In terms of building wealth and laying the foundations for your retirement, there’s no safer bet than real estate investment. However, not all investments are best suited to every investor. Depending on your goals and financial situation, some options are better than others, and it’s up to every investor to decide what those are. But, for most investors, the choice comes down to REITs (hands-off) or rentals (hands-on). Today’s article looks at both these options and what a beginner investor needs to know about them when making this decision. Hopefully, by the end of this, you’ll know exactly which option is best for you.
Rental PropertiesRental Properties
This is what most people think about when it comes to real estate investing. Buying properties that you renovate to raise the market value and rent out to tenants. This is super easy to get started with. All you need to do is enlist the help of an experienced buyer’s agent, shop for property, purchase, and then start looking for a tenant. But while there’s a lot of advantages to this approach, there’s also a lot of responsibilities that you need to be ready for.
Advantages of Rental PropertiesAdvantages of Rental Properties
Regular Cash FlowRegular Cash Flow
Rental payments provide a regular and reliable monthly cash flow and draw to this investment type. In NYC, rental properties are secured by a lease agreement. This allows the landlord to dictate the terms of the agreement ahead of time. As a result, your first purchase will likely lead to more in the future, raising your monthly cash flow each time.
- Asset Appreciation – Along with rental payments, landlords can also build wealth through appreciation. Over time, the market value of your property may start to rise. As you pay down your mortgage and build your equity, you’ll be able to access more of this value. Should you choose to sell at some point, you stand to gain a significant profit from your original investment.
- Tax Deductions – A clear benefit to direct ownership is significant tax benefits. Rental property owners can deduct the majority of the expenses they incur from their investments. This can include legal fees, insurance premiums, and maintenance costs. While renovations can’t be deducted in a single year, you can depreciate these costs over the lifetime of your ownership. In addition, each deduction lowers your net income, which lowers the amount of taxes you’ll pay each year.
- Freedom and Flexibility – With direct ownership of the property comes complete freedom and flexibility to decide how you handle it. Owning a townhouse property gives you complete freedom. However, if owning a condo or co-op, you’ll need to consider the house rules and bylaws required to be followed. Otherwise, the decision is entirely yours as to how much rent you wish to charge, what kinds of improvements to make within what is allowed by said building, and the sort of tenants you want to take on. For many investors, this is what makes rental investments so appealing.
Disadvantages of Rental PropertiesDisadvantages of Rental Properties
- Requires Access to Extensive Experience – While the process of buying a rental property can be pretty straightforward, there’s still a lot involved in assessing each property to make sure it’s a good investment. You’ll need to determine; occupancy rate, monthly income, operational costs, renovation costs, common charges/maintenance, and a host of other important factors. For most experienced investors, this process will be almost second nature. But for new investors, this can be a hurdle and require extensive experience from qualified professionals. You may require the help of a buyer’s agent, a property manager, a real estate attorney, an accountant, and more. Experienced investors will have a team they can rely on in place, but beginners will have to start from scratch.
- Active Property Management – With the need for experience also comes the need for time. Rental properties are very hands-on and require a lot of time to manage. Owners are responsible for drafting lease agreements, finding and screening tenants, ensuring they stick to the lease terms, overseeing maintenance, and, at times, handling evictions. You can make things easier by hiring a property manager to oversee the day-to-day running of the place. But that means an extra expense of 3-5% depending on the company and cuts into your profits. In addition, not everyone’s cut out to be a landlord.
- Access to Capital for a Down Payment – You’ve got to spend money to make money. Getting into rental investments in New York City means first acquiring enough savings to cover the down payment. This can be a challenge, and the lower your down payment, the more interest you’ll pay on a loan.
Less understood than rental investments, real estate investment trusts make debt or equity investments in commercial real estate. They were created to help individual investors get into income-producing purchases without the responsibility of becoming a direct owner. Compared to traditional rental investments, they offer a more passive way to build wealth by purchasing shares, much like a stock investment. They come in three ways, private REITs, public REITs, and public non-traded REITs. Most investors look for public or public non-traded REITs. The reason being that private REITs tend to come with high investment minimums and accreditation requirements that put them out of reach of most people.
Advantages of REITsAdvantages of REITs
- Passive Investing – For those who prefer a more hands-off approach, REIT offers a way to get into investing without the responsibility that comes from private investment. Instead, all they need to do is provide the capital for the investment and let the other professionals handle everything else.
- No Expertise Needed – Since a REIT investor does not need to manage the investments, there’s no need for all the experienced professionals that a traditional investment would require. This presents a lower barrier of entry for new investors.
- Low Investment Minimums – While investment minimums vary across REITs, public and non-traded public REITs present the lowest barrier of entry. While a standard rental purchase can require tens or hundreds of thousands of dollars for a down payment, you can get into a REIT with as little as $1,000.
- Liquidity – Real estate tends to be a highly illiquid investment. Once you’re in, it cannot be easy to get out. By contrast, REITs are highly liquid as you can buy, sell or trade your shares whenever you wish. This provides far more flexibility than a traditional investment.
- Diversification – Every investor should aim for diversification, but it takes time to build with individual investments. With a REIT, you can immediately invest in tens or hundreds of properties across all types, geographic locations, and real estate sectors. This can significantly reduce the risk factor in your investments as they’re not tied to the performance of one or two properties.
- Regular Cash Flow – REIT investors typically receive their income through share dividends. By law, every REIT must distribute at least 90% of its taxable income each year to its shareholders, making this a very reliable form of income generation.
- Tax Benefits – Since 2018, REIT investors have been able to claim a tax deduction of up to 20% on income earned through loan interest and rental payments. As a bonus, REITs can eliminate taxation at the company level, meaning that each investor only gets taxed at their own level.
Disadvantages of REITs Disadvantages of REITs
- Volatility – Since publicly-traded REITs are traded on the stock market, this ties them to the stock market’s performance as a whole. As a result, sudden fluctuations could see the values of your shares rise or fall suddenly. This doesn’t apply to non-traded public REITs where the value is more driven by the state of the real estate market.
- Correlation – While publicly traded REITs provide access to a large portfolio of different investments, they don’t provide much room for diversification. As a result, investors who have most of their investments in the stock market should look for diversification by also getting involved in non-traded REITs.
- Less Control – With less responsibility comes less control. Unlike a rental property, REIT investors have no say in the operations of their investments. This can actually benefit you if you’re looking for passive income that doesn’t require your own input. However, it’s worth considering before getting involved in REITs as they may not be what you expected.
Evaluating Your Investment OptionsEvaluating Your Investment Options
All investors are out to make money and expand their portfolios. When well-managed, rental properties and REITs can be a valuable source of income that builds with each new investment. However, it may be that you’re more suited to one rather than the other. When deciding on the best approach, ask yourself these questions:
- Do you have the time, expertise, and commitment to manage your own rental property investments? If not, would you prefer a more passive approach such as a REIT?
- How much starting capital do you have? Is it enough to purchase a starter rental property? Would you be prepared to wait longer until you have enough saved?
- What kind of REIT would you be interested in, publicly traded or publicly non-traded? Both have their own pros and cons; which is better suited to your need?
Regardless of what decision you make, real estate in any form is a great investment strategy that can set you on the road to financial independence. Just remember that not all investments are equal or suited to everyone. So instead, find the ones that feel just right for you.