The most significant advantage of REITs is that they allow regular investors to participate in commercial properties.
Adding real estate to your investment portfolio can help you diversify, increase profits, and even hedge against inflation risk. When it comes to investing in real estate, though, you have a few options. Rental property and real estate investment trusts are two of the most common real estate investing options (REITs). But, what are the advantages and disadvantages of each of these investment vehicles for you and your portfolio? Which is the better investment: REITs or rental property?
Rental property vs. REIT
You must first grasp how each real estate asset class works before deciding which is best for your investment portfolio.
Property for rent
The concept of rental property is familiar to the majority of people. Residential property, such as a single- or multifamily home, condominium, or apartment building, can be purchased and rented out by investors. This property should, in theory, bring in more rent each month than the investor spends in mortgage, taxes, insurance, maintenance, and other costs. Any delta generates a monthly cash flow profit for the investor, which they can save or reinvest in the property. The hope is that the rental property would appreciate over time or after a renovation.
Real Estate Investment Trust (REIT)
A REIT (real estate investment trust) operates in a somewhat different way. You buy shares in a REIT, which is a trust that owns and manages real estate. You will have no say in the property held by a REIT, and you will have no involvement or responsibility in its management as an investor. Investors get dividends when the REIT’s assets appreciate and generate profit. If an investor needs to sell his REIT shares at any point, he can do so.
If an investor has to sell his REIT shares at a later date, he can do so at the current market value. REITs come in three varieties: publicly traded, privately traded, and public non-traded. Each has its investment requirements and money accessibility, and each runs in a somewhat different way.
Similarities between REITs and Rental Properties
Investing in rental property and REITs are comparable, if not identical, in many aspects. Here are some examples of how the two possibilities intersect.
Both REITs and rental properties might supply you with a source of cash flow if you’re seeking a cash-flowing investment. REITs must disperse at least 90% of their taxable revenue to investors in the form of dividends, according to the IRS. As a result, REITs are a dependable source of this type of passive income. A rental property might also supply you with regular income flow in the correct circumstances. However, market rental pricing, property taxes, vacancies, and even maintenance all play a role.
Many investors consider rental property and REITs to be good long-term investments since they both have the potential for high growth and asset gain. If and when these assets improve in value, investors can expect increasing cash flow regularly. Any increase in value will be recognized by the investor when the assets are sold later.
Another similarity between REITs and rental property is that both can be volatile and have value fluctuations over time. Investors would likely feel the effects of a REIT’s reduced profit margin – whether owing to rising expenses or market dynamics – through smaller dividend payouts. This reduced cash flow may influence your budget and other financial endeavors. If you need to liquidate your portfolio, REIT volatility can be a problem. When it comes time to sell your REIT, you will notice if the price has plummeted since you bought it.
Volatility, unscrupulous renters, and plummeting property values are just a few of the threats that rental property faces. Rental costs might change in tandem with the rest of the real estate market, resulting in lower rents and even longer vacancies. Increased property taxes or unforeseen costly repairs, which are the responsibility of the owner-investor, might also generate volatility.
Both offer diversification
Real estate investing can help diversify your investment portfolio, better secure your assets, and lessen the impact of market downturns and inflation. Both rental property and REITs help to diversify your portfolio by incorporating real estate investments. The more diverse these investments are, the better diversified your portfolio will be: this could involve buying several REITs or several forms of investment property or investing in multiple places.
Also Read: A Beginner’s Guide To Investing In REITs
The Differences Between a REIT and a Rental Property
If you want to make an informed investment decision, you need to understand the differences between rental properties and REITs.
Direct ownership receives tax benefits.
Many IRS tax deductions are available to property owners who have an investment property. Mortgage interest, property taxes, repairs, management, and other expenses can all be written off. Investors in REITs do not get these kinds of tax savings.
Flexibility and control
You don’t have much (or any) control over your REIT investment, whether you wish to choose the next batch of tenants or just paint colors. You should choose rental property if you want to be more hands-on with your investment.
Possibility of utilizing as collateral
You may be able to borrow against a portion of your rental property’s equity (or the value that you own) as needed if you own a rental property. This can be accomplished with the help of a home equity loan or a home equity line of credit.
Active vs. Passive investments
One key distinction to keep in mind is that rental property is an active investment, whereas REITs are a passive one. Even if you engage a management company to handle the majority of the day-to-day choices, rental property demands a hands-on approach and regular attention. REITs, on the other hand, allow investors to “set it and forget it” when it comes to investing. Except for receiving dividend payments and watching your asset(s) develop, there’s nothing else you have to do once you’ve purchased shares in your REIT.
If you ever need to sell your investments, REITs may be a better option than renting a home. You’ll almost always have to sell a rental property to get rid of it. Between preparing and listing the house, showing the property, and closing on a transaction, can take a lot of time, effort, and money. A rental property asset can take months to liquidate from start to completion. However, with REITs, it might be as simple as pressing a button on your brokerage’s app. If you possess publicly traded REITs, you can sell them in minutes (if not seconds) if a buyer is willing to buy them.
Costs and investments upfront
For investors, a rental property can be many things, but cheap on the front end isn’t usually one of them. To buy a rental property, investors must have enough money to cover the down payment, earnest money, and closing charges. If renovations are required, the investor must either pay cash or obtain a loan.
You may often get started investing in REITs with as little as a few dollars. While some REITs (especially those that are privately traded or non-traded) have hefty investment minimums, many others are available on ordinary brokerage platforms with no such limitations.
REITs vs. Rental- The safer option
As you can see, both property rental purchases and REITs have their own set of advantages and disadvantages. The safest option is determined by your particular investing preferences and what you genuinely desire from your investment. Investing in real estate, regardless of which path you take, is a terrific method to supplement your income and diversify your assets and financial portfolio.
It’s critical to consider the benefits and drawbacks outlined above and choose the choice that best fits your lifestyle, as well as the amount of time, effort, risk, and money you’re willing to devote. Housing will always be a requirement. As a result, it’s a far better investment alternative. While prices in the housing market may fluctuate, overall demand for housing remains consistent.
Do you like to take a step back and let things happen on their own? Then think about include REITs in your portfolio. Are you seeking a tax-advantaged investment that also gives you more control? Then a rental home is a good option. Purchasing rental property with REIT shares may be the ideal happy medium for some investors. After all, the more diversified your investment portfolio is today, the more protected you will be in the future markets. The best option depends on an investor’s objectives and investment style; in some circumstances, combining REITs and rental properties may be the best option. Assetmonk is a WealthTech platform offering real estate investment opportunities in top cities like Bangalore, Hyderabad, and Chennai with an IRR of 14-21%. Visit our website to start investing with us!!
Rental Property vs. REIT FAQ’S
A rental property is a residence or commercial that is leased or rented to a renter for a defined length of time. There are holiday rentals and long-term rentals, such as those with a one-to-three-year contract.
The primary advantage of REITs is that they allow individual investors to profit from real estate without having to own, operate, or finance properties directly. They provide a low-cost method of real estate investment. REIT shares, like stocks, can be bought and sold on an exchange.