Becoming financially independent and wealthy is the American dream. One of the best ways to achieve the American dream is by investing in real estate.
You can invest in residential or commercial properties, and you can have a short-term or long-term investing strategy. You can also purchase stocks in REITs, which are companies that invest in real estate.
There are benefits and drawbacks to investing in REITs and rental properties. Whether you decide to invest in REITs, rental properties, or both, your priority is to make money.
The best way to make money in real estate is to understand your investment, including all the risks and rewards.
We will explore the basics of short-term and long-term investing in REITs and rental properties and go over the pros and cons of each investing strategy.
Hopefully, this will give you a better understanding of investing in real estate and which type of real estate investing will work best for you.
What are REITs?
A Real Estate Investment Trust (REIT) is a company that owns and operates a pool of properties. A REIT may specialize in investing in one type of property. They may also invest in two or more different types of properties.
Most REITs invest in commercial properties, but some REITs invest in single-family residential properties and mobile home parks.
REIT companies offer shares of stock through a stock exchange like the NYSE. Investors can purchase these shares through a broker. Purchasing shares of a REIT enables investors to own a portion of a REIT’s real estate portfolio.
By law, a REIT has to distribute at least 90% of its taxable income to shareholders. Most of this taxable income comes from tenant rent payments, leases, and the sale of one or more properties in a REIT’s portfolio.
On average, REITs offer dividend yields that are higher than stocks in the S&P 500 offer because of the legal distribution requirement.
REIT companies fall into several categories. These categories are:
- Industrial – warehouses and distribution centers
- Hotel and Resorts
- Office buildings
- Health care – Hospitals, nursing homes, assisted living facilities
- Retail – shopping centers and malls
- Residential – multi-family homes, apartments, student housing, and manufactured dwellings
- Diversified – Mix of two or more property types
- Specialized – Amusement parks, golf courses, and casinos
You will also hear of mortgage REITs, also called mREITs. These companies generally do not own or operate real estate. Instead, they finance income-producing properties by originating or purchasing residential and commercial mortgages and mortgage-backed securities.
You can buy mREIT stocks through your broker.
Pros and Cons of REIT Investing
REITs offer people the benefits of investing in real estate and publicly traded stocks. One advantage to investing in REITs is having access to income-producing multi-million-dollar commercial properties like hospitals, shopping centers, large-scale apartments, and office buildings.
This access allows you to receive a portion of the rent or lease income generated by these properties in monthly or quarterly dividend payments.
Other benefits to investing in REITs include:
- Long-term returns on REITs are historically better than other stocks.
- REIT stocks diversify your portfolio because real estate is a different asset class than equities.
- REITs are easier to buy and sell than rental properties.
There are some downsides to investing in REITs. These include:
- Taxes on REIT dividends are at a higher rate than dividends from equity stocks.
- REIT stock prices are sensitive to the 10-year Treasury yield. A high 10-year Treasury yield generally means lower REIT stock prices.
- Certain REITs that focus on one type of property like hotels or entertainment/tourist attractions can get hit hard in an economic downturn.
Long-Term Buy-and-Hold Real Estate Investing
Real estate investing is not a get-rich-quick scheme, but it can make you fabulously wealthy when you approach it in the right way with a long-term outlook.
There is the potential to quickly earn a lot of money in real estate through short-term fixing-and-flipping, wholesaling, or tax lien certificate investing. Yet, these are risky and speculative ways of making money in real estate.
You can invest in different types of rental properties for long-term buy-and-hold investing. Single-family residential properties are what most people tend to think of when it comes to rental properties.
Yet, every type of real estate can be a rental property, including multi-family homes, apartments, and commercial properties.
You make a profit in long-term buy-and-hold real estate investing through rental income and property appreciation. Rental income is straightforward. Your tenants pay you monthly rent that you can use to pay the mortgage and other expenses.
You can also save rent payments to purchase another rental property.
Making a profit on real estate appreciation takes a little longer the accomplish. Real estate appreciation is when the value of your rental property increases over time.
You make a profit when you sell the property at a higher price than when you purchased the property minus commissions, fees, and taxes.
Pros and Cons of Buy-and-Hold Investing
Long-term buy-and-hold real estate investing is usually very profitable for several reasons. These include:
- Consistent positive cashflow where rental income is more than property expenses
- High long-term capital appreciation
- Numerous tax benefits, such as deductions, depreciation, and the 1035 Exchange
- Relatively low long-term risk
There are several risks to buy-and-hold real estate investing that you need to consider before you invest. These risks include:
- A rental property investment in a bad location can hurt your profitability.
- An unpredictable real estate market can hurt the capital appreciation of your rental property.
- Negative cash flow where you spend more money on your rental property than you have money coming in.
- High vacancy or problems with tenants
- Lack of liquidity
REITs vs Rental Properties: Which is Better?
Everybody has individual preferences, especially when it comes to real estate. As we have discussed, REITs and rental properties offer many benefits to investors, but neither one is a perfect investment.
When considering investing in REITs or rental properties, you should keep three things in mind.
How much money do you have?
The first thing to consider is the amount of money you have to spend upfront. It does not take a lot of money to start an investment portfolio of REIT stocks to benefit from the monthly or quarterly income distributions REITs provide.
You can reinvest these distributions to buy more REIT stocks and increase your income.
It takes thousands of dollars to purchase a rental property. Unlike buying a primary residence where you can qualify for a no or low-money-down loan, lenders require a down payment on rental properties.
This down payment can be anywhere from 10% to 25% of the purchase price. Other costs can include renovations and advertising the property’s rental availability.
The second thing to consider is the number of responsibilities you want. You are not responsible for the rental properties of the REITs in your stock portfolio.
Your only responsibility is spending a few minutes following the stock price, reading news alerts, and researching the fundamentals of the REITs in your portfolio.
Owning rental properties is a hands-on endeavor. You can hire a property management company to handle your rental properties, but this can negatively affect your cash flow.
It takes a lot of time and money to take care of rental properties and deal with tenant issues and requests.
My Final Thoughts on REITs vs Rental Properties
Long-term investing in REITs and rental properties is profitable. There are pros and cons to each type of investment that you need to consider seeing which one is best for you.
If you like a hands-off approach to real estate investing, then REITs may be for you. If you prefer a hands-on approach to real estate investing, then choose to buy rental properties. You can also choose to invest in REITs and rental properties.
Continue researching both options before investing. I would love to hear from you. Please send me your comments to let me know what you think.
Thank you very much and have a great day.