REITs vs. Real Estate: Which is the Better Investment?

Real estate is an excellent investment that yields high dividends over time. It can offer a steady passive income with numerous tax benefits.

If you are contemplating real estate investment, it comes down to one thing: REITs vs. real estate.

You can invest in a real estate investment trust (REIT), a company that owns or invests in real estate on your behalf, or you can directly invest in real estate properties yourself.

Both avenues involve benefits and drawbacks, and one option may be more appealing than the other, depending on your current financial situation.

Are you stuck on which investment is suitable for you? Keep reading to learn more about each type of investment and which better suits your goals.

What is a Real Estate Investment Trust (REIT)?

Investors offer their capital by buying shares and, in return, receive dividends; this allows them to earn income from real estate without the need to purchase or manage property themselves.

Examples of REITs

The stock market’s historical trends can provide insight into a company’s future prospects. For example, the National Association of Real Estate Investment Trusts has been tracking the return data of the REIT sector since as early as 1972.

Below you’ll find an analysis of three real-world examples of REITs that have done well historically: Realty Income has an impressive portfolio of more than 11 thousand commercial real estate properties in Europe and the U.S., which it rents out to notable brands such as 7-Eleven and Walgreens.

Collectively, these brands make up 8 percent of its annual REIT income. Realty Income has seen a 15.3 percent compound average on an average return since its first public offering as far back as 1994.

BRT Apartments Corp owns and develops multi-family properties spanning 11 states. However, the majority of their properties are in Texas and the Southeast.

Although it is far from being the largest company of its kind, its performance over the past five years has been remarkable: since September 2017, its stock price has grown from $7.84 to $23.94.

Life Storage Inc is based in Buffalo, New York. This REIT purchases and manages self-storage facilities in 36 states, as well as in Ontario, Canada, and has over 1,100 storage facilities and more than 2,200 employees.

Over the past five years, Life Storage Inc. has appreciated from $49.22 to $129.18.

Benefits of Investing in REITs

Low investment minimums: REITs provide a low-cost means of investing in the real estate market. You can invest in a fund with as little as $500, which is much less than you would spend if you were to invest in real estate directly.

No experience required: The simplicity of investing in a REIT is another added benefit. A REIT allows you to partake in a pro-rata share of a property and benefit from its appreciation and rental income without any direct involvement.

Professionally managed: REITs are a great way to incorporate real estate assets into your investment portfolio without owning or managing a property yourself.

A dedicated team takes care of that for you by overseeing daily operations and maintenance.

Passive investing: If you are looking for passive income, REITs are an ideal option for you. You own the stock; the company owns the real estate.

High dividend yields: REITs have historically exhibited long-term capital appreciation and generated competitive returns and consistently high dividends.

For example, you may receive dividends in excess of 5 percent on your investment.

Tax benefits: REITs are also exempt from most corporate income taxes. Additionally, if you invest, you receive a 20 percent reduction to single tax rates on regular income portions. 

Consistent cash flow: By law, REITs must pay at least 90 percent of their taxable income to their shareholders, offering you, as an investor, a constant cash flow.

Diversification: Real estate investment offers excellent diversification opportunities as it is separate from other assets.

Disadvantages of Investing in REITs

Illiquid investments: With non-traded REITs, the investment is illiquid. They typically take time to sell on the open market, meaning it will take you longer to raise money on these assets.

Subject to higher interest rates: The overwhelming majority of REIT dividends are not considered “qualified”; therefore, they are subject to a higher tax rate.

If you own shares in a REIT through a taxable brokerage account, you should beware of this.

Volatility: Even though REITs have a low correlation with the stock market, a sell-off is still possible if the stock exchange plummets.

Some require accredited investor status: Typically, private REITs can only be sold to institutional investors, such as “accredited investors,” or substantial pension funds, which means you must have a net worth of $1 million or a high annual income.

Less ownership: When you own and manage a commercial building or a rental property, you have a sense of control. REITs do not provide this level of autonomy.

Dividends are taxable: Your REIT dividends constitute taxable income, depending on your filing status and overall taxable income.

Direct Investing in Real Estate

As an investor, you can own a real estate property either independently or jointly with one or more other investors.

When you are the direct property owner, you can choose to retain it for an extended period or renovate it and flip it for profit.

Such properties can be commercial or residential and may include:

• Single-family homes
• Multi-family homes
• Apartment complexes
• Condominiums & townhomes
• Commercial properties
• Storage units
• Warehouses
• Office buildings
• Land for development

Examples of Direct Real Estate Investing

When you make a direct real estate investment, you typically purchase a commercial property (such as a shopping mall) or a residential property (such as an apartment complex).

For a multitude of reasons, income-producing rental properties such as those listed on Airbnb are among the best forms of real estate you can invest in.

Above all, they yield a substantial and steady profit.

The U.S. housing market experienced an average growth rate of 5.3 percent between March 1992 and March 2022.

It is difficult to calculate the average commercial real estate ROI owing to market diversity. In addition, many such transactions occur privately, so they are not easy to track.

Nonetheless, we can utilize specific stocks to make a generalization. The average return for commercial real estate property is 9.5 percent.

Benefits of Direct Real Estate

Rental income: Ideally, your rental property should generate sufficient income that it can cover your operating expenses and mortgage while still allowing you to make a profit after every period.

Cash flow: If you choose to invest directly in real estate, the main advantage is that it creates a steady cash flow. With time, you can establish multiple income streams from various properties.

Tax deductions: Another benefit of direct real estate investments is that you are eligible for tax breaks to reduce your capital gains and net income tax liabilities.

One of the ways you can do this is by deducting operating expenses, such as leasing fees, property management, insurance, mortgage, property tax and repairs, from your rental income.

Leverage: You can use the funds from a cash-out refinance to purchase a rental property, claim tax benefits and generate an income stream.

Alternatively, you can leverage your home’s equity by borrowing money against your current home’s value.

Asset appreciation: As an investor, you can purchase a property and allow it to appreciate, then sell it for profit at a later date.

Though the market for real estate can fluctuate, average sale prices of homes have historically increased in value over time.

Direct control over property: If you directly own real estate, you are free to make independent decisions about your property, such as whether to contribute

Disadvantages of Direct Real Estate Investing

Property management: The investor is responsible for managing the property, which can be intensive. This includes finding tenants, decorating, marketing and organizing repairs.

You may outsource these tasks, but the buck ultimately stops with you.

Finding tenants: You must decide who you allow into your property, which involves screening for candidates who will take care of it and who have an interest in staying long term.

Large down payment: Direct real estate investments require large sums of money upfront. The general rule of thumb is that you will need a minimum of 25 percent of the total value of your rental property to secure a loan.

Higher mortgage rates: If these increase, it can damage the housing market and lead to a lower demand for property.

Extensive research: Selecting the most suitable direct real estate investment requires an enormous amount of time, effort and research.

You will also need a certain level of expertise to understand state and local federal fair housing and landlord–tenant laws.

Illiquid investment: If you need cash quickly, you won’t be able to sell your property overnight; therefore, it isn’t a liquid asset.

Real Estate vs REITs: How do they compare?

Similarities	REITS	Direct Real Estate
Asset appreciation	Illiquid	Liquidity
Diversification	Less control	Flexibility
Tax benefits	Low minimum investment	Tax Deductions
Subject to higher interest rates	Dividends	Higher upfront investment
Passive	Professionally managed	Leverage

Which is the Better Investment?

As for the dilemma of REITs vs. real estate, the better investment for you ultimately depends on several factors, including your financial goals, your level of expertise regarding real estate and whether or not you desire a hands-on approach.

Here are some reasons you may choose one over the other:

Choose a REIT If:

• You want to avoid managing a rental property yourself.
• You don’t have the funds to purchase real estate property directly.
• You’re a beginning investor who wants to gain real estate experience.

Choose Direct Real Estate If:

• You want to create a steady cash flow.
• You want to get tax breaks to reduce your overall tax liabilities.
• You like to be directly involved in managing a property, and you enjoy creative control.