Comparison Between Direct Real Estate Investment vs Investing in REITs. Which One To Choose?

There are two main options for real estate investing: REITs or direct real estate. It's common for investors to feel confused about which option to choose. While some may find direct real estate investing a hassle, others may prefer the comfort of REIT investments.

What is Direct Real Estate Investment?

Direct real estate investment refers to an investor purchasing a physical property. This type of investment involves buying a specific property, such as residential or commercial buildings, to generate revenue through rental income, appreciation, and profits from any business activities in the invested facilities. Direct real estate investments are advantageous in that they offer more tax breaks than REIT investments and allow investors to own more physical properties.

Benefits of Direct Real Estate Investment

Investing in physical properties has several benefits. One of the primary advantages is the potential to generate substantial cash flow. Additionally, direct real estate investments offer more tax breaks than REIT investments, allowing investors to deduct necessary costs like property management and maintenance expenses. Investors can also use depreciation over a property's useful lifetime to reduce the costs of buying and improving the property. Moreover, the real estate market tends to appreciate with time, increasing the property's value and making it eligible to be sold later at a higher price. Finally, direct real estate investments offer more control over decision-making than REITs.

Disadvantages of Direct Real Estate Investment

One of the main disadvantages of direct real estate investing is that it requires significant time and energy to generate an income. Investors must deal with tenant issues, property maintenance, and accident liability. Additionally, financing a direct real estate investment requires taking on a mortgage or loans, which can be problematic if the market experiences a downturn. Direct real estate investments are also illiquid, meaning they cannot be sold quickly for quick cash. These factors make direct real estate investing a daunting prospect for many investors.

What is REIT?

A Real Estate Investment Trust or REIT is a company that owns, operates, or finances income-generating real estate or assets. Unlike direct real estate, you don’t need to own a physical property for income. REITs combine the capital of many investors. REITs can be appropriate for new investors with limited real estate experience and for diversifying their portfolios.

Benefits of REIT

Any individual investor can access real estate profits without owning a physical real estate property. They offer a less expensive way to invest in the real estate market. That’s one advantage. Another one is that REITs offer attractive return potential. By law, REITs have to pay a minimum of 90% of taxable income to the shareholders, which would provide a 5% dividend yield or more. REITs have the potential for capital appreciation with increasing asset value. Another significant benefit is that REITs are liquid. Thus, you can buy or sell shares anytime you want. 

Disadvantages of REIT

One significant drawback of REITs is that most of their dividends aren’t considered qualified, resulting in a high tax rate. You must pay extra attention if you own REITs in a taxable brokerage account. You can hold REITs in a tax-advantaged Roth IRA account. Another problem is that REITs can be sensitive to interest rate fluctuations, which can negatively impact their price. Another drawback is that while you can diversify your overall investment portfolio, most individual REITs aren’t diversified.

Investing in direct real estate is a better option if you're looking for positive cash flow, tax breaks to generate income, or significant potential. However, REITs will be a good choice if you don’t want to get into the hassles of investing in physical properties. REITs are suitable for beginners, so you can start from here to gather experience.

Direct Real Estate Investment vs REITs Cheat Sheet