Individuals looking to invest in real estate often need to choose between REIT vs. real estate. REITs are real estate investment trusts that own, operate, or finance income-producing real estate across a variety of sectors, such as office buildings, shopping centers, or apartment complexes. On the other hand, investing in physical real estate involves purchasing properties directly, whether residential or commercial, to generate rental income or capital appreciation.
Continue reading to find out more about these two investment options to help you decide which is more suitable for you: REIT or real estate.
What Are REITs?
Real Estate Investment Trusts (REITs) are a popular investment vehicle that allows individuals to invest in real estate without having to own or manage physical properties themselves. REITs are companies that own, operate, or finance income-generating real estate across a variety of sectors, such as commercial buildings, residential properties, and infrastructure projects. Investors can buy shares of publicly traded REITs through the stock market or invest in non-traded REITs through private offerings.
REITs: Pros and Cons
First, let’s take a look at some of the benefits and drawbacks that come along with investing in REITs. Remember, since a real estate fund works differently than other real estate companies, you could be buying into a data center collective, a portfolio of cell towers of infrastructure, a broad portion of the housing market, apartment buildings, etc.
REIT Pros
- You can purchase a REIT using the same method as stocks. This makes it significantly easier to invest in a REIT than a piece of real estate.
- REITs have lower minimum investments than property. You can purchase 1 share of a REIT for less than $100 in many cases. Some brokers even allow you to purchase fractional shares, which lowers your minimum investment to $1.
- REITs provide you with a truly passive way to invest in the real estate market. After you purchase your shares, the company will directly distribute dividends to you through your brokerage platform.
- REITs have higher liquidity because you can buy and sell them using the same method as any other share of stock. If you have an emergency expense, you’ll have a much easier time accessing your capital if it’s held in REITs compared to real estate.
- A REIT can sell above market value and buy below market value because it has the leverage required to make advantageous deals. Therefore, the investment managers working for these firms can broker deals that benefit every shareholder, including you.
- Focusing on property sectors is a good way for you to know what you’re buying into because the sector is easy to track. For example, buying into timberland lots tells you quite a bit about how these investments would tend to perform.
REIT Cons
- While REITs are easier to invest in and come with lower minimum investments, they also give you much less control over where your money goes. You can’t choose where to invest and you can’t devote your investment to a specific property in the REIT’s portfolio. If the managers of the REITs mismanage your money or the REIT goes bankrupt, you could end up losing a significant amount of money.
- REITs trade on the stock market, which means that they’re subject to market conditions. If the market crashes, your REITs will decrease in value much faster than a similar investment in property. This makes REITs volatile investments.
Compare REIT Investment Platforms
If you’ve ever bought or sold shares of stock before, you already understand the REIT-buying process. Don’t have a brokerage account? Consider a few of our top choices below.
What is Real Estate Investing?
Real estate investing involves purchasing, owning, managing, renting, or selling properties for the purpose of generating profit. The primary goal of real estate investing is to make money through the appreciation of property value, rental income, or both. Investors can choose from various types of real estate investments, including residential properties (such as single-family homes, apartments, and vacation rentals), commercial properties (such as office buildings, retail spaces, and industrial properties), and land.
Real Estate: Pros and Cons
Now, let’s take a look at a few of the benefits and drawbacks that come with investing in real estate directly.
Real Estate Pros
- Real estate gives you direct control over your investment. You get to choose how the property is used, how much you’ll charge in rent, any upgrades you need to make to the space and more. If you decide to sell the property, you have the final say on how much the property sells for.
- If you rent out your property, you can create a reliable stream of income each month. You can interview tenants and draw up a lease agreement that ensures that you’ll receive a monthly rental payment each month.
- Real estate is a more stable investment when compared to REITs. It’s very unlikely that your investment in a property will ever be worth $0 — which is possible if you invest in a REIT that goes bankrupt.
Real Estate Cons
- Real estate investments come with a much higher initial investment. Depending on the type of property you’re purchasing, you could need a down payment equal to as much as 25% of the value of the property. This is in addition to closing costs, which usually average around 3% to 5% of the value of the property you’re buying.
- As soon as you become a landlord, you forfeit certain rights to your property because your tenants have the right to enjoy the space in private. For example, in most states, it’s against the law for a landlord to enter a unit without at least a 24-hour notice except in the event of an emergency.
- If your tenant stops paying rent, you must legally evict them. This can be an expensive and time-consuming process.
- Real estate properties require a large amount of work and ongoing maintenance to retain their value. Even as a landlord, real estate investing is not a truly passive form of income.
Compare Real Estate Investment Platforms
You can also invest in real estate through a real estate investing platform. These platforms make it easier to compare commercial options and pool your money with other investors through crowdfunding to access a more diverse range of options. Browse a few of our favorite real estate investing platforms below.
Fundamental Differences
Direct real estate investing involves the purchase of a property. You can purchase a property in cash or using a home loan called a mortgage. After you close on your loan or make an agreement with the seller, you own the home and can use it how you like assuming that you stay on top of your mortgage payments. Some investors “flip” houses by fixing them up and putting them back on the market quickly for prospective homebuyers and either selling them personally or hiring an agent. Others rent out their investment properties to long-term tenants and create a stream of income by charging rent.
A rental property has quite a lot of income potential, especially when you’re in big cities like New York, Los Angeles, San Francisco, Kansas City, Washington DC or even exclusive locations like the Hamptons. However, not everyone can hire a real estate agent, get a good interest rate, and buy in.
When you invest in an equity REIT, you don’t own any type of investment property outright. Instead, you’re purchasing shares of stock issued by a corporation that owns or manages properties. Shares of equity REITs trade the exact same way as individual shares of other types of stock, meaning that they’re highly liquid. They offer shareholder dividends and they can increase your taxable income. Minimum investments are also lower when you invest with REITs than when you purchase real estate directly.
Stronger Return Potential
REIT shares have a history of outperforming the real estate market at large. From 1977 to 2010, investments in REITs have returned about 12% each year. This return is significantly more than the S&P 500 overall, which tends to return about 10% each year. Real estate in the U.S. has historically risen by 3% to 5% annually, though this percentage can vary widely depending on where the home is located.
While this data might seem like a slam-dunk for REIT investors, it doesn’t give a complete picture of each investment’s potential. When you invest in property directly, you have the potential to create another stream of income through rent, which isn’t considered in the calculation of rising home prices. Even if you decide not to rent out your home, the property has functional utility because you can live in it or use it as a vacation home. The best choice for your real estate investment will vary depending on your needs, where you live, your unique level of risk tolerance and more.
Add Real Estate to Your Portfolio Today
Struggling to decide between investing in REIT vs real estate? Many investors choose to do both, invest in a single-family home to use as a primary residence as well as invest in REITs through their 401(k) or IRA. Planning your future real estate investments can help you lay out a path for a higher level of diversification.
Frequently Asked Questions
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REITs are considered safer than stocks in some respects due to their stability and income generation potential. REITs invest in real estate properties and generate income through rental payments, making them less volatile compared to individual stocks. On the other hand, stocks are more volatile and can be affected by various external factors such as market conditions, economic trends, and company-specific news. Stock prices can fluctuate rapidly, posing a higher level of risk for investors compared to REITs.
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REITs and traditional real estate ownership each offer unique benefits and drawbacks, making it challenging to definitively say which is better. The choice between the two depends on individual preferences, risk tolerance, investment goals, and the level of involvement desired in managing real estate assets. It may be beneficial for investors to diversify their portfolios by including both REITs and physical real estate to capitalize on their respective strengths and mitigate potential weaknesses.
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While REITs are not traditional real estate companies in the sense that they develop or directly manage properties, they play a significant role in the real estate industry by providing investors with a means to invest in real estate assets without having to buy or manage properties themselves.
