Many investors are aware of the advantages of making long-term real estate investments, including the potential for a steady cash flow from income-producing properties and the minimal engagement needed on that part of the investor in some strategies. However, specific plans of action are more effective for investors than others, so there might not be a single ideal approach to investing in real estate for everybody.
Most investors choose between rental properties (hands-on) and REITs when considering their real estate investment possibilities (hands-off). In this article, we evaluate the benefits and drawbacks of rental properties and REITs, as well as other elements that investors should consider before deciding how to invest in real estate.
Property rentals
Do you want to get more involved in your real estate assets, investing in rental properties is a rewarding opportunity. Along with long-term appreciation, they can generate monthly cash flow. Additionally, they provide the advantage of direct ownership, which has advantages in terms of taxes, increased investment control, and the opportunity to increase your own net worth. But these advantages also come with a plethora of obligations on the part of a landlord, many of which call for constant and personal care.
The Advantages of Rental Properties
Investors with the skills, time, and resources to manage rental properties can reap several rewards. If everything goes according to plan, a rental property can provide:
The Regular Financial Flow
Rental revenue from “properties” can provide a consistent monthly cash flow. With lease agreements that specify a rental payment due from renters at the start of each month, landlords can rest easy. Their monthly income probably increases as more units get taken on rent. Enlarging one’s revenue sources allows for increased income while minimizing reliance on a single source of income.
Asset Appreciation
Rental properties can make money through asset appreciation in addition to receiving rent each month. The Investors with equity ownership are also entitled to any appreciation realized upon the give-off of the property. The investor’s potential return from selling property rises if it appreciates.
Tax deductions
Bulk expenditures incurred by rental property owners in operating their investment property are tax deductible. Examples include the expenses incurred for upkeep, taxes, legal fees, and insurance premiums while maintaining the property. While you cannot deduct the cost of property renovations in a single tax year, you may record the methods you enhance the property and then depreciate the expenses throughout the property’s life. Therefore, you may reduce the expenditures over several years when you increase the worth of the property through landscaping or new worktops in order to get a higher rental charge.
Freedom and Flexibility
Because you are responsible for your investment, you are in command and have complete control over it. You have control over how much rent to charge, what improvements to perform and when to deal with, the property’s final resale pricing, and the date of the sale.
Rental property disadvantages
Rental property owners may profit from them, but investors must also worry about many responsibilities. For the investment in time and money to be repaid, rental property has to have many functional parts. The fate of rental property investment, like any other direct investment, is dependent on the investor. A potentially successful investment property might become a money pit if purchased or cared for incorrectly. Before investing in a rental property, a buyer should consider potential difficulties, such as:
Comprehensive Knowledge
You must evaluate the investment’s feasibility before purchasing a rental property. It implies that you must have the financial and real estate knowledge necessary to calculate the estimated occupancy rate, monthly rental revenue, operational costs, and potential upfront remodeling expenditures. You also need to know how many men-hours you and your staff will need to put in to run the property for renters. Successful landlords typically have access to a team of professionals, including property managers, a maintenance crew, a legal team, and an accountant are seasoned rental property managers with experience in each of these areas. You may steer clear of these dangers by working with an experienced team. However, expert fees can mount up and can reduce total profits. In addition, you give up some control while yet maintaining complete accountability.
Active property management
One of the most active real estate investments you can make is in a rental property. You must invest time in the practice of management in addition to expertise. Once you own the property, your duties as a landlord include locating renters, doing background checks, creating leases, ensuring that tenants adhere to them, supervising property maintenance, making prompt repairs, evicting tenants, and more. You may outsource some of these duties to a property management business, but you forfeit some control and a share of your revenues when you do so.
Regardless of who is in charge of overseeing the management of the investment property, if repairs are not completed immediately or a difficult tenant is permitted to remain there, you face the risk of tenants withholding rent or leaving the entire building in favor of one that is better managed. Additionally, there is a potential that you might run into legal problems.
Real estate investing is an example of the saying “you have to spend money to make money,” since it necessitates having access to cash upfront for payment and funding. When a landlord wants to purchase real estate, they need to have the money for a deposit (or be able to secure a mortgage loan). Certain assets require far more financing than single-family residences do, such as commercial real estate or structures with several residential units. If the down payment is less than the purchase price, a mortgage client often pays greater interest over time. If you don’t fully pay for the house upfront, you’ll need to get a loan with an interest rate that matches the monthly rent you want to charge. High-interest rates can drastically diminish monthly revenue, especially if the property has a lower vacancy rate than anticipated. They are also long-term investments by nature, as rental properties are sometimes expensive to purchase.
REITs
Investing in commercial real estate with loans or equity is what a real estate investment trust (REIT) corporation does. To provide private investors with the opportunity to participate in income-producing real estate without the commitment associated with conventionally owning an investment property directly, REITs got developed in 1960. Similar to how investors usually purchase the shares of a company’s stock, REITs provide a passive option to invest in real estate and possibly make substantial returns by acquiring shares. Investors gain from greater liquidity and reduced accountability with this passive strategy.
There are three types of REITs based on investor access: private REITs, publicly listed REITs, and public non-traded REITs. Most ordinary investors remain deprived of purchasing private REITs due to their high investment minimums and stringent accreditation standards. As a result, most individual investors have a practical choice between publicly traded REITs and public non-traded REITs.
Advantages of REITs
People who don’t want to become landlords, REITs provide simple entry into real estate investing. Investors can receive returns from REITs just equal to those from properties on rent, but without any maintenance or obligation. When selected wisely, a REIT can provide the advantages of:
Passive Investing
Investors that prefer to have no hands-on responsibilities can invest in real estate through a REIT, as opposed to renting out a property, where the success of the investment depends totally on the investor. The majority of the time, passive real estate investors merely provide the initial funds for an investment, leaving the rest to specialists.
No expertise needed: There is no requirement for in-depth real estate or financial knowledge for REIT investors to make successful investments because they are not involved in managing the day-to-day operations of their assets. Before investing, an investor should be aware of all the risks and rewards.
Low initial investment thresholds
REITs are among the most cost-effective real estate investment vehicles. Different kinds of REITs may have varying investment requirements, generally speaking, publicly listed REITs and public non-traded REITs have lower investment requirements than private REITs and active real estate investments, including rental properties. A share of publicly listed REITs and public non-traded REITs can frequently acquire with a minimum investment of $1,000 or less, in contrast to rental properties, which can have acquisition and operating expenditures that span from tens of thousands to millions of dollars.
Liquidity: Compared to rental properties, most REITs, especially publicly listed REITs, provide far more liquidity. An investor must commit thousands or even millions of dollars to one rental property over an extended period to make an illiquid investment like a rental property. In contrast, REIT shares are simple to buy and sell daily, monthly, or quarterly(depending on the type of REIT).
Diversification
If you actively engage in rental properties, you generally won’t be able to diversify your holdings to the same extent as a REIT unless you possess a wide variety of properties around the nation. A REIT can invest across tens or hundreds of properties spanning debt and equity, property kinds, real estate industries, and location, reducing the REIT’s reliance on the performance of one or two assets. For one or a few major active investors, the investment may result in far higher losses if a rental property underperforms owing to remodeling expenditures or lower-than-expected tenancy rates than if the property were one of several properties held by a variety of REIT investors.
Regular cash flow
REIT owners might earn income from the REIT’s debt and equity assets. The dividends get this money. In contrast to rental properties, which typically give monthly cash flows as rental revenues, REIT dividends provide monthly or quarterly cash flow. A REIT is essential to law to pay out at least 90% of its annual taxable profits in dividends to its shareholders. It depends on how well a REIT’s assets perform over time among different REITs, the dividends amount may change.
Tax advantages: The traditional pass-through business structure of a REIT allowed for a new tax deduction for REIT owners to be available starting in 2018. Investors in REITs can now deduct up to 20% of their rental income and interest payments from their taxes. Furthermore, REITs can do away with corporate taxation, allowing only individual investors to pay taxes on the earnings.
Disadvantages of REITs
Although certain REITs provide benefits that significantly allure more than others, all REITs may assist investors in making real estate investments with a minimal outlay of resources. The qualities of each REIT investment choice should be considered before deciding because they might differ in terms of returns, diversity, length, and other factors. It’s crucial to assess any potential drawbacks faced by REITs, such as:
Volatility
Because publicly traded REITs are exchanged on the stock market, their prices vary in unison with the stock market’s rise and fall, irrespective of whether or not the value of property managed by the REIT has changed. These developments continuously impact the value of each share. The only REITs that are impacted by this volatility are publicly listed, these are crucial to remember. Non-traded REITs are the same as their names imply; they are not listed on a stock exchange and their share values are not affected by fluctuations in the open market. Share price changes for non-traded REITs are more influenced by the underlying real estate and various market conditions.
For instance, because its success is unrelated to the stock market’s performance, a share in an eREIT (a non-traded REIT) does not fluctuate in value in reaction to a rise or decrease in the stock market. Instead, its value fluctuates in reaction to changes in the underlying assets it owns. As well as in the marketplaces where those properties are located. These modifications might be neighborhood improvements, sales, vacancy swings, or appreciation.
Correlation
As was previously said, because publicly listed REITs are that, traded on a stock exchange, the value of their shares relates to stock market swings. Publicly listed REITs can give investors access to real estate portfolios they cannot diversify an investor’s portfolio that is mostly made-up of securities sold on the public markets, such as equities and bonds. Non-traded REITs, on the other hand, might supplement the diversification capabilities of a stock and bond-based investment portfolio because they are not publicly listed.
Less control
Investments in rental property provide investors with a great sense of independence and flexibility for complete accountability. On the other hand, investors in REITs only risk losing their initial investment when investing in these securities. Since they have little control, they also carry a lot less danger. Despite having little control over how their investment is run, REIT investors nonetheless get a part of the profits. It may be the ideal scenario for a passive investor, an amateur real estate investor, or even a seasoned investor who lacks the spare time to invest in rental properties. However, it’s a trade-off to carefully consider before you decide to entrust other managers with your money.
Assessing your investing alternatives
The advantages of using real estate in their investment portfolios are well known to many investors. When properly managed, it may produce a consistent revenue stream and be a crucial source of cash flow. It’s crucial to determine which alternative, given your knowledge and time, money, and responsibility commitment, would yield the highest overall return before starting.
To choose which kind of real estate investment is ideal for you, ask yourself relevant questions such as these:
When we talk about renting out your home, do you have the time, knowledge, and willingness to participate in the choices regarding it? Or would you want to take on a more passive role by investing in a professionally managed alternative, such as a REIT?
How much money do you have on hand to make your initial investment? Are the less expensive REIT shares more doable? Or can you afford a sizable down payment?
Which type of REIT is the most appropriate for you if you’re interested in investing in one? Would you like a publicly listed REIT that has more liquidity but is also connected with the stock market and is volatile? Or might a non-traded REIT, like ours, better fit your needs because it is safe from stock market ups and downs?
Whatever your method is, real estate investing is a great way to expand your portfolio’s asset class offerings and a possible source of passive income. Even though real estate has always been the preferred investment for affluent investors, the advent of new technologies and legislation has made real estate more accessible than ever.
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