REITs vs. Rental Properties
You want to invest in real estate but you’re not sure if you should be buying your own properties or investing in a REIT. Well there are some things that you should know about both of them before you make your decision about whether to investing in REITs VS Rental Properties.
REITs (Real Estate Investment Trusts)
There are two different types of REITs – public and private. Many people know of publicly traded REITs, which are actually on the stock market, so you can buy those REITs on your phone. Private REITs are not on the stock market and are normally just for a small group of investors.
The way that REITs work is that you buy shares of the REIT. Those funds that you have invested allow the REIT to buy real estate. Those investments produce cash flow or capital gains. Ninety percent of the profits that the REIT is generating have to go back to the investors who own shares of those REITs.
There are a couple different benefits to owning your own rental properties instead of investing in a REIT. First, you get to hedge against the stock market risk. When you’re investing in a REIT that’s on the publicly traded stock market, the prices of the REITs tent to move the same way that the stock market does. For example if there’s a stock market correction or collapse, the REITs tend to go the same direction, even though the investments that the REIT is making may not be going downhill.
If you’re already in the stock market and you already have some funds invested there, investing in a REIT, while you think you may be diversifying, you actually aren’t, in my opinion. Just because that REIT is still publicly traded, it’s still on the stock market. If the stock market does have a collapse, you’re still invested into paper assets. You own a piece of paper essentially instead of owning physical assets under your name. So if you think you’re getting into a REIT just because you want to hedge against the stock market risk because you already think you have a ton of money in the stock market, I don’t think that’s a good option.
Therefore owning rental properties which are off the stock market would help to hedge against that stock market risk. For example if you had $100,000, you could use $50,000 to invest in the stock market, you take the other $50,000 and buy yourself three or four rental properties out-of-state and collect some cash flow. That would help you hedge against that stock market risk that you may have if you were to invest in a REIT.
The second benefit of investing in your own rental properties and actually buying properties under your name is they have intrinsic value. Something that I always love to talk about when it comes to real estate investing is that these properties that you’re buying they have some intrinsic value, they’re worth something. They’re made out of wood and nails and bricks. These are all things that have value and can be sold. Whereas a paper asset is only worth a piece of paper and can go down to $0.
Another benefit to investing in real estate and buying your own rental properties is you’re able to use financial leverage. You can use leveraged debt financing to buy rental properties, whereas you can’t with a REIT. For example you could put very little down to buy properties worth way more than what you put down. For example, you’re buying a $100,000 dollar property, you only need to put $20,000 or 20% down and now you own this property worth $100,000. Whereas if you only had $20,000 and you wanted to invest in the REIT, then your equity would be $20,000 and nobody would be growing your equity for you.
By using financial leverage and getting a loan on a rental property, you’re growing your equity every month. Tenants are living in your house, they’re paying down your loan and they’re growing your equity each and every month. REITs don’t do this and instead will just generate you little capital gains. But you’re not using financial leverage to buy properties worth much more than the cash that you have available in your bank account.
The final point about investing in rental properties is that you have control over your investment strategy. You have full control over the investment and what you want to do with it. You can choose how much debt you want to apply to it, when to make capital improvements, when you want to sell your property, etc.. You’re in full control. You’re the CEO of that rental property.
With a REIT you invest your funds and somebody else takes over. So it’s very passive and very liquid in that sense. But if you want to have more control and want to be able to use financial leverage then rental properties are the way to go.
Low Cost of Entry
To invest in a REIT compared to investing in real estate, there is a very low cost of entry. You can go invest $20 into a REIT, do it all through your phone, sit back and relax and watch your money grow 6-8% a year. So it is very low cost of entry.
Whereas if you were to buy your own rental properties, you’re going to need $15,000. You’re also going to need to find a property management company, a rehab crew, a realtor, an escrow company, etc.. Or find a turnkey provider who will do all of that for you.
Therefore, REITs not only have a very low cost of entry in terms of dollars but also in time. You can do some research online to figure out what are the best REITs to invest in and their track record and all that kind of stuff. That can take a couple hours, while on the other hand if you wanted to buy a rental property on the MLS would take much more work. You’d have to find a good market to invest in, find a good property, analyze that deal, make an offer on that property, find a property management company, complete the rehab to that property. There is a lot of time that goes into buying rental properties if you’re going to do it yourself without using a turnkey provider.
With REITs you can buy and sell whenever you want to. You can invest your $20 today and sell it tomorrow and pay your buying and selling transaction fees. But you’re able to get that money out when you want to. That provides a benefit if you’re investing a large sum of money and you don’t know when you’re going to need it back. You want to make a little return on that money and just set it into that REIT as it grows.
That’s a benefit of a REIT over rental properties. You can’t buy a rental property for $70,000 and then go and turn around and sell it the next month. I guess you could, but it takes time to sell. So as you can sell shares of your REIT instantaneously just from your phone, selling your rental property could take 30 days, 60 days, you never know how long, until you find the right buyer to buy at the right price. And you may even need to sell that property at a loss if you need to get your cash out fast.
If you’re buying your own rental properties and those properties need rehab and you need property management, all those things take time and energy for you to go and find, whereas investing in a REIT is very passive. You give your money to somebody else, they’re already doing all of those things, they’re finding the properties, analyzing the deals, finding contractors, finding teams on the ground, and property management companies to manage those deals.
You can just buy these shares through your phone with as little or as much money as you’d like and you can sell whenever you want to as well. However, with less risk comes less reward. While REITs may generate 6-9% cash-on-cash return, buying rental properties and using financial leverage where you can put $20,000 down to buy an asset worth $100,000, there’s no other investment like that. With rental properties your cash-on-cash return can be 15-20% compared to the 6-9% return and having a little or no control over your investment.
What are your goals?
Do you want passive income where you don’t have to lift a finger but therefore get a lower return? Do you want to be completely hands-off? Do you want to take a couple hours out of your month to do some work to get a much larger return?
You also have to think about some personal items to see if you can even buy rental properties right now. Are you financeable? Do you have good W2 income? Do you want to be a landlord? Do you want to manage tenants or even manage a property management company?
If you’re not financeable and you don’t have good W2 income, then maybe you look at other options. Maybe it’s looking at buying properties all-cash or investing in REITs until you save up $60,000 so you can buy properties all cash.
REITs are definitely a good option if you don’t have $15,000 to buy your own rental properties. They’re definitely a great option to take a little bit of the risk off. There’s going to be a much lower return, but they are very liquid and are very passive. It really depends on what seat you’re sitting in and what your goals are for the future.
Reach out if you have any questions. We’re here to help!