REITs vs rental property? Which one is the best to make money in the long run? I will share everything from the beginning, their pros and cons, and the differences those investments have. So first, let’s understand what a real estate investment trust (REIT) is and what kind of rental property makes the most money. Then we will explore the differences.
Table of Contents
- What is a REIT?
- What is a Rental Property?
- REITs vs Rental Property – The Main Differences
- 1) The Upfront Investment Cost
- 2) Control Over Your Investment
- 3) The Liquidity Factor
- 4) Overall Tax Benefits
- 5) The Ease of Borrowing Money
- 6) REIT is a Passive Investment
- 7) Stable Cash Flow Opportunity
- 8) Market Volatility Factor
- 9) Capital Appreciation Factor
- 10) Portfolio Diversification Options
- Final Words
What is a REIT?
A REIT or real estate investment trust is a company that owns and runs commercial real estate buildings and generates rental income as profit. And then, they distribute that rental income to their investors as dividends, about 90 percent of their distributable money.
REIT is a stock, not a physical property, and you can invest with very little money here, maybe with just $1,000. It’s a good source of yearly cash flow options and diversification opportunities. It is a pretty stable investment, as those properties produce rental income continuously.
What is a Rental Property?
On the other hand, a rental property is a physical asset that produces cash flow every month, not once a year. It is a far safer investment than any other on the market, as the market condition does not affect it much.
But the initial investment cost is too high, with an average cost of $100,000 for a single-family rental unit, as you have to look at the supply and demand, location, and the neighborhood before you buy one.
Plus, the landlord is responsible for the care and management of the property with strict regulations from the government, especially if the property is residential. Rental property management is stressful and not suitable for everyone.
REITs vs Rental Property – The Main Differences
So here are the primary differences between REITs and rental property that you must know before investing in either one. But both investments are good. It depends on how you invest. If you know your game, you will make money in both. If not, then you will lose money in both. So first train yourself and then invest.
1) The Upfront Investment Cost
As I have said earlier, the biggest opportunity or setback for an average man is the upfront investment cost. In REITs, you can start investing with a few dollars ($1,000) from your regular brokerage account. It is like buying a stock. Some brokerages also offer no minimum investment cost to invest in REITs. That is huge for an average man.
But to purchase a rental property, you need to have at least the down payment, which is 20 percent of the total cost ($20,000) available. If renovations are needed then the expense will go even higher. In simple words, the initial investment cost is higher in every way than REIT.
2) Control Over Your Investment
I love the control, and the rental property is the best. You can not control your REIT shares as they are not in your hand, but you can control the rental property in every way you want. You can increase the cash flow by adding some extra amenities to the building or refinance it from other investors. But in REIT, what you can do is limited. You can buy and sell. That is it. For control, I choose rental property.
3) The Liquidity Factor
You can sell REITs in a second with just a click on your phone. But to sell a rental property, you need to wait months. That is one more advantage REIT has in the battle of REITs vs rental property as a rental does not give you liquidity. If you want liquidity over control, choose REIT.
4) Overall Tax Benefits
When it comes to tax breaks, then rental property wins. Property owners can take advantage of many tax deductions related to their investments, from a capital tax deduction, depreciation, 1031 tax exchange, and many more tax rules built to empower rental property investors.
But REIT does not have many advantages here. Although with proper planning, you can reduce our capital taxes. But rental property gives you more opportunities to save your taxes.
5) The Ease of Borrowing Money
No, you can not borrow money using REIT, but with a rental property, you can. Banks are ready to give you money to invest in a rental unit. You can also refinance the rental investment with the equity you have. The option of borrowing is more in rental property. But no bank will agree to give you money to invest in REIT. You have to invest what you have with no support from the banks.
6) REIT is a Passive Investment
If you think about this in the battle of REITs vs rental property the REIT is a perfect winner. Yes, REIT is a passive investment. You don’t have to work continuously on it to produce income like a rental property where you have to manage the building, look for maintenance opportunities, and take care of your tenants.
The rental property includes active work unless you hire a property manager for a fee. But REITs are passive. I think it is one of the main reasons people invest in REIT.
7) Stable Cash Flow Opportunity
The chance of stable cash flow is good on both investments. REITs are managed by big real estate companies that have strong management. On the other hand, rental property is managed by you, and you want to make sure the cash continuously flows into your pocket. In the REITs vs rental property war, there is no clear winner as both are good for cash flow.
8) Market Volatility Factor
Here also, market volatility does not affect that much on both sides. But if you look closely, I think rental properties are more secure than REITs. Although, they have a bad tenant problem that may leave the unit vacant for months, costing them money.
But the value of a rental property will never bottom out as it does in stocks. So market change does affect both, but you can be sure that here both are pretty stable and will not move unless a financial cyclone hit them.
9) Capital Appreciation Factor
Both give a good capital gain, but rental properties can do better with an improvement. You can increase the overall value of the building by adding some improvements to the property, which is not applicable in a REIT. When we talk about the capital appreciation factor between REITs vs rental property, it is the rental unit that wins.
10) Portfolio Diversification Options
People only invest in REITs to diversify their overall portfolio. These investments are much more stable than other stocks and make good money. But rental property is also a good option for diversifying your assets with many legal advantages. Both are good for diversification. Stock investors choose REITs, and real estate investors choose the rental property for diversification. That is it.
So now you give me the answer of REITs vs rental property and which one is the best, according to you? I would say the following.
- Invest in REIT if you do not have huge money to invest and you don’t want to handle all the management in a rental unit.
- Invest in a rental property if you want complete control over your investment and to hold your wealth for years to come.
But in the end, it’s your choice, what you will choose based on your personal preference. Both are good but have advantages and disadvantages. I would say REITs are good for a beginner, but for little advance investors, choose good rental properties.