Every article that I have seen on this subject simply lists the pros and cons. Lame! I’m taking a stand. For me, buying property has been much better than REITs. Let me explain.
What is a REIT?
Ok first things first. Real estate investment trusts (REITs) own and manage property and/or finance property and then pass the income through to shareholders. This is essentially an alternative to buying and managing real estate yourself. REITs must meet a number of IRS provisions including that at least 75% of income come from real estate related business and that 90% of income be distributed to shareholders each year.
A small investor can get diversification across many properties by having a REIT rather than owning say one single family rental. REITs also often focus in one area. For example, oil and gas related real estate, malls and retail, or office space. This means that if you are bullish on energy, you could invest in pipelines. You wouldn’t likely have the resources to do this as an individual.
What are some positives of REITs?
No Property Management Hassle: No call from a tenant saying that he can’t pay rent because he needs money for burning man (yes this has happened to me). The REIT handles everything and hopefully makes you money.
Low Minimum: you don’t need to buy or finance six figures to get in. You can buy in for as little as around $100.
Diversification: Like a mogul, you get to own a lot of properties (a piece of them anyway). If one property has issues, it may only make up a tiny percentage of the REIT value.
Why I like buying property more than REITs
Diversification sucks! I know it sounds like heresy for a portfolio (and it might be for stocks) but when it comes to real estate this is the main reason I like buying property as opposed to REITs. A REIT may buy up entire portfolios of single family homes 50 or 100 at a time. I have talked to guys that sell portfolios of homes. I know how they often bundle in some junk along with solid properties to maximize return on the sale. In fact, REITs own over 500,000 homes in the USA.
In a previous post about How To Invest and Get Wealthy, I asked a question. If I put you in front of a bowl of strawberries and asked you to pick the best tasting average of strawberries would you sort out some ugly looking ones or just take the average of the whole bowl? With respect to real estate, this may be even more important than for stocks in my opinion. The old real estate adage is that it is all about location. If this is true, why would I buy a tiny piece of hundreds of properties located all over the place rather than buying into the one with a fantastic location and tasting like an organic strawberry straight off the vine popped into my mouth in the middle of the August sunshine?
When I tour properties, I look for value add opportunities, I check out the true condition of things to understand costs I might expect over time, and more. I believe that real estate is influenced by local economics and concerns and even an individual can learn enough to have some usable insight in purchasing and selling properties as opposed to the more broad market of a publicly traded REIT.
Ability To Control Individual Properties
The Choice to Get Dirty 
Saving $
I can choose to make some repairs myself to make extra cash. Deferring repairs or bringing in someone that I know will give me an optimal price and quality balance is an option. I can also choose to get a property manager (or get rid of one) at any time if I find the value of these tradeoffs has shifted for me. If I own a REIT, I am hoping that someone who is just doing their job has the same level of care.
Leverage
When you buy a property, it is possible to get $100K of real estate for around $20K-30K money down and finance the rest. If you cashflow that property, your effective cash on cash return can be much greater than if you had to put up the full $100K. This leverage can be a powerful tool for an experienced investor. The leverage is also the reason why many go broke during real estate down turns if a property no longer cash flows.
Tax Benefits
I know taxes are boring as hell. However, when you get to deduct your operating expenses on your taxes and depreciate the property every year these can add up to real money. In addition, with a 1031 exchange it is possible to defer taxes on real estate sales and buy into another property. If you live in the home for a period of time before selling, you may never have to pay taxes on the profit! You just can’t do that with a REIT.
Overhead
While a REIT has overhead of management at multiple levels, overhead can be zero if you choose to manage your own property.
Owning Real Estate vs. REITs
If we compare the S&P 500 (green) to the Vanguard Real Estate Index Fund (purple) over the past 10 years or so we see that real estate has outperformed the market in the past and also has underperformed the market recently. Real estate does not track the broader market. Sometimes it lags and sometimes it leads. Hence, learning more about this sector will only benefit your financial independence and ability to live one’s life outside the maze.
When it comes to deciding on REITS vs buying property I have owned both. REITs give you diversification, a low investment minimum, and no property management hassles. It is also true that I once lost $2500 by making one little mistake with a property that I owned. That sort of thing never happens when you simply own a REIT. However, if you are looking to become knowledgable in real estate investing, I believe that it is worth digging hands on in the real estate dirt for pennies until a money tree grows. Personally, I have gotten a better return with individual ownership.
I have properties at 10-12% cap rate over the past couple years and also have around 30% appreciation in value. I would love to hear from other investors in the comments but this type of performance is consistent with investors that I know. Meanwhile, if we look back at the Vanguard Real Estate Index Fund (in purple on chart above) it had appreciation of around 26% in that same time period with an average dividend rate of around 4-5%. This is only one man’s anecdotal experience however the point that I am making is that it is possible to get a better return with individual properties due to some of the reasons that I mentioned above.
Best of luck on the path and I would love to hear your thoughts in the comments. I would also like to point out that this post is one man’s experience and opinions. These should not be construed as professional advice or an investment plan recommendation but rather aim to inspire you to do additional research of your own.
4 comments
we own our house but no real estate assets that bring in cash. our house was a good and lucky investment as my wife bought it before i knew her just as a place to live. it must have gone up about 4x in value in about 20 years but we’ve had some big maintenance bills the past few years. 32k for a roof with asbestos abatement, 9k paint job for example. it’s still been worth it because we paid so little and own it outright.
as far as income i prefer a REIT. i’m sure i would hate any tenant who didn’t pay on time or messed something up and i would hold a grudge. gotta know thyself i guess. i can sell my REIT for a $7 commission and not 6% of the property value too.
That’s a good point on the liquidity of a REIT Freddy and also understanding personal comfort levels. It is true that a REIT can be sold pretty much instantly for a low commission versus a property. I appreciate your perspective and also stand by my personal physical property preference for the reasons in the post (sorry that was a lot of P’s in a row). As time goes by and my financial situation changes I may value the ease and lower stress of REITs over what I consider to be a better return currently with the property I own outright.
I think the better side is a buying property. If the property is available at a good location and locality so the benefit is more with it.
Thanks for a great post. I now have the choice to buy or not to buy real estate. You have excellent information to analyze.