A Real Estate Investment Trust (REIT) provides an opportunity for individual investors to invest in real estate without having to own or manage their own physical properties. Direct real estate ownership is when an investor has a tangible asset that can be bought, sold, and rented out.
There are a number of different reasons that an investor would choose a REIT over simply buying a property. There are an equal number of reasons for why some investors would avoid that type of deal altogether.
What’s best for each investor will depend on investment goals, available capital, and tolerance for risk.
If you’re not sure where you should be investing, or how, contact Bell Properties. We can make sense of what the California real estate market offers. In the meantime, let’s take a look at how REITs compare to direct ownership. We’re listing off the pros and cons of each investment type.
Maintaining Liquidity with California Real Estate Investments
Before buying a property, investors like to think about resale possibilities and how quickly and easily they’d be able to unload that property if they needed to exit the market. It’s not always so easy, and it depends a lot on the market and the property in question. Here’s how REITs might have the upper hand when it comes to liquidity.
REITs and Liquidity
Pros: REITs are publicly traded on stock exchanges, providing investors with high liquidity. Investors can buy and sell shares just like they would with stocks, making it easy to exit the investment.
Cons: While liquid, REIT prices fluctuate with market volatility, even if the underlying real estate assets remain stable.
Direct Ownership and Liquidity
Pros: Property ownership offers the potential for long-term appreciation. Unlike stocks, real estate prices tend to be less volatile in the short term.
Cons: Real estate is not a liquid asset. It can take months or even years to sell a property, making it harder to access invested capital quickly.
Asset Control
Who is making decisions about the investment that is owned? This is also an important part about choosing between a REIT and direct ownership.
REITs and Control
Pros: REITs are managed by professional teams, so investors don’t have to deal with property management, tenant relations, or maintenance. REITs remain a passive investment.
Cons: Investors have no control over which properties the REIT invests in or how the properties are managed. Decisions are made by the REIT’s management team, which may not always align with individual investor goals.
Direct Ownership and Control
Pros: With direct ownership, investors have complete control over decisions related to the property, including management, tenants, improvements, and when to sell.
Cons: Managing real estate involves significant responsibilities such as dealing with tenants, repairs, and compliance with local laws. It can become time-consuming and stressful, especially for inexperienced investors. Professional property management is always an option, and we can tell you more about our services at Bell Properties.
Diversification of Investment Portfolios
Smart investing requires an intentional look at the property type, location, condition, and other factors. Diversifying a portfolio always protects investors against risk. So, which is better for diversification?
REITs and Diversifying
Pros: REITs typically invest in multiple properties across various sectors (residential, commercial, industrial, etc.) and locations. This provides investors with broad diversification, reducing the risk associated with individual properties.
Cons: Although REITs offer diversification, they are still concentrated in real estate as an asset class, which may not provide the same risk reduction as a more diversified portfolio across multiple industries.
Direct Ownership and Diversifying
Pros: Investors can choose specific properties, giving them full control over their diversification strategy. If they own multiple properties in different locations, sectors, or cities, they can achieve some level of diversification.
Cons: Individual property investments are inherently concentrated, and one bad property or market downturn can have a significant impact on the investor’s overall portfolio.
Exploring Tax Benefits
Tax benefits and deductions can reduce what an investor has to pay on income received from real estate. The benefits are a little different between REITs and property ownership.
REITs and Taxes
Pros: REITs are required to distribute at least 90% of their taxable income to shareholders, which can result in high dividend payouts. Additionally, under U.S. tax law, REIT dividends may qualify for a 20% deduction under the 2017 Tax Cuts and Jobs Act, though they are generally taxed as ordinary income.
Cons: REIT investors do not benefit from property-specific tax breaks such as depreciation or direct capital gains tax advantages that come with owning real estate.
Direct Ownership and Taxes
Pros: Property owners benefit from several tax advantages, including the ability to deduct mortgage interest, property taxes, and depreciation. When selling a property, investors can defer capital gains taxes through a 1031 exchange by reinvesting the proceeds into a similar property.
Cons: While direct ownership offers valuable tax benefits, property owners must navigate complex tax rules and regulations. Losses from properties may also be capped or subject to passive activity loss limitations.
Income and Returns
Wondering what kind of money can be earned on a REIT or on direct ownership? Contact us at Bell Properties and we’ll take a nuanced look at specific portfolios. Here’s what we can say in general terms:
REITs and Earnings
Pros: REITs typically provide steady and reliable income through dividends, which can be attractive for income-focused investors. Additionally, as the REIT grows in value, there’s potential for capital appreciation of the shares.
Cons: Dividend yields can vary based on market conditions, and share prices can fluctuate with the stock market, potentially limiting capital appreciation during market downturns.
Direct Ownership and Earnings
Pros: Owning rental properties can provide consistent rental income and long-term appreciation. Investors can benefit from cash flow and can set rents, giving them direct control over income potential.
Cons: Income from direct property ownership can be inconsistent due to vacancies, unexpected repairs, or fluctuations in rental demand. Investors may also have high upfront costs and ongoing expenses (e.g., maintenance, property management fees).
Accessibility and Capital Requirements
Understanding what’s needed to enter a market is an important part of investing. Here’s how it shakes out for each investment vehicle we’re discussing.
REITs and Access
Pros: REITs are accessible to almost any investor with a brokerage account, and they require relatively low initial capital. Investors can buy shares for as little as the price of a single stock, allowing them to enter the real estate market without significant upfront investment.
Cons: While REITs are accessible, investors only own shares in the trust, not the actual real estate. This means they do not directly benefit from property-specific appreciation.
Direct Ownership:
Pros: Direct property ownership allows investors to control the full value of the property, including any future appreciation. This can lead to significant wealth creation if the property value increases over time.
Cons: Direct real estate investment typically requires substantial capital for a down payment, closing costs, and ongoing expenses. This can be a barrier to entry for many investors.
Risk Exposure
Uncovering an investor’s tolerance for risk is a big part of choosing the right real estate assets. Here’s how to understand which type of investment might best suit a particular risk profile.
REITs and Risk
Pros: REITs offer a lower level of risk due to diversification and professional management. Investors are not exposed to the same degree of property-specific risks like sudden repairs, tenant disputes, or local market downturns.
Cons: REITs are subject to stock market volatility and interest rate risks, which can affect share prices even when the underlying properties are performing well.
Direct Ownership and Risk
Pros: Direct ownership gives investors full control and exposure to the real estate market, without stock market volatility. Investors can directly influence the performance of the asset through property management.
Cons: Direct property ownership comes with higher risk exposure to individual property issues, such as vacancies, natural disasters, or market declines. Additionally, being highly leveraged in a downturn could result in financial distress.
REIT or Direct Ownership: Which is Better?
The decision between investing in REITs or direct property ownership depends on individual goals, risk tolerance, and investment preferences. There’s no single answer, and there’s no one way to invest. Consider investment goals, financial positions, and other assets. Look at risk tolerance and income needs. Contact us at Bell Properties, and we’ll do some deeper digging.
Here’s a summary of each investment type to help with decision making:
REITs are best suited for investors looking for liquidity, passive income, and low capital requirements. They are ideal for those who want to diversify into real estate without the responsibilities of property management.
Direct Ownership is better for investors seeking control over their investments, tax benefits, and long-term wealth building through property appreciation and rental income. However, it requires significant time, effort, and capital.
We’ll walk through each potential investment and discuss what’s going to work best for your particular portfolio. Contact us at Bell Properties for investment advice and all of your California property management needs.
