If you’ve thought about allocating some money into real estate, you’ve probably come across two attractive real estate investing options:
Both options are very popular, and they each have their pros and cons.
Let’s dive into the differences between investing in a REIT and investing in actual rental properties so you can determine which option is right for you and your real estate investment strategy.
What Is a REIT?
In simple terms, a REIT is like a mutual fund full of real estate investments. When you invest in a REIT, you’re buying shares of a company that owns and operates income-generating real estate.
There are many different types of REITs. Some focus on residential real estate. Others focus on commercial properties like retail strip malls, medical facilities, or office buildings.
When you purchase shares of a REIT, the idea is that you are buying a small slice of a very big operation, so while you have no control over the assets that the REIT owns, your money should be well diversified.
Average REIT Returns
Historically, REITs provide investors with attractive returns. Actively managed REIT investors realized an annualized return of 10.6% over a 15-year period, according to Cohen and Steers.
This outpaces the return of many other stock market, bond, or Treasury investment options and is achieved through the income generated from the rental properties within the REIT portfolio, combined with the appreciation potential of the properties the REIT is invested in.
Comparing REITs to Rentals
On the surface, owning shares of a REIT is an attractive option. You, as the investor, do little to no work, and you get to enjoy a healthy return on your investment while indirectly owning real estate.
That said, there are a couple of things to consider when comparing a REIT investment to a more active investment option, where you own and operate rentals yourself.
Diversification vs. control
REITs offer instant diversification across a bunch of different properties, which minimizes risk. On the flip side, owning a rental property yourself allows you to have more hands-on control and make decisions that will directly impact your investment.
Hands-off vs. hands-on
With REITs, you can sit back and relax as professional operators handle the process of picking properties and managing those properties well. If you’re the landlord, you will need to deal with tenants and maintenance.
REITs are traded on the stock exchange, which means they are very easy to buy into and sell out of. Selling your shares is literally as simple as the click of a few buttons. If you own actual real estate, on the other hand, it will require a lot of time, effort, and paperwork to either buy or sell your rental property.
Potential for appreciation
Owning shares of a REIT and owning rental property both have the potential for appreciation. In the case of the REIT, you will realize appreciation through the share price of the REIT. When you own a rental property, you have the ability to “force” appreciation through renovations and other improvements.
When you own shares of a REIT, you will often receive a stream of income in the form of monthly or quarterly dividend payments. This will give you a somewhat reliable stream of steady income.
Owning rental property also provides income in the form of cash flow, which is calculated by taking your gross monthly rent and subtracting out all of your expenses, including your mortgage payment.
Which Is Right for You?
When weighing these pros and cons, consider your own personal preferences and financial goals. Owning actual property feels more tangible and controllable while owning shares of a REIT is more passive.
Whether you buy shares of a REIT or own rental property yourself, it will boil down to your preferences, risk tolerance, and personal goals. REITs will give you a more hassle-free and diversified investment, plus they also will offer you a solid return.
Owning rental property gives you a lot more control and, over a long enough period of time, should provide returns that outpace the returns of larger REITs, where you are sharing profits.
Both investment strategies have their merits. I’m personally investing in both REITs and rentals. Let me know your approach in the comments below.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.