Landlord vs. REITs: Pros and Cons (2024)

Investors seeking exposure to real estate can look for investment properties to purchase and rent out, or they can buy shares of a real estate investment trust (REIT). Becoming a landlord offers greater leverage and a better chance of realizing big returns, but it comes with a long list of hassles, such as collecting rent and responding to maintenance issues. REITs provide a much simpler way to invest in real estate and earn consistent income through dividends, but they confer less control, and their upside tends to be lower than that of rental properties.

Landlord Pros

Becoming a landlord offers several advantages. Perhaps the biggest advantage is leverage. Investors with good credit can buy rental property with as little as 20% down, financing the rest. Therefore, the investor's cash outlay on a $100,000 property is only $20,000. If the value of the property increases by 20% in the first year, an amount not unheard of in a hot real estate market, then the investor enjoys a 100% return.

Although mortgage payments must be made on the financed amount, a smart real estate investor earns enough money in rental income to cover the mortgage, with money left over as profit. This allows the investor to earn money from both property appreciation and rent payments from tenants.

Landlord Cons

Being a landlord is a much more hands-on investment than owning shares of a REIT. Many people who have gotten into the business of purchasing rental properties have quickly learned that the time required to manage all of their properties becomes another full-time job. A person considering buying rental properties should brace themselves for a huge time commitment, or be prepared to pay a professional property manager to handle the minutiae involved, such as advertising vacancies, collecting rent and dealing with delinquent tenants.

Then there are the myriad expenses involved with owning property. Depending on how the lease agreement is written, a landlord could be financially responsible for everything from a leaky faucet to a broken refrigerator. This can eat into an investor's profit quickly. Moreover, dealing with frantic late-night phone calls every time a tenant's toilet does not flush properly can impede quality of life.

REIT Pros

Perhaps the biggest advantage of buying REIT shares rather than rental properties is simplicity. REIT investing allows for sharing in value appreciation and rental income without being involved in the hassle of actually buying, managing and selling property. Diversification is another benefit. Building a diversified portfolio of one's own rental properties requires a hefty budget and a lot of time and expertise. Investing in the right REIT offers done-for-you diversification in one simple purchase. Furthermore, while rental properties are potentially lucrative investments, they can be highly illiquid, particularly when the real estate market turns soft. REIT shares, on the other hand, can be redeemed for cash in one five-minute phone call.

REIT Cons

REITs lack the leverage advantage offered by financing rental properties. Because a REIT is required by law to distribute 90% of its profits to investors, that leaves only 10% to grow the company by investing in additional properties. Consequently, REIT share prices rarely grow as fast as, say, Silicon Valley tech companies, which rarely pay dividends and usually invest every penny of their profits into growth and innovation.

REIT investing offers less control than being a landlord. When an investor buys rental properties, the investor can see, touch and smell each property before owning it. The investor can research the local rental market and examine data on how similar properties have fared recently. Buying REIT shares means ceding that control to someone else. This can be ideal for investors not wanting to make such decisions, but those who prefer a hands-on approach might be better off as landlords.

Landlord vs. REITs: Pros and Cons (2024)

FAQs

Why buy REITs instead of rental properties? ›

In short, studies show that REITs are more rewarding investments because they enjoy: Significant economies of scale. Better access to capital. Development capabilities to earn better yields and create value.

What is the downside of REITs? ›

Non-traded REITs have little liquidity, meaning it's difficult for investors to sell them. Publicly traded REITs have the risk of losing value as interest rates rise, which typically sends investment capital into bonds.

What are 3 drawbacks to owning rental real estate? ›

The drawbacks of having rental properties include a lack of liquidity, the cost of upkeep, and the potential for difficult tenants and for the neighborhood's appeal to decline.

What is the five or fewer rule for REITs? ›

General requirements

A REIT cannot be closely held. A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).

Why I don t invest in REITs? ›

However, REITs are not risk-free: they may have highly inconsistent, variable returns; are sensitive to interest rate changes are liable to income taxes may not be liquid, and can be dramatically affected by fees.

Why are REITs losing value? ›

The overall business performance of the S-REIT sector has been lacklustre and some segments of the industry have not been able to recover to pre-COVID levels, either due to a change in business dynamics or due to an inflationary environment. Office REITs have faced challenges due to the new work-from-home (WFH) trends.

What are the dangers of REITs? ›

Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.

Can REITs go broke? ›

REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures. Thereafter, REIT managers became far more conservative in their investment and financing practices.

Do REITs do well in a recession? ›

REITs Outperform Stocks During Recessions

Publicly traded stocks rely heavily on the performance of the companies that are being traded in order to succeed. During a recession, those companies struggle, and their stock value drops.

What is the biggest risk of owning a rental property? ›

An extended vacancy is undoubtedly one of the biggest financial risks involved in investing in rental homes since it's essentially lost money. If you can't consistently rent your space, you're still responsible for paying the property's expenses — without generating income to offset the cost.

Is it wise to keep a rental property? ›

Protection Against Inflation

Owning a rental property is a safe investment and an even better asset that can make money during periods of high inflation. It gains value when inflation is high and creates cash flow from renting during any economic period.

What is the Brrrr method? ›

What is BRRRR, and what does it stand for? Letter by letter, BRRRR stands for “Buy, rehab, rent, refinance and repeat.” It's like flipping, but instead of selling the property after renovation, you rent it out with an eye on long-term appreciation.

What is the 90% REIT rule? ›

To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

What is the 75 75 90 rule for REITs? ›

Invest at least 75% of its total assets in real estate. Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate. Pay at least 90% of its taxable income in the form of shareholder dividends each year.

What is the REIT 10 year rule? ›

For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.

Is it better to invest in REITs or real estate? ›

Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.

Why would an investor want to invest in a REIT? ›

REITs offer a number of attractive attributes such as growth, income, and diversification. REITs have historically delivered strong results and provide attractive income relative to other asset classes. They offer diversification relative to traditional investments like stocks and bonds.

What is one advantage of investing in REITs? ›

REITs offer investors the benefits of real estate investment along with the ease and advantages of investing in publicly traded stock. REITs have historically provided investors dividend-based income, competitive market performance, transparency, liquidity, inflation protection and portfolio diversification.

Why you should have REITs in your portfolio? ›

Real estate investment trusts (REITs) are a key consideration when constructing any equity or fixed-income portfolio. They can provide added diversification, potentially higher total returns, and/or lower overall risk.

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