direct-real-estate-investing-vs-reits

Direct Real Estate Investing Vs. REITs | Reits Investments

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The two most popular ways of investing in real estate are direct real estate investing and REITS investing (real estate investment trusts). Many investors who are looking forward to investing in this sector compare actual real estate to REITs. While real estate investment trusts are like mutual funds for real estate, direct real estate investment involves buying physical properties.

direct-real-estate-investing-vs-reits

If you want to choose one over the other, you need to explore their merits and demerits.

Direct real estate investing

Direct real estate investing means buying a complete property or a stake in the property that could be residential or commercial. Earning from direct real estate comes in rental income, property value appreciation, or profits generated from the business that depend on direct real estate.

Merits of direct real estate investing

As you know, income from direct real estate is derived either from property rent, profits received from business conducted on the property, appreciation, or a combination of all or any two. In such a scenario, the biggest merit of direct real estate investing is the decision-making power and the direct control you can exercise on your investments.

For example, you can choose how many and what property to buy and decide the tenants and the rental income. Additionally, there is always value appreciation. Property prices rarely come down, unlike REITS investments that depend on the stock market and are subject to fluctuations.

Another merit of investing in direct real estate is the number of tax reliefs you get to offset the purchasing cost. Also, you get a tax break for depreciation. This way, you gradually decrease your taxable income by deducting the cost of purchasing and maintaining the property throughout its serviceable life.

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Demerits of direct real estate investing

The biggest disadvantage in direct real estate investing is liquidity. In case of urgency, you might not be able to sell off your physical property quickly to generate cash. Another demerit is getting finance for purchasing real estate since the amount involved is usually high. An investor may resort to external financing or mortgage. 

Even after the real estate is acquired, if the market conditions are not suitable, finding quality tenants could be difficult, leading to a scenario of defaulting on the loan.

Direct real estate ownership includes sweat equity, wherein the owner has to tackle all maintenance and tenant-related issues, which could pose a bigger challenge. Moreover, the owner is also liable for any accidents on the property.  

Real estate investment trusts

Real estate investment trusts or REITs are a company that finance, owns, or manages real estate or real estate-related assets. It functions in the way mutual funds do by pooling the capital of many investors.

With more than 225 REITs in the US listed on the primary stock exchange, the combined equity market capitalization is more than $1 trillion. Over 35 countries offer REITs worldwide (As per data published on investopedia.com). 

Merits of REITs

With REITs, investors do not have to purchase any physical property by investing exorbitantly. Investors have the option to derive income from real estate without having to own or manage any property.

REITs offer liquidity, high return, and capital appreciation potential. REITs are legally bound to pay a minimum of 90% of taxable income to their investors, and often the dividend yield surpasses 5%. Additionally, the increase in the value of the assets makes way for capital appreciation. 

Since REIT shares are like stock, you can buy or sell them on an exchange as an investor. This solves the liquidity issue, which is a big demerit if you invest in direct real estate.

Demerits of REITs

REITs investments are burdened with heavy taxation. Most REIT dividends are taxed at a higher rate since they are not considered “qualified dividends.” 

Whatmore, REITs are prone to interest-rate fluctuations. In general, there is an indirect relationship between Treasury yields and REIT prices. When one increases, the other declines and vice versa.

REITs also suffer from a lack of diversification. The investments are focused on a specific type of property, like shopping malls, offices, or resorts. If these sectors go through a rough economic patch, REIT investors could face higher risk in investment.

REIT vs. Real Estate – Which is better?

With REITs, investors have the hands-off option of investing in real estate. Such investments are affordable and suitable for beginners who are willing to delve into the world of real estate. Direct real estate might be expensive upfront but allows the investors to have more control over their investment. 

Both the investments help hedge inflation and market downturn risk. Both can be a source of regular cash flow. However, REITs are a more passive source of income compared to real estate. 

What is better for you depends on the investment burden you are willing to take. For analyzing the best financial objectives and proper investment recommendations, you can refer to a financial advisor, a broker, or an investment advisor. 

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