REIT vs. Rental Property

Real estate is an excellent way to help your money do more for you. It allows you to generate a solid monthly cash flow while also building equity for the future. There are various potential real estate assets, each with benefits and downsides. Here’s a comparison of two ways you can invest in real estate; REIT investing and buying rental property,

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Investing in Rental Properties

When you buy a rental property, you directly add income-producing real estate to your investment portfolio. It's the most well-known and popular investment strategy because you have the satisfaction of direct ownership with the benefit of rising equity value and regular cash flow.

Essentially, you decide on a particular market you'd like to pursue, research the available properties, then purchase it and prepare it for tenancy. You'll pay the mortgage from the rent you collect from tenants, then keep the rest of the income for your own needs. It allows you a great deal of control over how your money is spent and gives you a liquid asset that will appreciate over time. 

Pros

There are many things that real estate investors love about purchasing physical real estate beyond the excitement of owning their residential property. Below, we've outlined some of the strongest benefits of rental real estate. 

Consistent Cash Flow

With rental property, you benefit from monthly rental income, which can significantly supplement your ordinary income. Depending on where you live, you could charge anywhere from $1,000 to $3,000 a month — and this is considering just one rental property.

Many real estate investors develop a portfolio with multiple properties, ranging from commercial to single-family homes. This helps hedge against vacancies or economic downturns while also providing a greater revenue stream throughout the years. Your personal net worth can skyrocket thanks to the consistent rent.

Higher Annual Yields

REIT investors will receive quarterly cash flow as dividends from the venture, whether it's from private or publicly traded REITs. While this is beneficial, the yields are much lower because you share the profit amongst many other real estate investors, who all get dividend income. 

When you buy rental property by yourself, you are the sole beneficiary of its yields, meaning you get to keep most of your taxable income but for the government's share. You'll be able to raise rents in accordance with local market conditions, improving your returns. Often, you can expect anywhere from an 8% to 12% return on investment every year with a rental, which is much higher than the 3.5% to 7.4% yield of a REIT. Plus, as you have total control of the rental, you can always devise strategies to boost your income even further, whether that is adding paid parking or vending machines.   

Liquid Assets

Buying rental properties provides you with liquid assets that can be sold should you need a cash infusion.

As real estate has some of the strongest asset appreciation of all assets, your property's market value will likely rise over the years, offering you an excellent windfall based on capital appreciation.

You can sell off an underperforming property and reinvest those funds in a new property, or you may refinance the mortgage to access the equity for new ventures. This allows you to continue collecting rent while expanding your portfolio, and it is the backbone of the incredibly popular BRRRR strategy.

Tax Benefits

Excellent tax benefits make buying a rental property one of the most popular investment strategies. While you will have to pay taxes on your rental income, there are many different tax deductions you can take that will vastly diminish your tax burden, letting you keep more of your income. Many other expenses, such as marketing, professional counsel, and travel expenses, can often be written off to further improve your tax advantages.

Working with a tax professional can help you maximize your deductions, particularly if you want to avoid capital gain when reinvesting in a different property. With their assistance, you can significantly reduce your taxation and improve profitability at the same time. Most of the time, you can also deduct most or all of this, further saving you money. 

Cons

While an investment property is an excellent passive income stream, there are also some downsides to consider. When you buy rental properties, you have to find a good rental property, which can be hard work. You also have to pay property taxes, work to lower your capital gains tax when selling, and handle all the difficulties that come with physical property.

In addition to the aforementioned concerns, these are some of the most considerable cons of owning rental property. 

Property Upkeep and Management Costs

Even the nicest rental properties require some property maintenance from time to time, such as landscaping and repairs. Maintenance costs can range from a few hundred dollars to fix a door to having to install a brand-new water heater, which can cut into your rental income.

There is also the matter of property management, such as collecting rent, negotiating the lease agreement, and evicting tenants who fail to make rent payments. This costs both time and money to manage effectively, as you want to ensure that you keep tenants happy while also avoiding losing money on a unit that is no longer making money. 

Many investors will hire a property management company to manage these issues, especially if they live far from the investment property. However, the property manager fees can be expensive.

Higher Investment Minimums

Not everyone can manage the upfront costs of direct real estate investing. A down payment can be $20,000 or more, especially as lenders expect a much larger down payment for rental properties. Because of the greater complexity, you will also need to pay closing costs, which can be a larger percentage of the purchase price than for an owner-occupied building.

In addition to this upfront cost, you must also consider that you'll have to pay higher mortgage interest because lenders see rental properties as riskier loans. While your cash flow will likely be sufficient to cover this, you may run into difficult times with vacancies, which can make it hard to pay your mortgage.

Investing in REITs

For individual investors who cannot afford their own rental property, real estate investment trusts have a lower barrier to entry and help introduce beginners to the real estate market. These are, essentially, communally owned properties that pay out the majority of their income to those who have bought into the property. 

Depending on where they can be purchased, REITs can be divided into three categories:

• Publicly traded REITs – They're sold on the stock market and comprise part of one's stock portfolio.
• Non-listed publicly traded REITs – You can purchase them from a broker that deals in public non-traded offerings. 
• Private REITs – They're private real estate deals between a closed group of REIT investors.

Depending on their investment holdings, they can also be divided into three categories: 

• Equity REITs – You make money off the property's growing market value.
• Mortgage REITs – You own debt securities backed by the property instead of the property itself.
• Hybrid REITs – A combination of mortgage and equity REITs.

You'll receive dividend payments, typically quarterly, based on the success of the property. As many REITs start out as potential construction projects, you'll get updates on the progress of building, finishing, and renting out the building. Most REITs will have a shareholder's meeting just like other stock options, and you'll be able to hear more about your investment and offer your own feedback. 

Pros

If you're new to real estate investing, a REIT may be a good way to get started, as it's less hands-on. You can avoid making costly decisions due to your inexperience, instead benefiting from the knowledge of others while taking note of what to copy as you grow your portfolio. Let's take a look at the benefits of a REIT.

Low Investment Minimums

Those who want to invest in real estate but don't have liquid funds consider REITs because there are very low minimums, sometimes as low as $500. It's the first step to building a diversified portfolio while also learning about real estate markets through the progress of your investment.

Passive Investing

Established investors appreciate REITs because there's very little work involved. You won't have to negotiate with property management companies, deal with upkeep, or find tenants because you don't have direct ownership. The REIT manager handles all of this on behalf of investors. 

Portfolio Diversification

Those familiar with real estate investing understand how important it is to have a diversified investment portfolio, which is why they gravitate to real estate investment trusts as a decent inclusion. They require little more than buying in, watching the progress of the project, and collecting dividends. These real estate investments can provide you with extra cash to pour into your own real estate, invest in other stock options, or build up the funds to buy a new property. 

Cons

While a real estate investment trust may seem like a safe bet, there are several downsides to this type of investing. 

Lack of Control Over Investment

As you don't have direct ownership, you also don't have much say in what happens to the rental property. You are essentially bankrolling someone else purchasing land, building a property, and then managing it rather than taking on all these decisions yourself. This can be frustrating if you're highly experienced in real estate and note that the REIT manager failed to consider things like market saturation or demographics of the area. 

You'll have to do your own research into the profitability of the venture. However, the manager may not take the same care, and you will have little recourse to share your concerns, given that you will be just one of dozens or even hundreds participating in the project. 

Someone else may take control of the property and fail to attract new tenants, or they may make business decisions you disagree with, in which case your only option is to sell your stock and take the capital gain hit.

Investment Volatility

Any real estate investment is risky to some degree, but REITs are not a well-established investment option, which makes them more volatile and prone to failure. If the REIT manager chooses a poor location and isn't able to attract tenants, you're unlikely to receive much benefit from your investment. Construction may take longer than expected, which will also cut into your profit. This isn't generally a problem when you are buying an existing structure to manage on your own.

Additionally, this real estate investment often consists of commercial rental properties like malls, shops, hotels, apartment buildings, and offices, which are innately riskier due to their high cost and risk of vacancy. As market conditions change, what seemed like a winning investment may slowly go downhill as businesses leave the area or inflation drives small companies out of business. This will all impact whether you receive any reward from your stock. 

Long Investment Requirement

It takes quite a while to get a REIT off the ground, especially if you're helping to fund its construction rather than buying into an established rental property. You may not see a payoff for months or even years while the project gets established, which can be frustrating if you expect quick returns. 

If you buy into a private REIT, one that is not traded on the stock market, you may have to wait for a redemption event until you can get out, and these may only happen on a quarterly or annual basis. The REIT manager may also charge you a fee for selling off and getting out of the venture.

Real Estate Investment Trust vs. Rental Property: Which One is Better?

As there are multiple ways to invest in real estate, you may struggle to decide which is best for you. The truth is that both of these strategies have benefits and downsides. For example, a rental property takes much more work to manage, while a REIT offers less control. 

While both offer you dividends, only directly owning real estate provides you with a higher return on investment. REITs can also be more volatile and are highly dependent on the experience of the manager rather than your own skills. 

Real estate is a safer investment

Ultimately, owning your own rental property is safer. Though it requires a higher upfront investment, it also entitles you to make as many renovations as necessary to attract good tenants. 

You'll have almost total control over the whole process and can ally with great professionals who will help you make your investment the best property it can be. As you aren't sharing the income with anyone else, you'll make a more consistent income and can reduce your tax burden significantly, helping you keep more.

REITs, while cheap, have a great deal of secrecy attached, which can potentially sink the entire venture if the property manager is inexperienced or makes poor business decisions. With a directly owned rental property, you and the market are the main deciding factors of success, which puts a great deal more control in your hands. Directly-owned rental properties are a safer investment — not to mention more lucrative, too.

If you're ready to get started as a real estate investor, get in touch with us to discuss your needs. We're the leading commercial lender in the US, offering an array of loans that are custom-made for investors. Enjoy fast turnaround times, a streamlined and simplified lending process, and expert advice that ensures excellent dividends for years to come. 

FAQs About Investing in Real Estate vs. REIT

Is it better to own REITs or rental property?

.Owning your own real estate is a better option. This is because direct ownership entitles you to a higher return on investment, as you don't need to share profits with other investors. You will also have far greater control over the process and can manage each aspect of selecting, purchasing, renovating, and renting out the property to tenants. 

Are REITs safer than rental properties?

Not necessarily. While you won't lose as much should a REIT go under, depending on how much you invested, you are also more likely to lose all of it than you are with a rental property. Poor leadership decisions, market downturns, and even changing legislation around REITs can all scuttle your dreams of a good passive income. 

There is also the fact that these are a newer investment product which hasn't been extensively tested for success like other forms of real estate investment. Instead of relying on someone else to manage your investment without your input, it's always safer to rely on yourself and your network of real estate professionals to assist you. 

How are REITs different from being a landlord?

REITs vary dramatically from being a landlord. They are far more hands-off — essentially, you buy stock in the property, and someone else manages it for you. You can participate in meetings regarding its management, but all the decisions will ultimately be made by someone else. You will also be in a cohort of investors who will share in the rewards.

When you're a landlord, you make all of the executive decisions, take on most of the risk, and complete many of the activities around property ownership yourself, such as deciding where to buy property and who to rent to. There is more work involved, as well as more risk, but this can pay off handsomely in the form of good equity and a steady income. 

What is the downside of buying REITs?

For many investors, the primary downside is that they don't provide as much return on investment as directly holding a property. You will only receive a fraction of the overall income because it's shared amongst numerous other shareholders. 

Even in a very small REIT, you might get less than 5% of the overall cut. This vastly diminished return means that seasoned investors tend to only add a REIT as part of a larger portfolio rather than relying on them for the majority of their passive income stream.

Another downside is that you get almost no say in how the property is run. This may appeal to investors who simply want to make a little bit of money off real estate. However, it can be a big turnoff to those who enjoy the responsibility of caring for a property, as well as the major benefits of selling it down the line.

Can REITs lose money?

Yes, REITs can lose money. Market volatility may mean that a previously attractive building loses tenants, while administrative delays may bring it to market during a downturn. There is also the fact that an inept manager may cost a property thousands as they make poor business decisions and fail to adapt to market changes. 

While it's true that you're likely to lose less because you will have probably invested a much smaller sum in the REIT, this can damage your portfolio and leave you with less to maintain other properties. 

You need to do your homework carefully on all aspects of a REIT, such as the business experience of the company running it and the market conditions surrounding the property, in order to ensure that you're making a safe investment. As there is so much speculation involved for far less profit, it often makes more sense to save up and buy your own property.

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