Real estate investment trusts (REITs) and rental properties are good ways for investors to earn passive income. If you’re wondering about a REIT vs. a rental property, you’ll discover in this article that both can be great investments. However, they differ significantly from one another in many respects.
Real estate is a solid place to start if you’re looking to diversify your portfolio. Two popular, cash-flow-generating types of real estate investment are rental property and REITs. However, before you start investing, it’s essential to understand the risks and benefits of buying rental property vs. REIT investing.
If you’re considering investing in real estate, we’ll give you a breakdown of what each option has to offer and why you may favor one over the other.
Why Should You Invest in Real Estate?
Investing in real estate is always a smart move. Rental properties are a great way to make money, and you can also use them as a passive source of income. There are multiple ways you can approach rental investing, such as short-term and long-term rentals, as well as a range of property types you can invest in, such as single-family homes or apartments. REITs provide a more affordable and diversified option. But what exactly makes real estate investing so lucrative?
Potential for Passive Income
Your ability to earn passive income will depend on how you invest in rental property. This is revenue that you receive just by investing your money. You can increase your chances of having various sources of income and a more stable monthly cash flow by investing in multiple rental properties or REITs.
Incredible Potential for A Decent Cash Flow
Real estate investing offers a decent potential, but it’s not a guarantee that you’ll make money. Cash flow is possible if you put money in commercial property and receive dividends or in rental properties and receive monthly rental revenue.
Solid Wealth-Creating History
Although no investment is entirely risk-free, real estate investing has a strong track record. Because housing values tend to rise, you have a chance of increasing your net worth and receiving profits or bonuses as the value of the asset rises. However, diversifying your investment portfolio is always a good idea to reduce the danger of losing money.
An Inflation Hedge
Inflationary price hikes are currently affecting all of us. Additionally they are damaging to your portfolio, inflation might hurt the overall market. But you can compensate for the loss by diversifying your investment holdings with real estate.
As inflation rises, housing values frequently do as well, resulting in higher profits for investors. Landlord cash inflows increase substantially as they gain more equity in the asset. You could increase the rent paid if the value of the investment property increases sufficiently.
You Can Grow Your Home Equity
Growing equity in your investment property is possible when you invest in real estate. If you buy a property or invest in a REIT, You might be entitled to a share of the proceeds and grow your wealth if you or the investment trust sell the property.
Possible Tax Deductions
This is one area where the rental property vs. REIT question tips in favor of rental properties. You may qualify for certain tax deductions according to your level of home equity. For instance, rental property investors can deduct their operating costs. Included are the price of upkeep and repairs, the interest on your mortgage, and any other expenditures you pay for running the rental properties.
REIT investments may not qualify for tax benefits, but if you keep the assets for a long time, there are certain tax benefits. You may qualify for fewer capital gains taxes in the long term instead of paying tax at your regular income tax rate.
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REITs vs. Rental Property
Real estate investing can yield excellent returns. It gives you the power to build wealth over the long term by making regular cash flow from tenants. But many investors need more time or resources to deal with the day-to-day issues of owning rental properties. That’s why REITs are popular.
Below we’ll go over some of the benefits and drawbacks of investing in REITs vs. rental property to help you decide if it’s the best investment.
Rental Property
Those interested in becoming more involved and controlling their investments may find that investing in rental properties offers lucrative options. They can generate monthly cash flow and create long-term wealth. They also have the leverage of equity participation, which offers tax benefits, more portfolio control, and the opportunity for increased private fortune.
The investor should make more money from the rent on your property each month than they spend on insurance, maintenance, mortgage, taxes, and other costs. Any surplus gives the investor a cash flow of each month’s profit that they can either save or put back into the asset.
However, these advantages also come with many duties that a landlord must continuously attend to.
Pros and Cons of Investing in Rental Properties
Pros
Total Control Over Your Investment: Which homes you acquire and rent out is entirely up to you. You will not need to rely on the investment decisions of fund management and hope for the best. As the landlord, you have the authority to impose all regulations, including the amount of money you will receive each month from rentals, the kinds of activities you permit and forbid on the premises, and even the duration of the lease.
You Can Enjoy Tax Advantages: As a rental property investor, you are also a business owner in the eyes of the IRS. Therefore, real estate investors have access to various tax exemptions. Rental property owners can deduct various costs associated with purchasing and managing the property, such as depreciation, maintenance and renovation expenditures, and travel expenses to and from the rental homes.
The mortgage interest deduction is an interesting incentive the IRS also offers to homeowners for a primary or secondary residence, which can sometimes apply to rental properties. It allows you to reduce your taxable income by the amount of interest paid on a loan associated with purchasing, improving, or building your home. If you’re eligible, this can result in significant tax savings over time.
You Own Every Profit From Asset Appreciation: If you are the only landlord of a rental property, your renters cover the building’s expenses while you benefit from asset growth. Your fortune rises as the estate’s equity rises. All gains from the sale of the property are yours to keep.
Cons
Hands-On Investment: Without property managers managing your investment properties, it can be quite a hassle. You must be present around-the-clock to guarantee that your tenants are safe and secure in the rental home. Additionally, you are responsible for finding and screening renters, coordinating rent collection, and managing disruptive tenants.
It Requires a Larger Upfront Investment: Although there are a few crafty ways to buy a rental property with little money upfront, you usually require a sizable chunk of initial capital to make real estate investments. Mortgage lenders typically require sizable down payments, and you also need money to maintain the house. Additionally, It can take time to raise enough money to purchase rental properties, limiting your investment options.
Potential Risk of Legal Liability: When investors directly own real estate, they are ultimately responsible. If a property is left unoccupied for a long time and cash flow declines, there may be a danger of borrowing default or potential individual liability in the case of legal action.
Real Estate Investment Trust (REIT)
A real estate investment trust operates differently. Holding stock of a trust that controls and operates real estate is what a REIT entails. You do not have any influence or role in the real estate operations that a REIT owns as an investment. Investors get dividends as the REIT’s assets increase in value and generate income.
As a shareholder, you can sell your REIT asset whenever you want. But you can only do so at the market price. Depending on their nature, REITs may be privately-traded, publicly traded, or non-traded. Each has a unique way of running, specific investment criteria, and capital availability.
Pros and Cons of Investing in REITs
Pros
Dependable Cash Flow: A REIT frequently pays its investors dividends regularly. These dividends come from rent or interest expenses and are paid at different intervals (monthly, quarterly or yearly).
Passive Investing: One of the least-involved real estate investing methods is the purchase of REITs. The real estate business handles everything else. You only supply the funds. The investments they make are made without your input, and you have no obligations to the properties, although you could still receive dividend payments or capital gains.
Diversity of Holdings: Real estate investments are frequently heavily diversified by REIT institutional investors. The distinction becomes apparent when you contrast this with how you might be able to mix your real estate investments on your own. You might put money into a REIT that oversees many properties for a higher probability of higher returns.
Low-Capital investments: The capital requirements for REITs are modest. You may require a $10 investment to join some real estate investing platforms. To participate in the thrill of real estate investing, you don’t need to be an accredited investor.
Cons
Investment Time Horizon: Most REITs demand that you invest your money for a minimum of a specific number of years, and not all offer early redemption options. To receive regular cash flow, you must be willing to forfeit the amount you are committing for the lifetime of the investment.
Minimal control: You have no control over the real estate that a REIT invests in or manages because REITs are passive investments. This is why it’s crucial first to investigate the business. You shouldn’t put money into a business that is unethical.
No Tax Advantages: If you don’t invest in a REIT via your IRA, any income you receive from one is subject to taxation at your standard tax rate.
REIT vs. Rental Property: What Should You Invest In?
When choosing between investing in a REIT vs. rental property, there are many factors to consider. Although both REITs and rental properties provide high yields, they are different. They have different benefits, and there is no legal restriction on an investor owning both.
You can purchase REITs with much less money and trade just like stocks, making them a potential asset class for portfolio diversification. However, making a direct real estate investment in a single-family rental home, offers several tax advantages and the opportunity for long-term gains from both monthly rental income and housing value growth.
If you own a rental property, are you equipped with the time, knowledge, and motivation to actively participate in choices that affect your real estate? Or might putting money in a high-performing solution like a REIT allow you to take on a more passive role?
What available funds do you have for your upfront outlay? Can you finance a sizable house deposit, or are REIT shares’ lower prices more doable?
What kind of REIT is the most appropriate for you if you’re considering one? Would you prefer a publicly traded REIT that provides extra liquidity but is also volatile and linked to the stock market? Or a non-traded REIT protected from stock market ups and downs?
The Bottom Line
There needs to be an all-around option for investing in real estate. Your choice will depend on the real estate investment that best suits your needs and the amount of money you have to invest.
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