A good investment is not just one that promises high returns and good income, it is also one that does not burden you in any way while also satisfying your monetary needs and meeting your financial goals.
While a person could be pursuing real estate investment as their primary source of income, someone else might be interested in using real estate as a source of passive income. Both of them have the same intention but their approaches are very different. This is what direct and indirect investments look like.
As you drill down in this dynamic field of the property investment business, you need to know the significant differences that exist between direct and indirect (also can be known as REITs) real estate investment. This will play a crucial role in deciding as it impacts mostly on risk, returns, and diversification of Direct or Indirect Real Estate Investment.
Direct Real Estate Investment
Direct real estate investment means buying a specific property at a stake. In other terms, it means acquiring ownership in a particular entity. It involves having a substantial interest in an asset either it is an apartment, shopping mall, or office building. It can be held either for a residential or commercial purpose. You can have two choices of doing direct investment in real estate:
- You can directly buy a real estate property of your choice i.e., residential or commercial.
- You directly invest in a property through partnership firms.
This business allows investors to make money through rental income investment. You can also earn money through the profits generated from any business activity carried in a particular field. It even allows you to make money on the appreciation of the assets held. As the price increases over time, resulting in a considerable amount of return on the assets.
Pros of Investing In Direct Real Estate
- One of the major advantages of investing in real estate is that it will increase the potential to generate positive cash flow. Such types of physical properties add regular cash flow to your pocket.
- The second advantage of such investment is appreciation. As you must know the common phenomenon prevailing in the market i.e. price fluctuation. It’s just like the stock market wherein second prices might be high or low. Depending on the period of holding, property prices may increase over time. And, this will add a strong value to your property. You can use your rental investment property for sale at much higher prices.
- The next perk is allowing a tax benefit. Suppose, you can deduct the necessary costs you have incurred either relating to maintenance or conservation of the asset. You can even set off the depreciation cost from buying to the improvement of the asset for increasing its useful life. This will have a great impact to lessen the amount of taxable income.
- Another important perk is to add control to taking the decision. You can choose and select the properties that match your preferences either it be location, property type, rental prices, and choosing the right tenant.
Cons Of Direct Estate Investment
- Every investment is followed by some demerits. Yes, it requires significant time and energy to be successful in this field. You need to deal with various issues starting from tenants to the liability of any accidental loss of property.
- Direct real estate is not considered a liquid asset often. It means you can’t sell easily and quickly in an emergency.
- To some extent, it is followed by financial default. Many investors usually mortgage some type of financial deed to pay off the investment. And here it becomes necessary to look for the right tenant as there can be chances for default in the payment of the loan.
Indirect Real Estate Investment
Indirect real estate investment means buying shares in a publicly or privately held company. This type of business is growing nowadays rapidly. In short, such a type of business means investing in real estate without buying property. There are several ways to invest and diversify real estate without clenching the headaches of down payments. Some of these have been mentioned as under:
Exchange-Traded Fund & Mutual Funds:
One of the simplest ways to invest in real estate without the holding of the property is to invest in stocks and funds in real-estate-related industries. It allows investors to diversify their equity portfolios by reducing the risk of having a broker assigned.
REITs or called real estate investment trusts are a type of fund that can be invested in real estate projects. It allows investors to contribute with as little as they have. REITs are traded funds that are listed in the stock exchange.
A relatively new option for investing money in real estate is going for crowdfunding. It is a simple way of investing in real estate. You will find some most popular crowdfunding websites that invest directly in real estate. It allows investors to have a diversified portfolio across many properties.
Peer-to-Peer Lending (P2P) or Crowdlending
P2P lending enables individuals to obtain loans from other individuals. It connects borrowers directly to the investors and thus bridging the gap of middlemen. P2P is an alternative method for financing. It is meant for those investors who want to get a better return on their cash savings.
Pros Of Indirect Real Estate Investment
- Is there any provision to do real estate investing with no money? This question seems to be common in networking sites. And the answer to this question is positive. This is the biggest advantage to go for real estate investment. As the investors need not operate or finance properties. They offer a very low-cost way to invest in the real estate market. You can invest as little you can at the entry level.
- Another advantage is the benefit of getting higher than an average dividend. In indirect investment, it is the law to pay investors 90% of taxable income to shareholders and it’s not usual to get 5% of dividend-yielding. It has the potential for capital appreciation as the value of assets increases with time.
- Another advantage is the liquidity of the asset. It allows you to exchange shares or sell easily and quickly. You can convert it into cash in emergency times.
Cons Of Indirect Real Investment
- Such investment is that most of the dividend on the indirect real investment isn’t considered to be a “qualified dividend”, so they are often taxed at a higher rate. This is a point requiring attention if you have the share in real estate in a taxable brokerage account as you will not get any tax benefits.
- Another point requiring attention is that indirect real investment is most sensitive to interest rate fluctuations. And rising interest rates are not good for any type of shares whether traded or non-traded. Because share prices and share yielding have an inverse relationship, when one goes up, the latter goes down and vice-versa.
Closure Interpretation on Direct Or Indirect Real Estate Investment
Choosing the option in real estate all depends on what type of investor you are. Some may prefer direct to be the right choice and some indirect.
But, yes, a direct option is good if you need to have control over the cash flow, offset the tax benefits, and have an appreciation over the assets. It will work as a boots-on-the-ground approach.
And, for investors who don’t want to operate and manage real estate in addition to it, don’t have the required money, or can’t get the financial help to buy real estate for them, an indirect scheme would be the best option.
Direct Vs Indirect Real Estate FAQs:
Direct investment has many upsides. But, it does lack in having a diversification of portfolios. They have a lower liquidity form and include a certain amount of maintenance costs.
Examples of direct investing- purchasing a property either on your own or with your friends and also includes purchasing under the partnership. But, indirect investing involves buying shares in publicly-traded real estate.
Some sources for doing indirect investment are- Mutual Funds, REITs, Real Estate Syndications, Private Equity Funds, Crowdfunding.
The most significant advantage indirect investment provides is it reduces a considerable amount of capital expenditure required to do any kind of investment.