Should You Invest in Rental Property or a REIT?

by Krantcents · 35 comments

Post image for Should You Invest in Rental Property or a REIT?

I love rental property!  I bought my first home when I was twenty-seven (27) years old.  My next investment was a nine (9) unit apartment building when I was thirty-one (31) years old.  Over seven (7) years, I accumulated more properties.  By the time I was thirty-eight (38) years old, I achieved financial freedom.  Investing has its risks and rewards.  Can you invest in rental property without being a landlord?

A Real Estate Investment Trust (REIT) is a company that owns and operates or manages income producing real estate.  It is also a security that sells like a stock on a major stock exchange.  It is a way of investing in rental property without some of the responsibilities of owning real estate.  Similar to any stock it is liquid because you can buy and sell it on any day.  You can invest directly by buying shares directly on a stock exchange or invest in mutual funds that specialize in various kinds of income property.

REITs invest in shopping malls, office buildings, apartments, warehouses and hotels.  They may invest in just one (1) area of real estate such as apartment buildings and specialize in one specific region, state or country.  It is a good way to invest in a diverse portfolio of income producing properties that were professionally selected and managed.  REITs have special tax status that allows them to avoid corporate tax as long as they distribute nearly all income to the investors.

Rental Property 

Advantages:

  • Control of property – selection, management, tenants, repairs, maintenance and rents.  You make the purchase decision, manage all aspects of your property or use a service.  You have more control of who rents your property and decide what repairs or maintenance is performed to increase or maintain value.
  • Equity – as you pay down the mortgage, you increase your equity in the asset.
  • Tax considerations – You can deduct your expenses and depreciation as well as associated expenses of managing your property.

Disadvantages:

  • Management – Owning rental property takes time and effort.
  • Problems – Delinquent tenants, lawsuits, vacancies, cash flow and rent limitations.
  • Illiquid Investment – Real estate takes time to sell.
  • Leverage – It is a disadvantage and advantage because a mortgage affects your cash flow, but allows you to buy a larger property with just a (20-25%) down payment.

 Real Estate Investment Trust (REIT) 

Advantages:

  • ResearchYou still need to do research because not all REITs are the same.
  • Professional Management – Hands off ownership, no day to day responsibility.
  • Cost – Share price is much lower than a purchase.
  • Diversity – A typical REIT has many more properties than the average person would own which may cover a region, state or country.

Disadvantages:

  • Performance – It typifies stock performance and relies totally on management.  If the stock or fund is out of favor or volatile, you are at the mercy of the market in terms of value.
  • Taxes – variety of tax disadvantages depending on choice of stock or fund.

Final thoughts

There are good and bad things about both owning individual properties and REITs.  If investing in rental property is a long term goal to build equity and income in an asset that may support you in retirement, you must buy property.  If you just want to have some exposure to rental properties to diversify your portfolio, REIT investment may a more appropriate choice.  If you want to have more control of your investments and counter the stock market volatility, you should buy an individual property.  Many people do not invest in rental property because of all the work and tenant problems.  You can hire a management company that will professionally manage the property for a service fee of six (6) to ten (10) percent.  It is important to look at ll the choices   and make a reasonable choice.  Let me know your thoughts in the comments.  I still love rental property!

Photo by:  Flikkesteph

Please make sure to subscribe to our RSS feed to get the latest updates!

{ 34 comments }

My Financial Independence Journey February 26, 2013 at 3:02 am

The main question for me is how easily can you cash flow rental property in your area. I did some envelope math on property in my general area, and it’s basically impossible. The rental yields are a joke unless you own the house outright.

REITs as a basket aren’t going to diversify your portfolio that much since they generally track with the S&P500. Some individual REITs may be better at adding diversity than others.

REITs do pay nice yields which makes them attractive investments for anyone looking to pull in additional income.

Krantcents February 26, 2013 at 6:58 am

Although interest rates are at a 60 year low, you still need to find the right property to buy. The diversity of a REIT is location and kinds of properties. They are generally larger apartment buildings in different parts of the country.

Eric J. Nisall - DollarVersity February 26, 2013 at 4:12 am

I agree that it’s definitely difficult to break even at the least in some areas. When I did my refi, the title agent claimed that I could get $1500/mo for my condo which had me thinking about it, but when I checked what the available units were renting for just in my own development, I realized that I would still have to put in my own money to make up the difference between the income and the mortgage payments. Of course, this is just one small area and I’m clueless as to what’s going on in other places.

The nice thing about the REITS is that they can be purchased within a Roth IRA and not have any of those tax-disadvantages be an issue while still benefiting from the nice payouts. That’s actually where I keep my REIT holdings at the moment.

Krantcents February 26, 2013 at 7:03 am

You still need to buy a property at the right price to make the numbers work. It may even require more than 20% down payment as well. REITS generally have higher returns because their is no underlying mortgages..

CR February 26, 2013 at 5:25 am

Thanks for the great comparison. I’ve been wanting to get into real estate for a while now, but I don’t have enough for a whole property. What do you think about buying into a Reit now, and then selling and buying a rental property when I decide to?

Krantcents February 26, 2013 at 7:41 am

Although I am in favor of rental property or investing in REITS, I cannot advise when to buy or sell.

John S @ Frugal Rules February 26, 2013 at 7:13 am

We would love to get into real estate, but there a re a number of things that would legitimately hold us back at the moment to adequately manage it. I do like the idea behind REITs in being able to have access to real estate as a whole without the day to day management. When I’ve REITs in the past I have been like Eric and held them in a Roth so as to avoid any taxation issues.

Krantcents February 26, 2013 at 7:38 am

REITS offer some diversification and allow you to participate in the rental market.

Howie February 26, 2013 at 10:17 am

When you depreciate the rental property are there different ways to do it ? which is the most common way? What are the pros and cons be if there are different approaches?

Krantcents February 26, 2013 at 1:05 pm

Assets are depreciated over their useful life. There are a number of different methods, but it is best for you to consult your tax professional to figure out what is right for the application.

Sicorra @TacklingOurDebt February 26, 2013 at 2:24 pm

In 2005 we debated renting the 2 townhouses that my husband and I each owned, as we were buying a new house together. We decided against it, pretty much out of fear of the unknown.

Instead we invested our money in something similar to the REIT you wrote about. We co-own a number of apartment buildings in Canada and some land as well. The difference is that we cannot trade our shares. Our investment is locked in until the entire project is sold.

Krantcents February 26, 2013 at 5:16 pm

When I was describing a REIT, I was thinking of a mutual fund that is freely traded similar to a stock. Much more liquid than owning real estate. Renting out your home(s) is a personal decision! It is neither right or wrong, it is what you are comfortable with.

Kim@Eyesonthedollar February 26, 2013 at 7:46 pm

I like the idea of a REIT if that is what you are able to afford, but I agree that buying actual properties is how you can replace your income from a job if you do it the right way. We co-own the commercial property that houses my optometry practice, and have one residential rental. When those are paid off, hopefully within 5 years, that will replace about 1/3 of my income. We will need 2 or 3 more properties or some sort of multifamily unit to replace the rest. This seems much more doable than investing in a REIT to do the same.

I guess it depends on your goal for investing in real estate as well. If you don’t want to leave your day job, the REIT would be easier.

Krantcents February 26, 2013 at 8:02 pm

I agree and you have more control of the investment. A REIT is another choice that does not have the headaches of ownership, but also less up and downshide.

KK @ Student Debt Survivor February 26, 2013 at 8:00 pm

We are really interesting in learning more about, and eventually purchasing, a rental property. It seems like such a good investment. We’d like to pay down the property quickly then use the rental income to buy another property. This will take time, but is part of our retirement strategy.

Krantcents February 26, 2013 at 8:10 pm

When I invested in income property, I refinanced a few times to acquire additional properties. I was trying to build a portfolio of properties and was less concerned about immediate income.I was able to build it into a busieness and it helped me reach financial freedom at 38 year sold.

Maverick February 26, 2013 at 8:14 pm

Yep, I’m not convinced you can make an investment rental work unless you buy well below market value or have significant tax deductions. Gee, I just bought $2000.00 of furniture for my current house. I’ll take the old furniture and place it into the rental. Then apply the $2000.00 receipt to the rental ledger. Do this for plumbing, paint, etc. and now you have a financial advantage. Ethical? Someone prove me wrong and show me a real-life example without this “financial house of cards.”

Krantcents February 26, 2013 at 8:29 pm

Rental property is no different than any other purchase. You have to buy it at the right price and it should have a positive cash flow. Interest rates are at historical lows and homes are selling at low prices as well. It is a great combination to run the numbers to see if it makes sense. For example, in a large metropolitan city like Los Angeles, you can find starter homes at every price range and rental potential. Your first purchase may not be perfect, but you are buying potential. I don’t think you need tax advantages to make it work either.

Shawn @ PipsToday February 26, 2013 at 9:33 pm

I think REIT is more control of the investment. REITs is completely new investment field for me. I invest money in stock and forex market but still awaiting for desirable success. REITs may be a nice option for me to test my luck. If I am not wrong then it is just like stock trading and there is also risk. Thanks share with detailed, informative and useful(for me) facts about REITs.

Krantcents February 27, 2013 at 6:53 am

Investigate thoroughly because luck should have very little to do with it.

Maverick February 27, 2013 at 1:38 am

Yes, so please share “running the numbers” in a real-life example so that we can see how the numbers should work. That’s all I’m asking. Just stating buy low, sell high isn’t helping the readership. Thanks in advance! :)

Krantcents February 27, 2013 at 7:00 am

I will put together an article on it soon, but realize that will be based on my criteria.

Greg@ClubThrifty February 27, 2013 at 4:13 am

I love real estate. For me, I don’t think I would ever use a REIT because part my reason for owning real estate is that I can touch it. A REIT may give you some exposure, but it is really just another piece of paper.

Krantcents February 27, 2013 at 6:59 am

REIT is similar to a stock, you let management run the company vs. you. A REIT can buy many more buildings in different parts of the country and you do not have the burden of owning it. A REIT also allows you to invest with relatively little money compared to a 20% down payment.

Squirrelers February 27, 2013 at 10:32 am

I think it’s about one’s risk tolerance, and time available. It seems to me that rental properties offer more potential and the chance to be a legit source of semi-passive income. But, they take time and energy along with bringing risks. With a REIT, you may be diversifying risks and putting in far less time, but I would think your upside would usually be less (in general). That said, I haven’t personally invested in rental properties so I’m basing this on what I know from reading, talking to others, etc.

Anyway, good informative post!

Krantcents February 27, 2013 at 3:38 pm

Being a landlord is not easy, but it is mostly front end loaded. You do a lot of work fixing things up and selecting tenants. Maintaining properties is not that difficult or time consuming. REITs are prodessionally managed and far less work other than investigating which REIT is best similar to any investment. It is a personal choice!

AverageJoe February 27, 2013 at 5:50 pm

Good comparison. While the REIT index has a similar performance to stocks over the long term, it doesn’t move in tandem with real estate and is a nice diversifier for a portfolio. Plus, REITs produce a nice consistent income stream which is often higher than many bonds (plus, because of the way this income is reported, a portion of it may be return of principal, making it tax advantaged as well).

I can’t decide which I like better….so I do both! My rentals can be a pain in the butt while my REIT can sometimes swing in the wind….

Krantcents February 27, 2013 at 7:50 pm

I know what you what mean! Rentals can be a bit of work, but it generally have more potential. REITS are more consistent and pretty good in terms of cash flow because many REITs have no mortgages.

Justin@TheFrugalpath February 27, 2013 at 8:10 pm

I’ve been thinking of investing in rental properties, but have been fearful of bad tenants. If only there was insurance to help you in those cases.
If I did buy a rental I’d make sure that I had enough money put aside for repairs after the tenant’s lease was up.

Krantcents February 27, 2013 at 8:18 pm

You generally have a security deposit for damage to the unit beyond normal wear and tear. Besides, you usually raise the rent when a new tenant moves in.

Martin March 5, 2013 at 7:56 pm

The problems you are listing with tenants and up keeping the property is discouraging me from investing into real estate. I few years ago I was managing a property of my friend and it was horrible work. I had to deal with the tenants as well as with the owner. I know when the property is mine I would deal with the tenant only, but the overall experience was very negative, so personally I would prefer REITs.

Krantcents March 5, 2013 at 9:05 pm

Business is never easy although the successful people make it look easy. I can tell you horrible stories about problem tenants, but it was worth it over all. You have to look at it long term.

Brent Pittman March 19, 2013 at 6:25 am

Both REIT and rental property hedge against inflation, which seems like a good play for the future.

Krantcents March 19, 2013 at 7:02 am

There are pros and cons for each. I like owning rental property because you have more control of your investment.

{ 1 trackback }

Previous post:

Next post: