Owning Rental Property vs Owning REITs

A reader emailed me recently about the benefits and pitfalls of owning a rental property versus owning a dividend stock.  As both aren’t on a level playing field, I thought comparing owning investment real estate to owning a real estate investment trust (reit) would be a more fair comparison.

Being a real estate investor was something I dabbled into upon graduating from University.  As it’s a popular and proven way to build long term wealth, I jumped in with both feet.  I soon realized however, that while managing properties was tolerable, managing tenants wasn’t as fun.  As a result, I eventually realized that the real estate rental business wasn’t for me and gradually sold off my rentals.  Today, the only real estate that I own is my principal residence.

What is a REIT?  A Real Estate Income Trust is a company that owns property, collects rent, and distributes the profit to shareholders.  It’s an easy way to get real estate investment exposure without getting your hands dirty or managing tenants.  However, the investor has no control over properties, purchasing/selling decisions, and especially the market.  Even if the REIT is strong, a weak market can irrationally decimate share prices (see crash of 2008) thus potentially reducing portfolio value.

Rental Real Estate

Advantages

There are advantages of owning rental real estate directly.

  • To start, you get control over the property, cash flow and tenants.
  • The investor can pick and choose which properties to purchase, as well as which repairs/upgrades to create value.
  • There’s something to be said about having capital in a physical property that’s more “real” than having money in the market.
  • There are many tax deductions when owning rentals and if you own multiple units, you can claim a portion of your vehicle and home office.

Downside

As with any investment, there are also drawbacks.

  • Owning rental real estate is a business and can be time consuming.
  • Working with non-paying tenants can be challenging and stressful if cash flow is tight.  Of course, this can be partially alleviated by hiring a property manager which of course eats into monthly cash flow.
  • Owning rental real estate directly is illiquid and quite costly to dispose of should the need arise (real estate, legal fees, time on market etc).
  • Leverage (mortgage) may be required along with the now minimum 20% cash down payment.

Real Estate Investment Trusts (REITs)

The Good

  • What I like most about REITs is how “hands off” it is and how picking strong REITs can provide a steady passive income source.
  • The investor can get real estate investment exposure without directly dealing with clogged toilets and late rents.
  • The barrier of entry is much lower where  any investor with a brokerage account can get REIT exposure.
  • One of the major advantages of REITs over rental properties is the diversification possibilities.  Instead of having a large portion of your capital in a single property, you can have them spread out over many properties across the country via a REIT.

The Bad

Sounds like a no brainer to go with a REIT instead of owning property directly, however, there are drawbacks.

  • For those of you who like the “control” of owning rental properties, REIT performance depends on the management of the company.
  • Your investment capital will be at the mercy of the volatility of market which can fluctuate significantly (see 2008).
  • Leveraging REITs can negatively impact the tax deductibility of the investment loan.

Final Thoughts

There are many advantages and drawbacks of both owning rental properties and investing in REITs.  Either can be successful depending on your aptitude and interest.  What do you think?  REITs or rental real estate?

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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cristine reyes
4 years ago

Helpful comments ! I loved the analysis ! Does someone know if my business might access a blank OREB No. 16 form to use ?

Gregg
6 years ago

I’m surprised that the main difference between RIET and Rental Real Estate has been left out……Return On Investment!

With a rental property your return is three pronged: 1. Monthly cash flow 2. Mortgage pay down 3. Property appreciation(percentage of full value of the property not just what you intially invest). Your ROI on a REIT is simply just a percentage (usually quite low) of what you invest.

Compare your ROI on an investment of $20k in a REIT with purchasing a rental property with the same $20k. REITs do not even come close to the ROI of a rental property.

If you buy a REIT you might as well just walk down the street to your local bank and buy a Mutual Fund….waste of time

Retireby55
9 years ago

after seeing the recent valuation of REITs, is price already at/near the top?

Jc
9 years ago

I am surprised at all the negativity towards Rental property, I actually own 2 semis and so far so good. I put 5% down of my own money, and now a tenant is paying off my house for me. So yes, if you only look at the $200/net income I make , it seems quite small. However the point here is that out of say $20K in mortgage payments per/year 12K goes towards principal aka EQUITY which a tenant is paying for me. So above the $2400 net income/year I also build 12K in equity which will only get bigger every passing year.

I was one of those people skeptical especially with so many “horror” stories you hear about tenants, but figured I would be patient , do really good screening and take a chance. Glad I did. The best part is that in 15 years both places will be paid off through tenants.

And all this talk about repairs, you would have to change the roof, windows if you lived there anyway.

REITS are definitely a good option if you have TONS of money. The Canadian reits payout roughly 7% /year so in order to make what I do through income/equity from my property roughly 14K, I would need to invest 200K in a REIT. Yes the housing market can crash, but it would take the stock market with it.

This is a great article, I think people discussing investments in general is great. Just wanted to share my experience. Passive income is GREAT no matter what the source.

BeachBoy
9 years ago

Time is money. Recently I have invested in a private REIT – Centurion (8.5% DRIP compounded return + expected 3-5% appreciation) and at the same time have been looking at a real estate joint venture for properties in Barrie. After dropping off a cheque, the Centurion folks take care of everything, even paperwork and setting up trust accounts (RESP, etc) – just sit back and collect returns. Most returns are return of capital which is an advantage for some.

With this REIT I can spend time with my kids, teach them The Wreck of the Edmund Fitzgerald on guitar, help research high schools, spend time with an aging parent, volunteer with Scouts Canada, etc – priceless.

Of course the ROI for Barrie rental properties is greater … but trekking up there for a home inspection during November’s first snow storm after work? Not so appealing. My read on some REIN types is they absolutely love real estate and don’t mind the time they invest in all the research, doing the books, or fixing toilets. For others who value time, consider the certain exit costs as noted above, and the certainty of big one-time repairs in the property life-cycle (roof, furnace), not to mention the longshot slips & trips liabilities, the real estate ROI is certainly eroded.

[ I also think Rachelle has shown how some of the general REIN ROI numbers broadcast on BNN for places like Hamilton have been “pumped up”. So unless you put in the time you could end up with a mediocre property.]

My first house purchase had 2 rental units and I’ve lived through the good and the bad tenants, the spring melt/flood etc and it is all part of the gig. If you are ready for that, are beginning your “journey” and need the potentially higher ROI, have no significant opportunity costs for your time (maybe think broader than your day job pay rate) then real estate is for you. If not, you can invest in a private REIT (accreditation depends on your province) and still enjoy the benefits of holding real estate assets … albeit at safe distance that doesn’t require snow tires!

onemillionby35
9 years ago

Rachelle,

You are right, I must have misread what he meant by $180k/yr is actually gross rental income and not NET. What I’m interested is knowing what his net profit (after paying taxes and all other expenses like mortgages, strata fees, property taxes…etc) would actually be.

Rachelle
9 years ago

If the numbers are correct and he has property valued at 3 million and his new worth is 1.3 million then his properties are about 40% equity. Which means they will definitely cash flow. However if you keep reading he also mentions that his net for the tax man I’d about 2 k but he pays his wife too.

Depending when he bought this is entirely possible. Keep in mind that inflation and improvements can substantially increase your rents while you are still paying the mortgage on the original purchase amount.

A lot of being in real estate is a waiting game.

onemillionby35
9 years ago

Can someone please explain to me how it can be possible for Nick to have a rental income of $180k/yr after all the expenses he stated above given that he has about $3.0 million in real estate properties and $1.2m in networth?

That works out to be 15% ROI in +ve cashflow! That number obviously doesn’t include any appreciations on properties themselves.I don’t know any where someone can buy properties that gives you that much return in cashflow.

I own four units of rental properties so I understand how numbers work but his numbers seems to be quite high for rental income. I would love to know and learn if it is actually achieveable.

Nat
9 years ago

I would talk it over with an accountant.. if you occupy the building yourself w. employees you will get many tax writeoffs plus appreciation, but if you invest in the REIT you will not have a tax advantage I believe. An accountant can calculate the benefit either way.

Rachelle
9 years ago

In this case I would just give you some examples of companies who have used this strategy extremely effectively. McDonalds for instance has a sizable percentage of it’s net worth in it’s well located retail spaces.

Google is also following this strategy.

Leasing commercial space for your company starts to have some problems for a few reasons, first any changes you make or anything attached to the walls and floors belongs to the owner, second at the end of the lease the owner can raise the rents as much as they like or refuse to negotiate entirely if they want to change the use. A ten year lease sounds long but isn’t that long when you consider the possible expense of moving.

Then there’s a possibility of buying something bigger and leasing out a part of the space to provide for future growth.

In your case, I would consider buying for other reasons not just the rent/REIT situation.