Most people know that real estate is often a profitable long-term investment. If you invest in a rental property, you can usually collect more in rent than you’re responsible for paying, resulting in a monthly profit. And in a good neighborhood with favorable conditions, you can often count on that property growing in value over time.
Of course, it’s intimidating to invest in rental property. Not only will you have to secure the financing and take on debt, but you’ll also be responsible for screening tenants and managing the property actively. On top of that, you’ll have to worry about the possibility of the property stagnating or even depreciating.
As an alternative, you could consider investing in a real estate investment trust (REIT). A REIT is a company that specializes in investing in property; you can purchase shares of a REIT the same way you’d purchase shares of stock in a publicly traded company. Accordingly, you can invest in property indirectly and benefit from the rising tide of the real estate market.
But is one of these options better than the other? If you want exposure to the real estate market, should you invest in a single property or purchase shares of a REIT?
The Advantages of Investing in Individual Properties
As you might imagine, there are some distinct advantages to investing in individual properties:
- Financial leverage. First, if you plan on taking out a loan, you’ll get access to financial leverage; in other words, you can gain buying power from someone else’s money. You can invest in a property with as little as 5 percent of the total purchase price and borrow money from the bank to afford the rest. Because the property will appreciate in terms of total value, you’ll have the potential to grow your investment much faster than if you bought it outright.
- Firsthand knowledge. Buying a property also gives you firsthand knowledge of how the money is being generated. While REITs are obligated to disclose financial matters to shareholders, you’ll still never reach the transparency you have when you’re the one making all the investments.
- Greater control. Similarly, you’ll have control over every decision. You’ll choose exactly which properties to add to your portfolio. You’ll choose the tenants that you want to bring on. You’ll choose which renovations and improvements to make, and when. If you like being in charge of your own money, this is the better option.
- Tax breaks. Depending on how you buy and manage property, you’ll likely qualify for some tax breaks, providing a significant financial incentive. You’ll get no tax breaks from investing in REITs (unless you’re doing so within a retirement account).
- Potential for higher gains. While far from a guarantee, it’s possible to earn higher gains with an individual investment than with a REIT – especially if you plan on adding multiple properties to your portfolio over time.
- Potential for passive income. Investing in rental property is also a form of passive income generation – if you adopt the right approach. Ordinarily, you’ll be responsible for marketing the property, screening tenants, rent collection, and regular maintenance (among other things) – but with a property management company, you can treat this as a totally hands-off investment.
The Advantages of Investing in REITs
Of course, there are also some advantages to investing in REITs:
- Truly passive income. Even if you plan on hiring a property manager to do much of the work for you, you’ll still be responsible for finding the right property, hiring the management company, and major decisions about the future of the property. With a REIT, you’ll have a truly passive income source.
- Lower threshold for entry. When you’re trying to buy a $200,000 house, even a 5 percent down payment represents a significant chunk of capital. When investing in REITs, the barrier to entry is much more approachable. You can get started with just a few hundred dollars – and sometimes, even less.
- Higher liquidity. Additionally, investing in REITs tends to be associated with higher liquidity. If you decide to change your strategy and sell a property, it might take weeks – or even months – to sell. But you can often sell REIT shares in a matter of seconds.
- Easy diversification. It’s much easier to diversify your property portfolio by investing in multiple REITs than it is to gradually add more properties to your personal holdings.
Direct property investment and REITs are both valuable investment opportunities that grant you exposure to the real estate market. However, each has advantages and disadvantages, so it’s tough to directly compare them.
You’ll need to consider your own financial position, your personal strengths and weaknesses, and your long-term goals to make the right decision for you.