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Real estate is an extremely popular asset amongst investors. Homes and commercial properties offer great returns throughout most economic cycles. Growing populations, growing demand, and loose central bank policies have spurred property prices over the last several decades.
Everyone needs to live and work somewhere, which makes real estate a relatively safe investment.
Buying physical properties is not the only or best way to invest in real estate. REITs offer many advantages and don’t require nearly as much capital to invest.
What is a Real Estate Investment Trust (REIT)?
REITs or Real Estate Investment Trusts are companies that own and typically operate revenue-producing real estate. There are REITs that own apartments, hospitals, data centers, malls, storage units, nursing homes, and more.
REITs allow investors to own equity in publicly traded real estate companies. For a company to qualify as a Real Estate Investment Trust, it must meet specific IRS standards. Some of the major IRS requirements of a REIT are:
- 75% of total assets must be real estate or cash.
- 75% of gross income must come from real estate investments.
- 90% of taxable income is required to be paid out to shareholders as dividends each year.
Companies will opt to be registered as a REIT to save on corporate taxes and get cheaper financing for properties.
Benefits of Investing in REITs
The biggest draw for investing in REITs is the high dividend yields and consistent payout. Remember, if a company is listed as a REIT, they must pay out shareholders in the form of a dividend every year.
Along with dividend payouts, investors can rack up returns as the value of the company increases. Share price can rise while dividends compound.
Investing in a REIT is much easier than acquiring physical investment properties. A REIT investor does not need to have large amounts of capital and secure financing to purchase real estate.
You gain easy access to a lot more options and different types of real estate you can invest in as well.
Best of all, there is no fuss or hassle of being a landlord either.
Cons of Investing in REITs
All investments come with risk, and REITs are no exception. Similar to investing in physical real estate, the interest rate risk affects REITs as well. Rising interest rates are harmful to real estate values, and the share prices of REITs will typically fall.
REIT dividends are also taxed at a higher rate because they are not considered a “qualified” dividend by the IRS. Most REIT dividends are taxed at your ordinary-income level.
The type of real estate that the company is invested in can come with specific risks as well. For example, hotel and hospitality REITs are more delicate during economic downturns and recessions.
Buying Physical Investment Properties
Owning and operating physical investment properties is a lucrative and exciting business. Many Americans wish to own physical real estate due to its historically strong returns.
There are opportunities to own commercial real estate, rental properties, and more. Housing demand is consistently high, and being a landlord can generate passive income if done right.
The work, knowledge, and capital needed to own physical real estate is much more than simply buying shares of REIT companies. When you own investment properties, you are a business owner versus owning part of the business when buying REITs.
Benefits of Real Estate Investing
There are multiple ways you can invest in physical real estate. Owning your home and renting out part of it is the most common way. Taking on a tenant can help you pay off your mortgage sooner and begin to build passive income. Another popular option is to own multiple single-family homes and rent them out.
Owning commercial properties or multiple housing units is an additional way to invest in physical real estate.
Property owners can get tax benefits and harbor consistent revenue streams that are relatively recession-proof. You’re likely to obtain much larger returns than you’d get from investing in REITs.
Cons of Real Estate Investing
The responsibilities of being a landlord can be very time-consuming, expensive, and risky. Homes and office buildings require a lot of maintenance that is quite pricy. You are responsible for repairs, upkeep, property taxes, and staying informed on housing laws.
Financing is the biggest hurdle for most people who want to invest in physical real estate. Large down payments of 20% or more are often required, along with a good credit history.
You will need to know what you are doing and have sufficient capital to limit the risk. If tenants end up leaving, you’ll still have to cover the mortgage payments until vacancies are filled.
The financial risk and capital requirements to invest in physical properties can outweigh the rewards.
Investing in physical real estate or buying shares of REITs are both rewarding in their own ways.
Physical properties can reap larger returns but can be a giant headache to manage and come with more risk. REITs aren’t going to get you rich overnight, but they can generate truly passive income.
You will need to evaluate your capital, real estate knowledge, and financing options to make the best choice.
Overall, it is much easier for the ordinary investor to invest in REITs than to buy investment properties. Real estate, in general, is a long-term investment and should be treated as such.