Most property investors are familiar with real estate investment strategies such as buy and hold, investing in traditional or Airbnb rental property, fix and flip, and house hacking. Investing in real estate investment trusts (REITs) is another popular option. However, it doesn’t require you to purchase a physical property. But what exactly are REITs? Do they make for a better real estate investment than rental property? Let’s dive into the debate of REIT vs real estate property.
So, What Are REITs?
Real estate investment trusts are companies that manage or own income producing residential properties or commercial properties. The company pools funds from different investors, and then invests the money in their real estate assets. Just like a mutual fund, investors can then make passive income from their investment without having to purchase a physical investment property.
There are three main types of REITs you can choose from:
- Equity REITs – This type deals with physical real estate that generates income through rent. Equity REITs usually specialize in specific kinds of investment property, such as office buildings and apartments.
- Mortgage REITs – Mortgage REITs involve purchasing existing mortgages or loaning money to property owners. With this type of REIT, income is earned mainly through mortgage interest.
- Hybrid REITs – These are a combination of mortgage and equity REITs. Profits are earned through both mortgage interest and rental income.
Related: What Is a Real Estate Investment Trust (REIT)?
REIT vs Real Estate: Are REITs Better Than Real Estate Rentals?
To resolve this perennial REIT vs real estate debate, we need to compare the pros and cons of both real estate investment strategies before coming to a conclusion.
Pros and Cons of Rental Investment
Benefits of rental property investment
- Regular cash flow – Rental real estate investing means that you can enjoy a steady cash flow in the form of monthly rental income. While some REITs pay dividends on a monthly basis, many pay on a quarterly basis. And unlike earnings from REITs which fluctuate due to market forces, being a landlord typically assures you of receiving a fixed rate of return on a rental property.
- Tax deductions – This is a major consideration when choosing between REIT vs real estate. Owners of rental property in the US housing market can deduct from their taxes most of the cost incurred in the running of their investment property. This includes costs such as property taxes, insurance premiums, maintenance costs, and legal fees. These deductions will lower your net income, thus reducing the amount of taxes owed.
- Freedom and flexibility – With a real estate rental investment, you get to call all the shots. You can decide how much to charge for rent, what improvements you will make, who to work with, and when to sell the house.
- Equity – Owning rental property investments allows you to enjoy the benefit of equity. This is simply the difference between what the property is worth and what you owe on your mortgage. You can leverage your equity to secure a loan for renovation or buying another investment property.
- Asset appreciation – Besides monthly cash flow from rental income, buying an investment property allows you to generate money through appreciation. Real estate generally increases in value over time. This means that you can sell it much later and make a good profit margin.
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Downsides of rental property investment
- Upfront capital required for a down payment – To invest in rental property, you must be prepared to produce a down payment. This amount will vary depending on the kind of property you are investing in. You will need more capital for investment properties such as a multi-family complex or commercial office buildings.
- Active property management – Investing in a rental property will require your direct involvement in its management to generate active income. You will need to advertise the property, screen tenants, draft leasing agreements, handle repairs, and deal with evictions. Hiring a professional property management company to handle these responsibilities means a reduction in your earnings.
- Taxes and fees – Whether you have tenants or not, you will be expected to pay property taxes, homeowners’ association fees, and property insurance. Since you will be paying such costs out of pocket, this will mean negative cash flow during vacancies.
Related: Top 5 Mistakes to Avoid When Buying Your First Rental Investment Property
Pros and Cons of REITs
Benefits of REITs
- Passive real estate investing – Unlike rental properties, which require hands-on involvement if you don’t hire a manager, REITs offer a great way to make money in real estate without becoming a landlord. All you need to do is provide some capital and let the experts invest on your behalf.
- Low investment minimums – To invest in rentals, you will have to spend tens of thousands to millions of dollars to purchase and probably renovate the property. However, REITs can be bought with an investment of as little as $1000.
- Liquidity – Real estate investors can buy and sell their REIT shares freely on a quarterly, monthly or daily basis. This is unlike rental properties which can remain illiquid for a very long time.
Downsides of REIT investment
- Volatility – Publicly-traded REITs fluctuate depending on the rise and fall of the stock market. With these constant changes, real estate investors can never be sure of making a good return on investment.
- Less control – Unlike rental properties that offer real estate investors lots of flexibility and freedom, REITs subject investors to control with little responsibility. Though they can enjoy returns, REIT investors are not involved in any decision making.
- Tax inefficient – As mentioned earlier, rental property owners can lower their tax obligation by deducting operating expenses. This is a privilege that is not available to REIT investors who are charged a dividend tax of 15% or more.
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REIT vs Real Estate: Final Verdict
REIT vs rental property: which is better? A critical look at the pros and cons will show that rentals are the best way to invest in real estate. The best thing about buying rental property is the ability to predict their performance. With tools like Mashvisor’s heat map, you can find the best locations to invest in based on listing prices, Airbnb occupancy rate, cash on cash return, and rental income. You can use the Property Finder tool to find and analyze properties that match your goals in terms of property type, market availability, return on investment, and optimal rental strategy.
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