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

Direct Real Estate Investment Vs REITs

last updated Tuesday, May 9, 2023
#REIT #Direct Real Estate Investment

John Burson     Subscribe
Direct Real Estate Investment Vs REITs - Which One To Choose?


If you want to invest in real estate, there are two ways to do that. One invests in REITs, and the other invests in direct real estate. Many investors can get confused about whether to invest in REITs or direct real estate. Some investors might think direct real estate investment is a hassle, so they are more comfortable with REIT investments.

What is Direct Real Estate Investment?

Direct real estate is a physical property that an investor can buy. Investing in direct real estate means buying a specific property, like residential or commercial buildings, and generating money through rental income, appreciation, and profits from any business activities in the invested facilities. Direct real estate offers more tax breaks than REIT investments and gives an investor more physical properties.

Benefits of Direct Real Estate Investment

One key benefit of investing in physical properties is to reap benefits from generating substantial cash flow. As discussed earlier, another advantage is that it offers more tax breaks than REIT to offset the income. You can deduct the necessary costs to manage and maintain the property. Another significant tax break is for depreciation, in which you can cut the costs of buying and improving a property over its useful lifetime. There’s also appreciation in the investment; while the real estate market fluctuates like the stock market, property prices keep increasing with time. This makes the property eligible to be sold later at a higher price. Plus, you can have more control over decision-making than with REITs.

Disadvantages of Direct Real Estate Investment

The disadvantage of direct investing is that it requires significant time and energy to generate an income. You have to deal with tenant issues, maintenance of the property, and your liability for any accidents. Many investors also need to take on a mortgage or loans for financing, which can be problematic. If the market has a downfall, this will profoundly impact the loan repayment. And real estate isn’t liquid, so you won’t be able to sell it quickly for quick cash. Thus, most investors dread investing in direct estates.

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 an income. REITs combine the capital of many investors. REITs can be appropriate for new investors with limited experience in real estate and to diversify their portfolios.

Benefits of REIT

Any individual investor can access real estate profits without owning a physical finance 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 potentials. By law, REITs have to pay a minimum of 90% of taxable income to the shareholders, in which you would have a 5% dividend yield or more. REITs have the potential for capital appreciation with increasing asset value. Another significant benefit is that REIT is liquid. Thus you can buy or sell shares anytime you want. 

Disadvantages of REIT

One real con of REIT is that most REIT dividends aren’t considered qualified, so the tax rate is high. 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 very sensitive to interest rate fluctuations which can be bad for the price. Another drawback is that while you can diversify your overall investment portfolio, most individual REITs aren’t diversified. 

Investing in direct real estate will be better if you want 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 experiences.

Cheat sheet.

Direct Real Estate Investment REITs investment
Low liquidity. Highest liquidity.
Highest tax benefits. Moderate tax benefits.
High control. Low control.

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