Real estate investment may not be as clear cut as you would like it to be. Like every other form of investment opportunity, real estate presents itself in a diversity of forms, each with its own set of benefits.
Among your options for real estate investment are two common categories: Real Estate Investment Trusts (REITs) and direct property syndication. The key difference comes down to how much control and ownership you have over the property, and one or the other may suit your situation and finances better than the other.
Here, we’ll break down what REIT and direct property investment types have to offer as well as their corresponding drawbacks.
Pros and Cons of REITs
To understand the benefits and drawbacks of real estate investment trusts, we must first define exactly what an REIT is and why these options make financial sense.
REITs Defined
Real Estate Investment Trusts, like mutual funds, are corporations created by the combined resources of many capital investors. These funds are used to purchase and manage properties, in turn allowing investors to accrue returns at a fractional level based on their contributions. This is a great way for investors to build their portfolios without necessarily having to own property outright.
REITs take the work out of property investment, leaving the benefits to their investors. With such a hands-off approach to real estate investment, virtually anyone can participate in REITs to grow their finances and build successful portfolios.
However, you should examine the pros and cons of REITs before investing.
Pros:
No vast down payment and mortgage interest. You don’t have to own the investment property, meaning a much lower market entry cost than outright purchasing. As little as $500 can get an investor in an REIT and begin building their returns.
Substantial dividends. Shareholders in REITs receive a minimum of 90% of the property’s yield, with many shareholders receiving 5% or more dividends.
High liquidity. You don’t have to keep your assets untouched in a REIT for long. You can buy and sell as you please in most cases, giving you greater freedom than other real estate investment options.
Cons:
Limited tax relief. The lack of “qualified” dividends provided by REITs mean investors tend to pay more when tax time comes around.
Lack of safety through limited diversity. Since REITs focus on one specific type of property, your investment could be at risk if the market for that property type goes down in value.
Dependence on internet rates. The value of REIT investments are often determined by interest rates, going up when rates go down. These fluctuations can make for problematic returns in some cases.
REITs offer many benefits. For real estate investors just starting out, the low cost of entry and high levels of liquidity may offer the perfect incentives. However, the lack of tax relief and dependence on interest rates could diminish your returns depending on market conditions.
Pros and Cons of Direct Property Investment
In many ways direct investment and REITs are similar. They both require a group of investors to pool funds for the ownership and operation of properties. However, direct property investment, or syndication, has some differences.
Direct Property (Syndication) Investment Defined
When directly investing in property through syndication, an investor places their money in a fund that is not open to the public after its creation. Profits at that point are then determined by the performance of the investment property, meaning returns can vary and aren’t expressly safe.
This form of investment is often used for flipping properties, raising values and distributing the returns among the pool of investors. It can be highly beneficial, but it can also come with its drawbacks.
Pros:
High cash flow potential. There are no limits on the income generated by direct investment properties, meaning your returns can flourish with the success of the property.
Tax breaks. Direct property investments come with deductions you can make on your taxes that allow you to save more money. With every necessary renovation and improvement, you can potentially reduce your tax load, allowing the property to all but pay for itself.
Power over property decisions. Direct property investments are better than REITs when it comes to control. This investment type gives you and the other investors combined power to determine factors like rent and tenant occupations. This is especially valuable if you want more say in how your funds are used.
Cons:
Paying for maintenance. Taking a direct approach to investment means you are responsible for property management. This includes the cost of maintenance and dealing with tenant issues. These problems can cut into your returns without the right planning.
Lack of liquidity. Direct investment properties do not share the liquidity offered by REITs. This means you can’t cash out and leave whenever you want. You’re locked into your investment until you can negotiate a purchase.
Risk of default. Since many investors choose to take out financing to fund direct investment properties, there is potential for low returns causing loan default. This can put the future of the property and your ROI at risk.
Direct investment offers benefits and control options unlike its REIT counterpart, making this investment type a good choice for investors who want to put in the time, finances, and the risk.
Bottom Line
For any investor looking to get started without all the work, risk, and hassle, REITs are a great way to break into the real estate game. This investment type means safe returns, high liquidity, and a laid-back approach to investing.
On the other hand, direct investments can offer unlimited cash benefits as well as greater control that can make them more desirable for real estate investors.
Every investor’s situation is different, so you’ll want to take into account your ultimate goals and desires for your portfolio. Speak to a finance professional before making any investment decisions, and stay up-to-date with your local real estate markets.
For more information on real estate management and property management, contact 208.properties or find us on social media.
