Two Millionacres pros, Liz Brumer and Matt Dilallo, tackle both sides of this investment debate.
Owning investment property to help build wealth has been practiced since ancient times and for good reason -- real estate has the potential to appreciate, provides tax breaks, and typically has multiple uses or options for generating income. But owning and managing investment properties isn't the only way to invest. If you're looking to invest in real estate, you may be wondering whether you should purchase investment properties or a real estate investment trust (REIT). While everyone's situation and investing goals are unique, there are some distinct advantages and disadvantages to both methods of investing.
Why owning investment properties takes the cake
Although you are indirectly purchasing investment properties when purchasing shares in a REIT, it is not the same thing as owning a property yourself. The government offers tax deductions specifically to those who are purchasing cash flowing investment real estate. While the exact tax benefits depend on the type of investment being purchased there can be a number of deductions that help offset income generated from the property or investing business. Owning physical real estate for investment purposes also unlocks the power of a 1031 exchange, which allows investors to roll any profits, including depreciation from one property into another, without having to pay capital gains taxes. This is something REITs simply do not allow to shareholders.
A REIT is managed for you, which can be great if you're looking to invest as passively as possible. But if you'd like some control over the use and overall performance of the property or portfolio or are looking for higher returns than a REIT typically offers (anywhere from 2% - 8% on average), your best bet is to own the investment property yourself. While active management does put more risk on the investor's plate, the likelihood of being able to buy a property that produces a higher return increases with it. Investors can still hire a management company to handle the daily ongoing management, but the investor still has overall control while benefiting from other advantages rental real estate offers. REITs also don't allow investors to benefit from appreciation. When you own an asset yourself, you have the opportunity to benefit if the property appreciates over time.
REITs reign supreme in many ways
Real estate investment trusts (REITs) can be a fantastic way to invest in real estate. For starters, they've done an excellent job creating wealth over the years. According to data from the National Association of Real Estate Investment Trusts, REITs have produced an average annual total return of 13.3% from 1972 through the end of 2019. That has outpaced the stock market, as the S&P 500 has generated a 12.1% average annual total return during that time frame. Because of that, REITs certainly can deliver compelling investment returns.
In addition to those attractive returns, several factors set REITs apart from investment properties. Topping that list is how easy they make it to invest in commercial real estate. All that's needed is a brokerage account and enough cash to buy at least one share in the desired REIT. Contrast that with an investment property, which often requires a significant down payment.
Meanwhile, REITs are truly passive investments. While a real estate investor needs to do some due diligence before buying shares and should check in on the company at least once a quarter, there isn't any actual work required when owning a REIT. On the other hand, an investment property requires a substantial amount of work if an investor doesn't hire a good property manager. Because of that, REITs are great for generating passive income since they allow investors to sit back and collect their dividend checks.
Finally, there's no additional investment required to keep that income stream flowing. Contrast that with an investment property, which might need an investor to fork over some cash to renovate the space to entice a new tenant after the existing one moves out.
Add it all up, and REITs stand out as an excellent investment strategy for all investors, especially those just getting started on their real estate investing journey.
Choose the strategy that fits your investing style
Investing in commercial real estate can be highly lucrative. While purchasing investment properties offers more upside and control, REITs are easier and as passive as they come. Because of that difference, investors need to decide which strategy best aligns with their lifestyle and goals.