Real estate investment trusts (REITs) offer savvy investors the chance to generate long-term income without purchasing physical real estate. They are suitable for investors of all experience levels and offer several benefits. When it comes to REITs vs. real estate, investors should examine how these investment opportunities can work together to create a high-performing, diverse portfolio.
How Do REITs Work?
REITs work similarly to mutual funds by awarding investors the opportunity to purchase shares in a company or association. REITs own or finance income-producing real estate. They can manage commercial or residential properties and will often specialize in a certain type. Investors earn profits through dividends, which they then pay income tax on. REITs typically do not offer the same tax benefits of investing in direct real estate.
REITs were first established by Congress in the 1960s as a chance to allow more individuals to get started investing in real estate. Their appeal stems from the fact that REITs require varying amounts of capital to get started. Additionally, they offer investors the opportunity to profit from real estate without owning or financing properties themselves.
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Types Of REITs
There are three main types of REITs available today:
Equity REITS: Equity REITs deal with physical real estate. They will own and operate properties, generating the majority of their income through rent. It is not uncommon for equity REITs to specialize in a certain property type, such as apartments or office buildings.
Mortgage REITS: These involve investing in property mortgages rather than purchasing physical properties. They work by loaning money or buying existing mortgages from property owners. Mortgage REITs earn income primarily through the interest accrued on mortgage loans.
Hybrid REITS: Hybrid REITs are a combination of equity and mortgage REITs. They earn profits through a mix of rental income and mortgage interest.
Benefits Of REITs
There are numerous advantages of REITs that investors should become familiar with. Here are just a few of the benefits of REITs:
REITs are relatively low risk and cost efficient
They have historically performed well
REITs offer the chance to generate passive income
There is less volatility involved in REITs when compared to other investments
Low Risk & Cost Efficient
By investing in REITs, investors can work with multiple property types and companies. This spreads out the risk of the investment by preventing investors from being as dramatically impacted in the event one property is not performing well. While concentrated investments can lead to potentially higher returns, REITs allow investors to spread out their capital and mitigate risk.
Additionally, REITs are relatively cost-efficient due to their high liquidity. Investors can typically sell their shares at any time, without penalty. REITs also allow investors to save money by avoiding high transaction costs. Investors can trade or sell their shares with minimal fees.
Through long-term property appreciation, REITs have provided investors with consistent returns over time. Their historical performance is due to several factors. For example, REITs are not affected by short-term inflation and interest rate changes in the same way other stock portfolios are. REITs also benefit from property appreciation—a perk that also applies to direct real estate investing. Together, these factors have lead REITs to perform year after year.
REITs offer the chance to invest and passively earn profits through dividends. While investors can and should monitor their portfolio’s performance, they are not directly responsible for an REIT or its assets. When looking at REITs vs. direct real estate, investors may notice both avenues provide the chance to generate passive income.
When purchasing real estate directly, investors can hire a property management company to oversee the day-to-day operations while reaping rental income benefits. Read this guide to learn more about generating passive income through direct real estate.
REITs provide more stability when compared to stocks or other investment opportunities. This is because real estate expenses are relatively predictable over extended periods of time. When it comes to owning and operating a rental property, companies (or investors) can use several calculations to predict the operating costs and plan accordingly. On the other hand, equity stocks are much less predictable and are thought of as more volatile than REITs.
What is Direct Real Estate?
Direct real estate investing is the form of real estate investing that you are probably already familiar with. investors directly invest in a residential or commercial property by either purchasing it. Therefore, they have “direct” ownership of their investment. Then, these investors earn income in the forms of rental income and appreciation.
Benefits of Direct Real Estate
Investors tend to find the main advantage of direct real estate investing to be the ability to generate cash flow. Each month, investors collect income from their properties that serves as a return on their investment.
Additionally, direct real estate offers the added benefit of appreciation. Over time, the value of their property will increase. This gives direct real estate investors the ability to sell their property at a higher price than they originally purchased. This can be a significant return on their initial investment.
Investors of direct real estate may be attracted to the control and power over their investment as a single investor. Since they directly own their property, they have decision making control over changes made to the property. They also have the ability to delegate responsibilities to property managers if they chose to do so.
Should You Invest In REITs Or Direct Real Estate?
When weighing REITs vs. real estate, it is important to understand that a high-performing investment portfolio is typically diverse. By pursuing multiple investment opportunities, investors can increase their income potential and minimize overall risk. Therefore, when choosing an REIT vs. real estate property, investors may be better off pursuing both.
REITs and real estate assets offer several of the same benefits, though there are many misconceptions regarding their differences. REITs are often thought of as having lower initial costs than real estate investments. While REITs are generally more cost-friendly, there are several inexpensive financing options available for investors wishing to get started in real estate. Be sure to check out our guide to financing your first investment property to learn more.
Many investors are drawn to REITs to get started in real estate because they are intimidated at the thought of purchasing properties themselves. It is important to understand that real estate investing strategies can fit any investor’s goals and schedule. Investors can look into wholesaling, rehabbing, operating rental properties, and even house hacking as ways to generate income through real estate.
Those who consider REITs’ benefits vs. real estate will find that the two investment opportunities are actually very similar. When pursued together, REITs and direct real estate can lead to a profitable investment portfolio. Check out this article to further understand the benefits of real estate investing.
REITs offer investors the chance to benefit from real estate’s historical performance without directly owning property. For those looking at investing in REITs vs. real estate, remember that by choosing more than one investment opportunity, individuals can increase their profits and minimize their overall risk.
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