?
Investing in REITs offers enhanced diversification across various real estate sectors, professional management expertise, and liquidity through easily tradable shares. It allows for passive income and potential capital appreciation without property management responsibilities.
What are the Risks associated with investing in rental properties?
While a rental property provides control and potential for higher returns, they require active management involving tasks like tenant selection and investment property maintenance. Additionally, lack of diversification and illiquidity can pose challenges in adapting to market conditions.
How can investors protect their real estate assets in the long term?
A strategic approach involves diversifying portfolios with a combination of REITs and rental properties. REITs offer stability and diversification, while properties for rental provide control and the potential for higher returns. Careful evaluation aligned with your financial goals and staying updated about market trends are key for long-term success.