Real Estate Investment Trusts (REITs) and rental properties offer several unique advantages compared to other real estate investment vehicles.
Both offer the possibility of passive income with minimal involvement and the ability to benefit from long-term appreciation.
However, REITs and rental properties also come with several downsides you should consider before investing your hard-earned money.
This article will compare a REIT vs rental property and give you actionable advice on how you can get started with real estate investing to build your future today.
Understanding REITs
Real Estate Investment Trusts (REITs) are publicly traded companies that own, operate, and manage cash-flowing real estate properties. These are typically commercial real estate properties that bring in consistent rental income from commercial tenants.
REITs operate similar to stocks; they fluctuate in value depending on market conditions and various economic factors.
As such, investing in REITs can be a sound investment during times of economic prosperity and a stable housing market.
» MORE: Best REITs for New Investors
Benefits of Investing in REITs
Investing in REITs can be a great way to gain exposure to the real estate market without owning physical property.
Here are some additional benefits you’ll find with REIT investing.
Dividend Income
REITs are structured in a way that requires them to distribute a significant portion of their earnings to shareholders in the form of dividends.
These dividends can be particularly attractive to investors seeking a regular stream of income.
Due to this distribution requirement, REITs can provide a consistent source of passive income, which is especially appealing in times of low interest rates or economic uncertainty.
Liquidity
Unlike direct real estate investments, which can take time to buy or sell and involve more complex transactions, REITs are listed on major stock exchanges. This means that investors can buy and sell REIT shares relatively easily and quickly.
The ability to exit an investment without the challenges associated with selling physical properties offers a level of flexibility and liquidity that direct real estate investments often lack.
Diversification
REITs allow investors to diversify their real estate exposure across various types of properties and geographic locations without the need to individually purchase and manage each property.
For instance, you can invest in residential, commercial, office, industrial, and even specialized property types through different REITs.
This diversification can help mitigate risk by reducing the impact of poor performance in any single sector or region.
Professional Management
One of the most appealing aspects of investing in REITs is that they are managed by experienced real estate professionals. These professionals handle property acquisition, leasing, management, and maintenance.
Investors don’t need to worry about day-to-day operations or the headaches that can come with direct property ownership.
» MORE: 7 Tips for Rental Property Maintenance
Accessibility
Investing in physical real estate properties often requires a substantial upfront investment, which can be a significant barrier to entry for many investors. REITs, however, allow individuals to invest with relatively small amounts of capital.
This accessibility gives all investors access to the real estate market, enabling a wider range of investors to benefit from the potential returns and diversification benefits that real estate can offer.
Drawbacks of Investing in REITs
Despite their benefits, REITs also come with certain drawbacks that investors should consider:
Market Volatility
REITs, like other publicly traded securities, can experience significant price fluctuations due to changes in the economy or geopolitical events.
During times of market uncertainty or downturns, investors might see declines in the value of their REIT holdings.
Interest Rate Sensitivity
REITs are often considered to be yield-oriented investments, as they tend to offer relatively high dividend yields to attract investors.
However, when interest rates rise, the yields on other income-bearing investments, such as bonds, can become more competitive.
This can lead investors to shift their allocations away from REITs, which can put downward pressure on REIT share prices.
Lack of Control
When you invest in a REIT, you’re essentially pooling your money with other investors to invest in a portfolio of properties. This means you have limited control over individual property selection and management decisions.
If the REIT’s management makes poor decisions or if the overall portfolio underperforms, you have little direct influence to change the situation.
Understanding Rental Properties
Rental properties come in many different shapes and sizes. They can include single-family homes, multi-family properties, vacation rentals, and apartment complexes.
The main appeal of rental properties is the rental income they provide. Property owners typically rent out the home to tenants who pay them rent on a continual basis per the terms of their lease agreement.
Rental properties can produce passive income, but also come with many risks and responsibilities of being a property owner and managing tenant relations.
Benefits of Rental Property Investing
Rental property investing is one of the most popular ways to get started in real estate investing. Here are some of the benefits:
Steady Income Stream
Rental properties can provide a reliable and consistent income stream for investors and property owners.
The monthly rent can help cover property expenses such as mortgage payments, property taxes, insurance, maintenance, and more.
Appreciation
Real estate properties have the potential to appreciate in value over time.
This appreciation can be influenced by factors such as location, demand, economic growth, and improvements made to the property.
As the property’s value increases, the investor’s equity also grows. This can allow them to leverage their equity to acquire more properties or sell the property for a profit.
Leverage
Real estate investing often involves using leverage, meaning investors can use borrowed money with a mortgage to purchase properties.
This allows investors to control a larger asset with a smaller amount of their own money. As the property appreciates, the return on the investor’s initial investment can be much higher due to the leverage used.
However, it’s important to note that leverage can also amplify losses if the property value decreases.
Tax Advantages
There are various tax benefits associated with rental property investing, including deductions for property-related expenses such as mortgage interest, property taxes, insurance, maintenance costs, and depreciation.
These deductions can help lower the investor’s overall tax liability and reinvest those savings into their real estate investing business.
» MORE: 9 Rental Property Tax Deductions to Take Advantage of
Drawbacks of Rental Property Investing
Rental property investing can be a lucrative venture, but it also comes with its fair share of drawbacks and challenges.
Here are some common drawbacks associated with rental property investing:
High Initial Costs
Acquiring a rental property often requires a substantial upfront investment. This includes the down payment, which can be up to 25 percent of the property’s purchase price.
Additionally, there are closing costs that include appraisal fees, loan origination fees, and title insurance.
If the property requires renovations or repairs before it’s suitable for renting, these expenses can add up significantly and increase the initial investment required.
Ongoing Expenses
Owning a rental property involves various ongoing costs that can eat into your rental income.
These costs include property taxes, homeowner’s association (HOA) fees, insurance premiums, and regular maintenance expenses.
You’ll also need to budget for occasional repairs and unexpected maintenance issues that can arise over time.
» MORE: Main Responsibilities of a Property Manager
Tenant Issues
Managing tenants can be demanding and stressful. Some common tenant issues include late rent payments, property damage, disputes over maintenance responsibilities, noise complaints, and lease violations.
These issues can consume a significant amount of your time and energy, and in some cases, they might lead to legal action.
Handling tenant concerns and conflicts requires effective communication skills and a clear understanding of landlord-tenant laws.
Market Volatility
A sudden downturn in the market can lead to decreased property values, potentially affecting your property’s equity and overall investment returns.
This market volatility can also impact your ability to sell the property at a favorable price or secure refinancing if needed.
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REIT vs Rental Property – Which is a Better Investment?
Deciding between investing in REITs and rental properties depends on your financial goals, risk tolerance, investment timeline, and personal preferences.
Both options have their advantages and drawbacks, so it’s important to carefully weigh these factors and consult a real estate professional or financial advisor if needed.
Here’s a breakdown of some key points to consider for each option:
Income vs. Growth
Determine whether you’re primarily seeking regular income or long-term capital appreciation.
REITs tend to offer more predictable income through dividends, while rental properties can provide a combination of rental income and property value appreciation.
Risk Tolerance
Consider how comfortable you are with market fluctuations. REITs are influenced by broader market trends, while rental properties’ performance is closely tied to local real estate market conditions.
Time Commitment
Assess how much time you’re willing to dedicate to managing your investment. Rental properties require hands-on management, while REITs offer a more passive investment with professional management.
Capital Availability
Evaluate your available capital. Rental properties typically require a larger upfront investment, including closing costs and potential renovations or repairs. REITs can be more accessible with lower initial investment.
Market Research
If you’re considering rental properties, research the local real estate market thoroughly. Analyze historical property value trends, vacancy rates, rental demand, and economic conditions.
This will help you gauge the potential for property appreciation and rental income.
Diversification
Consider whether you’re looking to diversify your investment portfolio.
REITs provide exposure to a broad range of real estate assets across different sectors and geographic locations, reducing the risk associated with a single property.
The Bottom Line
When comparing a REIT vs rental property, it’s important to consider your financial goals and the level of involvement you want with your investments.
REITs are ideal for investors who want to participate in real estate investing but don’t want to deal with hands-on property maintenance and managing tenants.
On the other hand, rental property investing offers cash flow and passive income for investors looking for stable revenue and long-term appreciation.