REITs vs Rentals: What's the Best Way to Invest in Real Estate?
April 11, 2022
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If you're looking for a way to invest in real estate, you've likely come across REITs vs rentals. They both offer a great way to invest in real estate, but with different responsibilities and outcomes. Here's everything you must know about investing in both types of real estate investments today.
Reasons to Invest in Real Estate
There are many reasons (and ways) to invest in real estate. However, buying an investment property outright or buying shares of a real estate investment trust are two of the most popular ways real estate investors make money.
If you're wondering why you should consider real estate investing, consider these reasons.
You May Earn a Decent Cash Flow
There isn't a guarantee you'll earn a cash flow investing in real estate, but there is a good chance. Whether you invest in commercial real estate and earn dividend income or invest in rental properties and collect monthly rental income, there may be cash flow.
Real Estate Is a Hedge Against Inflation
We're all experiencing inflationary prices right now, which can hurt the pocketbook. Inflation can also negatively affect the stock market, which can hurt your investment portfolio. However, diversifying your portfolio with real estate properties can offset the loss.
Real estate prices often increase with inflation, which means real estate investors make more money. Rental property owners earn more equity in the property when values increase, which increases your capital gains. If the value of the investment property rises enough, you may even be able to increase the rent charged.
You May Be Eligible Tax Deductions
Depending on how you own real estate, you may be eligible for certain tax deductions. For example, if you own rental properties, you may be able to write off the expenses of running your business. This includes repair and maintenance costs, mortgage interest, and other expenses you incur managing the rental properties.
If you invest in real estate investment trusts, you may not have tax deductions, but there are some tax advantages if you hold onto the investments for the long-term. Rather than paying taxes at your ordinary income tax rate, you may pay lower long-term capital gains taxes.
You Can Build Equity
Real estate investing opens you up to the possibility of building equity in the property. Whether you make a direct real estate investment in a rental property or you invest in a REITfor passive income, you have the chance to build equity. When you (or the REIT company) sell the real estate, you may be eligible for a portion of the proceeds, helping to increase your personal net worth.
A Chance to Earn Passive Income
Depending on how you invest in a rental property, you might be eligible for passive income. This is income you earn for doing nothing except investing your funds. If you invest in multiple rental properties or REITs, you stand the chance to have multiple income streams and have a more reliable monthly cash flow.
Real Estate Has a Solid History
No investment is 100% foolproof, but real estate investing has a solid history. Since real estate values historically increase, you have a chance of increasing your net worth and earning dividends or payouts as the property appreciates. It's always a good idea to diversify your investment portfolio, too though, to offset the risk of a loss.
Real estate investment trusts are a way to invest in real estate passively. You don't personally own the rental properties. Instead, you buy shares from a real estate company that buys and usually manages the income-producing real estate.
REITs invest in many types of real estate, and there are several ways to invest in REITs, whether publicly-traded REITs or private.
The key is to do your due diligence to ensure the company you're buying shares of has a good track record in property management, real estate portfolios, and choosing/managing the right commercial real estate properties.
One of the largest benefits REIT investors enjoy is having no responsibilities. For example, you aren't responsible for property management, dealing with tenants, collecting rent, or repairing the properties.
Your only job is to do your research to ensure the REIT has the same beliefs you do and chooses properties you want your money to go toward.
- Hands-off investing
REIT investing is one of the most hands-off approaches to real estate investing. You provide the capital (your investment), and the real estate company does the rest. You don't have a say in what they invest in, but you also don't have any responsibilities toward the properties, yet you may earn dividend distributions or capital appreciation.
- Low investment minimums
REITs don't require a lot of capital. Some real estate investing platforms allow investors with as little as $10 to invest join. You don't have to be an accredited investor, and you can jump in on the excitement of real estate investing.
- Portfolio diversification
REIT fund managers often diversify the real estate portfolio considerably. Compare this to how you could afford to diversify real estate investments yourself, and the difference is clear. You could invest in a REIT that manages hundreds of properties, giving you a greater chance at better returns.
- Consistent cash flow
REITs often pay their investors regular dividends from rental income or mortgage interest if the REIT funds the loans builders and developers need to invest in real estate. Each REIT pays dividends in different intervals - some pay monthly while others pay quarterly or annually.
- Little control
Since REITs are a completely passive investment, you don't have a say in the properties the REIT invests in or how they manage them. This is why doing your research on the company first is so important. You don't want to invest in a company with bad practices.
- Long investment requirements
Most REITs require you to tie up your money for at least a few years, and not all have early redemption programs. You must be able to give up the capital you're investing for the duration of the investment to get the regular cash flow.
- No tax benefits
Any income you earn from a real estate investment trust is taxable at your ordinary tax rate unless you invest in it using your IRA. Whether you earn monthly or quarterly cash flow, you'll pay taxes on the income as you earn it.
How to Invest
Real estate investors have many ways to invest in REITs. First, you must decide whether you want publicly traded or private REITs. You can buy publicly-traded REITs during regular trading hours on the stock market or buy private REITs from brokers through mutual funds or ETFs.
There's no guarantee of profits when you invest in real estate investment trusts. How much you make depends on the REIT you choose and what commercial properties the fund invests in. You can see dividends quickly if the company pays monthly or quarterly dividend payments. Still, it could be several years before you see the full return on your investment, depending on the investment timeline.
Rental property is another way to invest in real estate, but this is a direct real estate investment. You buy the property yourself (with or without a mortgage loan), rent it out, and collect rental income.
When you buy rental properties, you are the landlord and responsible for all aspects of the home and the tenants, but you can also hire a property manager to handle the aspects of the property management for you.
As a landlord of a rental property, all responsibilities fall on your shoulders. If you manage the property yourself, you'll market the property to potential renters, screen tenants, create and execute leases, and manage the property. All maintenance and repairs are your responsibility, as is paying the mortgage, property taxes, and homeowner's insurance.
If you don't want the burden of property maintenance and repairs or even dealing with the hassle of screening tenants and collecting rent payments, you can hire a property management company, but make sure you have enough room in your profit margin to pay for it.
- All asset appreciation is yours
If you're the sole owner of a rental property, your tenants pay the costs to own the property while you enjoy the asset appreciation. As the property builds equity, your net worth increases. When you sell the property, all profits belong to you.
- You're in control of what you invest in
You get to decide which properties you buy and rent out. You don't have to be at a fund manager's mercy, hoping that they make good investment choices. As the landlord, you also get to set all rules, including the monthly rental income, what you will and will not allow on the property, and even the lease length.
- You may be eligible for tax benefits
You are a business owner, not just an investor, when you own rental properties. Therefore, the IRS offers many tax deductions for real estate investors, including the opportunity to write off all expenses you incur running the properties, including property taxes, mortgage interest, repair and maintenance costs, and commuting costs to and from the property.
- It's a lot of work
It's a lot of work without property managers running your rental properties for you. You are on call 24/7 and have to be available to ensure the property is safe and sound for your tenants. You also bear the burden of finding and screening tenants, dealing with rent collection, and handling unruly tenants.
- You need expertise to find a good rental property
Not every property makes a good rental property, and you need a good eye and expertise to find them. While many properties have potential profit, some can be complete losers and are a liability risk.
- You need a lot of upfront capital
To invest in real estate, you need a lot of money upfront. Mortgage lenders require a large down payment, plus you need money to run the property. Raising capital to buy investment properties can be time-consuming and an opportunity cost to other investments you could make.
How to Invest
Buying rental properties can be done easily with the help of a qualified real estate agent. As long as you have the money for a down payment and qualify for mortgage financing (or have the cash available), you can buy a property and become a landlord within a few months.
You can also look for deals, such as foreclosed properties, or you know of undervalued homes, and with a little TLC, can be worth more and strike a deal. Just be careful that you don't buy a money pit and end up without enough money to make a profit.
Investing in rental properties is a long-term investment. While you could list a home for sale at any time, it takes months to sell, and if you sell too soon, it may not sell at a profit. The key is buying for the long-term, creating a reliable income stream from the rental income, and enjoying equity build-up and eventual capital appreciation.
REIT vs Rental Properties: Which Is the Safer Investment?
The safer investment between REIT and rental properties depends on your situation. Some people want a hands-on approach to investing, so rental properties are the best bet for them, while others prefer a hands-off approach letting someone else do the work, which makes REITs safer for them.
Do REITs Have Good Returns?
REITs invest in real estate, and real estate often appreciates, so REITs do often have good returns. Like any investment, though, there is no guarantee. You could always have a loss, so it's important to diversify your portfolio to make the most profits.
Is Investment in Real Estate a Long-Term or Short-Term Investment?
Any way you invest in real estate, it's typically a long-term investment. However, it may be a shorter-term investment if you invest with a REIT platform that invests in short-term loans to investors. Those investments turn over in 6 - 12 months, but the average real estate investment lasts 5+ years.
The Bottom Line: Which Is Better?
The right real estate investment for you is the one you are most comfortable with and the one you can fund easily. Look at the investment's cash flow, historical performance, and potential tax benefits as you decide which real estate investment is right for you. Learn more by signing up and visiting our blog.
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