What makes sense for me?

What makes sense for me?

REIT vs rental property

REIT vs rental property

Adding real estate to your investment portfolio can be a smart way to diversify, increase returns and even hedge against the risk of inflation. However, when it comes to how to invest in real estate, you have a few options to choose from. Two of the most common avenues for real estate investment are rental properties and Real Estate Investment Trusts (REITs). Like any investment, each one comes with its own pros and cons. Investing in real estate is undoubtedly an attractive proposition. However, consider consulting a financial advisor beforehand.

REIT vs rental property

Before you can decide which real estate investment is best for your investment portfolio, you must first understand how each investment works.

rental item

The premise of the rental apartment is already known to most people. Investors can purchase residential real estate such as single or multi-family houses, condominiums or multi-family houses and then rent them out.

Ideally, your property will bring in more rent each month than the investor pays in mortgages, taxes, insurance, repairs, and other expenses. Each extra provides the investor with a monthly cash flow gain that they can save or reinvest in the property. The hope is that the rental property will appreciate in value over time or after a refurbishment. If the investor decides to sell the rental property, it will prove to be a source of long-term growth.

Real Estate Investment Trust (REIT)

A REIT, or real estate investment trust, works a little differently. With a REIT, you buy shares in a trust that owns and manages real estate. As an investor, you have no influence on the real estate held by a REIT, nor do you have any influence on or responsibility for the management. As the assets in the REIT appreciate in value and generate profits, investors are provided with dividends.

If an investor ever needs to liquidate their REIT shares, they can do so at the then current market value. REITs can be publicly traded, privately traded, or not publicly traded. Each works a little differently with their own investment needs and fund accessibility.

Similarities Between REITs and Rental Properties

In many ways, investing in rental properties and investing in REITs are similar, if not the same. Here are some ways the two options overlap.

cash flow

If you’re looking for an investment that will provide you with a source of cash flow, both REITs and rental properties may be right for you. The IRS requires REITs to return at least 90% of their taxable income to investors in the form of dividends. Because of this, REITs are generally a reliable source of this passive income stream.

In the right circumstances, a rental property can also provide you with monthly cash flow. However, this depends on factors such as market rental rates, property taxes, vacancy and even repairs.

capital appreciation

Rental properties and REITs represent strong long-term investments for many investors because they can each offer strong growth and appreciation. As these assets appreciate in value, it can regularly result in increased cash flow for investors. If the assets are later sold, the investor will also see an increase in value.

volatility

REIT vs rental property

REIT vs rental property

Another similarity between REITs and rental properties is that both are potentially volatile and can fluctuate in value over time. If a REIT sees a reduced profit margin — either due to increased spending or market trends — investors will likely feel the impact through lower dividend payouts. This reduced cash flow can impact your budget and financial efforts elsewhere.

REIT volatility can also be an issue if you need to liquidate your portfolio. If your REIT has fallen in price since you bought it, you will feel the impact when you sell the investment.

Rental properties are vulnerable to a number of hazards, including volatility, bad tenants and falling property values. Rental rates can fluctuate along with the rest of the real estate market; This can lead to lower rents and even longer vacancies. Volatility can also be caused by increased property taxes or unexpected major repairs that are the responsibility of the owner-investor.

diversification

Investing in real estate can help diversify your investment portfolio, better protect your savings and help cushion the blow of factors such as market downturns and inflation. Both rental properties and REITs are working to diversify your portfolio by adding real estate investments into the mix. The more diverse these investments are, the better your portfolio can be buffered: This can mean investing in a variety of REITs or buying multiple types of investment properties or in multiple areas.

Differences between REITs and rental properties

There are some differences between rental properties and REITs that you should understand if you want to make an informed investment decision.

Direct property tax credits

Property owners can take advantage of many IRS tax deductions related to their investment property. This includes depreciation such as mortgage interest, property taxes, repairs, administration, and other expenses. REITs don’t offer investors these types of tax deductions.

control and flexibility

Whether you want to pick the next group of tenants or just pick the colors, you don’t have much (or really any) control over your investment with a REIT. If you want to play a practical role in your investment, you must choose rental properties.

Ability to use as collateral

If you have a rental property, you can borrow some of the equity (or the value you own) if you need to. This can be done through an equity loan or home equity line of credit, also known as a HELOC.

Active vs Passive

A very important difference is that rental properties are an active investment while REITs are a passive investment. Rental properties require a hands-on approach and constant attention, even if you hire a management company to make most day-to-day decisions. REITs, on the other hand, offer investors a sort of “set it and forget it” approach. Once you’ve bought shares in your REIT, all you have to do is receive dividend payments and watch your assets grow.

liquidity

If you ever need to liquidate your investments, REITs might prove a little easier than rental properties. In order to dissolve a rental property, you usually have to sell it. This can take time, energy and money between preparing and listing the home, presenting the property and completing a sale.

From start to finish, it can easily take you months to liquidate a rental property. With REITs, however, it can be as simple as clicking a button on your broker’s app. If you own publicly traded REITs, they can be sold in minutes (if not seconds) as long as a buyer is available.

upfront costs and investments

Rental property can mean many things to investors, but cheap at first sight isn’t usually one of them. In order to purchase a rental property, investors must have at least the down payment, the share capital and the closing costs. If renovation is required, the investor must either provide cash or take out a loan.

With REITs, you can often start investing with just a few dollars. While there are REITs (particularly privately traded or not publicly traded) with high minimum investment requirements, many other REITs are available on everyday brokerage platforms with no minimum investment requirements.

bottom line

REIT vs rental property

REIT vs rental property

Do you prefer a hands-off approach? Then see if you can add REITs to your portfolio. Are you looking for an investment that offers tax advantages and more practical control? Then renting an apartment is worth it. For some investors, buying rental properties and buying shares in REITs can be the perfect happy medium. Because the more diversified your investment portfolio is today, the more secure you are for future markets. The right choice depends on an investor’s goals and investment style; In some cases, adding REITs and rental properties could be the answer.

Investing Tips

  • Consider working with a financial advisor when considering opportunities to add real estate assets to your portfolio. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool puts you in touch with up to three financial advisors operating in your area and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.

  • As an investor, finding the right risk tolerance for your portfolio is crucial. Bonds can help you find the perfect balance you’re looking for in your investments. But navigating how much to place where comes with its challenges. SmartAsset offers an asset allocation calculator that can help you determine the right allocation for your desired risk tolerance.

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The article REIT vs. rental property: which is better? appeared first on the SmartAsset Blog.

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