There are several options for how you can invest in real estate, as you well know, and a lot of them are so different from each other that you may not have a hard time choosing which to go with. But what about some of the less obvious differences between some of them? Or rather, what if two different options seem obvious as to which is better — are you sure you know which one is actually better?
To give you a better idea of weighing different options, I’m going to choose a battle between:
Rental Properties and Real Estate Investment Trusts (REITs)
More often discussions of different investment methods are comparing things like rental properties and flipping properties, which have a much more distinct difference between their work levels and return styles. Rental properties and REITs, though, often get grouped together because they are both methods of passive income and the return styles are similar (cash flow).
The Basics of Rental Properties and REITs
To make sure everyone is on board with what we’re really talking about here, let me just clarify how both of these work.
- Rental Property. This is when you own an actual piece of property that you rent out as a means of collecting income. The property itself is in your name, you own it, you can do whatever you want with it — live in it, rent it out, make improvements, sell it, refinance it, spray paint it. Whatever you want.
- REITs. Think “mutual fund for real estate investments,” and you are thinking along the right track. It’s just like buying stocks, but instead of buying stock in a company that does whatever business, you are buying into a company that owns or finances real estate. If you buy into a REIT, you don’t personally own any of the properties; you own shares just as you would if you were buying stocks.
Which to Choose: Rental Property or REIT?
Well, as with any decision in life, there are pros and cons to going with either. Here is a list of the most basic pros and cons for both rental properties and investing in REITs:
- Sole control over any decisions, improvements, or changes to the asset
- Major tax benefits, usually resulting in tax-free income or better
- Ability to leverage capital invested (ability to buy a $100,000 property with only $20,000)
- Hedge against inflation
- Appreciation potential
- Passive income
- Income is directly tied to performance of the individual property
- Requires more capital to purchase property
- Less liquid
- Ability to be part of a very large asset holding — better security typically (especially with publicly-traded REITs) due to strict oversight, professional large-scale management, and diversification of assets
- Long-term growth potential and typically provides high dividends (from non-taxable pool of money)
- Options for liquidity of money invested
- Stable income generation — not tied to individual property performance
- Low-entry costs to invest
- Passive income
- Income is fully taxable
- No equity build
- Value of shares often trend with the general stock market
- Less flexible management of assets, if any flexibility
A Hidden Advantage to Rental Properties
It’s not hidden in the sense that it’s not in the above list (because it is), but the big picture idea of it isn’t blatantly stated up there. I also don’t emphasize this pro for rental properties to suggest rental properties are better; I just point it out as a major clarification point.