What if you want to invest in real estate without all the risks and hassles of being a landlord? Another option is to invest in a REIT (real estate investment trust), which is kind of like a mutual fund for rental properties (although there are mutual funds of REITs too). Let’s look at some things to consider when deciding between the two:
How easily might you need access to your money?
This is one of the biggest differences. You can sell a publicly traded REIT immediately like a stock. (There are also non-traded REITs that come with their own rules.) On the other hand, a directly owned rental property can take months to sell and can cost thousands of dollars in transaction costs. The advantage here clearly goes to REITs.
How important is diversification for you?
A single REIT can invest in a range of commercial and residential properties. As if that wasn’t enough, you can also buy multiple REITs individually or through a real estate fund. You need a lot more money to buy enough individual properties to even approach that level of diversification. Otherwise, you’re taking more risk with less diversification and it’s a risk that doesn’t necessarily come with higher returns.
How involved do you want to be?
With a REIT, your only involvement is whether to buy the REIT and when to sell. With a rental property, you have a lot more control over the type of property you own and how it’s managed. If you know the real estate market well and/or are good at property management (or choosing good property managers), this can be a huge advantage.
For example, many real estate investors are able to keep their maintenance costs low by doing their own repairs or having a network of contractors who they trust to deliver value. If you don’t want to be that active, you might want to delegate those decisions to a REIT.
Which provides a better tax benefit?
REITs can easily be held in tax-advantaged accounts like a 401(k), IRA, and HSA. While rental properties can be held in a self-directed IRA, that can be quite complex. However, a rental property can allow you to write-off depreciation, potentially benefit from the new 20% pass through deduction, and have the basis stepped up at death. That could make it preferable from a tax standpoint if you’ve already maxed out your tax-advantaged accounts and are looking to invest in a taxable account.
At the end of the day, the decision is a personal one. If you’ve maxed out your tax-advantaged accounts and want to be actively involved in your investing, you might prefer owning a rental property directly. If you’re investing in a tax-advantaged account or prefer having easy access to your money and being more diversified, you might choose to invest in one or more REITs.