May 28, 2021

REITs vs. Real Estate (8 Differences + How To Invest)

Being a unique asset class, real estate has long been a sought-after investment opportunity. After all, a real estate investor can benefit from passive income generation, portfolio diversification and certain tax breaks. 

However, the high investment minimums needed to purchase property have made it a tough market to enter. 

Fortunately, there’s an alternative to buying property outright: REITs. 

But, what is a REIT? And what are the differences between REITs vs real estate?

In this detailed guide, we’ll answer those questions and suggest three REITs worth considering.

article-logo

This Article Contains: 

(Click on a link to jump to the specific section) 

Let’s dive in. 

Note: We’re first going to briefly go over what REITs and direct real estate investments are. If you want to skip ahead to the section on differences, click here.

What Is A REIT?

A REIT, or real estate investment trust, is a company that functions like a mutual fund for real estate investing. Investors pool funds which the REIT then uses to buy and manage residential or commercial properties.

Introduced in 1960, REITs were created as an affordable means for more investors to access income producing property without the commitments of owning physical real estate. 

More than 225 REITs are currently available in the US that are registered with the SEC (Securities and Exchange Commission) and trade on major exchanges. 

They offer the investor the potential for sizable returns by purchasing shares in their portfolio properties, much like you would buy shares on stock exchanges. 

The three kinds of REITs

There are largely three kinds of REITs available today, a mortgage REIT, equity REIT, or a hybrid REIT. These can be a private, a publicly traded, or a public non traded REIT. Being a non traded REIT simply means it doesn’t trade on stock exchanges. 

A mortgage REIT is one that uses short-term loans at low interest rates to purchase existing loans at a comparatively higher interest rate. The mortgage REIT’s profit is the difference between these two interest rates. 

Equity REITs are more common and tend to be a lot less volatile. Equity REITs focus on investing in income producing rental property in specific sectors. For example, some REITs focus solely on healthcare, residential, or office buildings.

Equity REITs primarily earn through monthly rental income and appreciation in the properties it owns.

Hybrid REITs are a combination of mortgage and equity REITs. 

What Is Direct Real Estate Investing?

Direct real estate investing involves buying a property outright or purchasing a stake in one, often through real estate syndications or private real estate investments like private equity. 

Direct investing can be a lucrative and more active alternative to REITs. 

Investors primarily earn through monthly payments (with rental property) and long-term property value appreciation.

When most people want to buy property, they do so with a loan. Some investors buy with a plan to hold it for the long term and earn through regular rent payments. Other investors adopt a more short-term approach, opting to fix and flip.

For long-term inventors, it’s not uncommon to see annual returns of 7-10%, depending on the property and its location. For a fix-and-flip investor, the profit is the difference between the purchase price and the selling price plus any additional expenses like holding costs. 

A fix-and-flip investor often tries to sell a property within 6 - 12 months. In these short-term investments, a rule of thumb is that you need to make at least 30% above the purchase price to make a profit.

REITs vs Real Estate: 8 Differences

There are several defining differences between REITs and a direct real estate investment. 

Some notable ones include: 

1. Level of control

REITs offer less control than direct property investments. The investor doesn’t have a say regarding the type of properties the REIT buys, where it buys properties, and when it sells them.

An investor has much more freedom and flexibility when investing directly in real estate. 

Investing directly into property means you have all the control over making decisions regarding your investment. Decisions like how much rent to charge, what renovations to do, and when to sell are all up to you.

2. Investment minimums

REITs have considerably lower investment minimums than purchasing property outright.

While minimums can vary between REITs, REIT shares in a publicly traded and non-traded public REIT tend to be the most affordable. Private REITs are generally only available to accredited and institutional investors and are therefore much more expensive.

However, even these are far more affordable than direct real estate investments.

Remember, purchasing property can cost hundreds of thousands to millions of dollars, while you can invest in shares of a publicly traded real estate fund as little as you want.

Because of the high investment requirements, financing a property purchase can be a challenge. Most investors would need to take on a mortgage to pay for the investment. 

These difficulties can stack up if the property market tanks or if there are complications involved in finding tenants. Some properties, like commercial office buildings and apartment complexes, require even greater financing.

The typical down payment for repeat buyers using financing is close to 16%. For first-time home buyers, the median down payment is 7%, alleviating some of the difficulty in entering this investment space.

3. Liquidity

Directly investing in real estate is far more illiquid than a REIT. If you need access to cash quickly, you’ll likely find it challenging to sell the property in an emergency.

On the other hand, a REIT, especially a publicly traded REIT, offers much greater liquidity. Shares can easily be bought and sold, depending on how it's structured.

4. Active vs. passive investing

One of the greatest  advantages of investing with a REIT is the passive nature of the investment. An individual investor can capitalize on the profits that a real estate investment generates without the hassles of having to finance, own, and manage the properties themselves. 

While owning the property outright has certain advantages, there are also several considerations to keep in mind. In addition to the expertise required, actively managing a property can take a considerable amount of time

As a landlord, it’s your responsibility to find tenants, perform background screenings, draw up lease agreements, ensure your tenants are abiding by the agreement, oversee the maintenance, handle evictions, and more. 

It’s possible to hire a property management company to alleviate some of these responsibilities, but this incurs additional fees. 

5. Potential earnings 

By law, a REIT is required to distribute at least 90% of its annual profits to investors through dividends and aren’t taxed at the corporate level, leaving more money to share among investors. Some REITs may even opt to pay dividend stock, which is a payment made in shares rather than cash. 

One of the biggest benefits of investing directly in a real estate asset is the substantial cash flow generated. They offer the potential for higher returns through reliable monthly income from rent payments and property appreciation with time.

6. Diversification

Achieving a good level of diversification is also far easier with a REIT investment. They can invest in dozens or even hundreds of properties across various real estate sectors, geographic locations, property types, and more. 

By comparison, unless you can afford several different types of real estate property or own properties in multiple sectors, acquiring the same level of diversification with direct property investing is considerably more difficult. 

7. Tax benefits 

Both REITs and direct investment have tax benefits. 

Since 2018, the pass-through business structure has provided new tax deductions for REIT investors. Those investing in REITs can claim a 20% tax deduction on income earned from loan interest and rental payments.

However, it’s important that REIT dividends are considered taxable income and, as such, are taxed as ordinary income. 

Rental property owners can deduct the bulk of their expenses they incur in managing the investment property. For example, the investor can deduct legal fees, insurance premiums, maintenance costs, and more.

8. Expertise and experience 

The real estate market is complex. 

REITs are much easier to get started with as an investor doesn’t need extensive real estate or finance expertise to ensure the investment is successful. 

Buying property directly requires extensive expertise as you need to evaluate the viability of the investment. You need to determine the expected occupancy rate, monthly rental income, operational costs, upfront renovation costs, and the time required to operate the property. 

If you’re interested in investing in real estate with none of the hassle, a REIT could be the best way to go. 

With far lower minimums and the potential for decent returns, REITs also alleviate many of the hassles that come with direct property ownership. With that in mind, here are three great REITs to consider investing in: 

3 Fantastic REITs To Consider Investing In

While there are plenty of REITs available, here are two that could be worthwhile investing in. 

1. Concreit 

Concreit is a real estate investing app that lets investors invest in a private REIT that targets private loans backed by real estate, and fractional shares of multi-family properties in the US. 

Concreit aims to provide investors with increased cash flow through weekly dividends from loan interest, rental income, and value appreciation.

Potential returns 

Concreit targets annual returns of 5% - 8%. 

Minimum investment 

$1.

Fees

There are no fees charged to investors.

2. Nico

Nico is a neighborhood REIT with the aim of investing in and developing community-owned real estate. While most traditional REITs build capital and invest it into commercial real estate, Nico prioritizes neighborhood equity, providing investors with ownership of their community.

Potential returns

An investor receives quarterly dividends generated from the income produced by the properties, which Nico reinvests to create compounding returns. There’s also the potential to benefit from appreciation.

Minimum investment

Less than $100. 

Fees

There are no fees charged to investors.

3. Streitwise 

Streitwise is a real estate investing platform aiming to provide non-accredited and accredited investors with access to commercial real estate properties through federally-registered offerings. Investors can access a professionally managed portfolio of real estate assets with the potential to earn passive income. 

Potential returns 

The most recent dividend paid to investors in Q1 2021 was 8.4%, with a historical average of 9.5%. 

Minimum investment 

The minimum investment is 250 shares at the NAV (net asset value) at the time of purchase. Thereafter you can increase your holdings in $500 increments. 

In Q1 2021, the minimum was $2,522. 

Fees

There is a one-time fee of 3% of your invested funds that go towards organizational and offering costs. The sponsor receives an ongoing 2% annual management fee taken from the distributions. 

There are no acquisition fees, servicing fees, financing fees, or disposition fees. 

Final Thoughts

While both, a REIT and direct real estate investment offer you some great benefits, they have some fundamental differences. The one you pick will come down to your personal preferences and financial goals. 

For most investors, REITs are probably the better option, given their passive nature and easy accessibility. However, if you’re looking for more control, direct real estate investing is an attractive option.

Are you looking for some information on additional alternative investments, like investing in farmland or hedge funds

Consider taking the MoneyMade Investor Quiz

Answer some short questions about your investment preferences and risk tolerance, and MoneyMade will recommend the perfect investments for you!

Share this article