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

Invest in real estate through REITs or direct real estate. Some avoid direct real estate due to hassle, preferring REIT investments.

last updated Tuesday, April 30, 2024
#REIT #reits vs real estate

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Direct Real Estate Investment Vs 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 helpful 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 an income. REITs combine the capital of many investors. REITs can be appropriate for new investors with limited real estate experience and diversifying 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 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.

Direct Real Estate Investment vs REITs 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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