Passive vs. active income. Dividends vs. rent deposits. Total automation vs. tax deductions. The REITs vs. rental property debate rages on. Both of these income-producing vehicles are phenomenal real estate investment choices for building long-term wealth, capitalizing on appreciation, and getting consistent cash flow.
In this guide, we’ll detail exactly who should be investing in these two very different types of real estate and the benefits (and drawbacks) of both.
Rental Property
This is your classic real estate investment. You buy a house, rent it out, and either manage a rental property by yourself or outsource it and hire a property management company. You’ll have far more autonomy with a rental than you will with a REIT, but that comes at the cost of your time.
Pros
- Multiple Ways to Build Equity: As a landlord, you’ll get to realize the equity gains that come with your property appreciating. This can either be through market appreciation (home prices going up naturally) or forced appreciation (renovating a home to be worth a higher price).
- Cash Flow: Rentals give landlords the ability to take home monthly cash flow from their rental property on a consistent basis.
- Tax Benefits: From write-offs to tax-free refinances, depreciation, and cost segregation studies, the tax benefits you get from rental property are significant.
- Complete Control: As the owner of the property, you can choose the strategy of your rental, the renovation standards, and the tenant!
- Leverage: Rental properties, unlike almost any other kind of investment, allow you to leverage anywhere from 50% all the way up to 95% of the purchase price. That means you can get into one with as little as 5% down!
Cons
- It’s a LOT of Work: Landholding isn’t easy— at least at first. You have to find the property, find a way to finance it, renovate/repair it, screen tenants, and then deal with repairs and tenant issues.
- High(ish) Barrier to Entry: Even if you plan on house hacking for your first real estate investment, you’ll still need to bring 5% down to the closing table. On a $500K home, that’s $25K!
- Steep Learning Curve: Your first day of landlording can feel like someone pushed you into the middle of the ocean with no life jacket. It takes time (and a lot of patience) to find success as a landlord!
- Hard to Liquidate: Selling a rental property can take anywhere from 30 days to 90 days (or more). So if you think getting rid of a rental means quick cash, think again!
Potential Profits on a Rental Property
Rental property profits range based on the size and strategy of the property. But most investors can expect something like this:
- Long-Term Rental: 8% – 10% ROI
- Mid-Term Rental: 12% – 20% ROI
- Short-Term Rental: 20%+ ROI
How to Invest in Rentals
To buy a rental you’ll need to find a property, run a rental property analysis or use a deal analysis tool like DealCheck, make a bid, close, do repairs, and sign tenants.
REITs
REITs (real estate investment trusts) are one of the best ways to make passive income with zero work. REITs allow everyday investors to buy shares in large landlord companies, which then split the profits with the investors every quarter. You invest, they find and buy properties, and everyone profits!
Pros
- Passive Investing: A REIT investment is ridiculously easy. You purchase a share (or shares) and let the profits roll in. That’s it!
- Low Barrier to Entry: REIT shares can be bought for as little as a few bucks, making them available to every stage of investor!
- Easy to Diversify: With different REITs for self-storage, data centers, multifamily housing, retail, and more, you can diversify in many types of rental properties, without the hassle of buying the property yourself.
- Easy to Liquidate: Want to sell off all your REIT investments? You can do so in just about five minutes!
Cons
- Little Control: When investing in a REIT, you are giving the REIT full responsibility to use your money in a smart way. And unless you’re a major shareholder or on the board, you’ll have zero say in how the property operates.
- No Tax Benefits: Unlike rental properties, you won’t get individualized tax benefits like depreciation or interest write-offs.
- Low Cash Flow: Most REITs offer dividends in the single-percentages, meaning you may be getting some solid appreciation, but a very small amount of passive cash flow every month.
Potential Profits on REITs
REITs are split into two categories: equity REITs and mortgage REITs. Equity REITs focus more on appreciation, while mortgage REITs focus more on cash flow. Here are some standard returns you would expect.
Equity REIT: 1% – 3% dividend, 7% – 10% appreciation
Mortgage REIT: 8% – 12% dividend, 5% – 0% (or sometimes negative) appreciation
*Please note that these figures vary drastically based on the company you invest in.
How to Invest in REITs
You can buy shares of your favorite REIT on any stock trading platform such as Fidelity, Vanguard, Robinhood, or E*Trade.
Similarities of REITs and Rentals
Both REITs and rental properties provide you with a way to generate passive income, but they have even more similarities than that.
Both are Long-Term Investments
Because REITs and rentals are both real estate, they should be thought of as a “get rich slowly” type of investment that you hold for years at a time.
Both are Subject to Market Fluctuations
If home prices start to dip, REIT prices will as well. Since REITs are just giant landlords, they are as vulnerable to housing market crashes and corrections as regular investors.
Both Help You Diversify Your Investments
REITs and rentals both allow individual investors to diversify outside of traditional investments like stocks and bonds. You can buy a rental property, multifamily apartment, self-storage facility, or anything else for that matter. Thankfully, you can also buy REITs that do the same!
REITs vs Rental Property Key Differences
While REITs and rentals do have some similarities, their individual differences can help investors, like you, figure out which is the better investment for a portfolio.
Rentals Offer Tax Benefits
Rental property owners pay FAR less in taxes than owners of REITs. Why? Repair write-offs, depreciation, interest write-offs, and real estate professional status are just a few ways to wipe out a rental’s profits (on paper at least). REITs don’t offer anywhere close to this amount of tax shielding.
You Can Leverage Rentals to Buy More Real Estate
Once one rental appreciates, you can take equity out of the property to buy another. With REITs, you can do margin loans, but this is nowhere close to as efficient as a cash-out refinance with a rental property.
REITs are Passive, Rentals are Active
Anyone who tells you that rental properties are passive is a liar. Rentals are NOT passive. They take time, brainpower, and constant care to function properly. REITs, on the other hand, are completely passive, making them a favorite for those who earn a high income but lack the time to invest.
REITs are Far Easier to Liquidate
You can sell your entire portfolio of REITS in a few minutes. If you wanted to sell an entire portfolio of properties, you’re looking at it taking at least a few months. So for those that don’t want to park their cash in places too hard to get it back out, REITs may be a better choice.
You Have More Control Over a Rental
As a rental property owner, you have complete control over the strategy of your rental property. With REITs, you just sit back and let the business do what it’s going to do.
Rentals Require Greater Upfront Investment
Unless you’re buying a new construction house hack with a VA loan, you’ll need to bring at least tens of thousands to the closing table to buy a rental property. This is much more than many Americans can afford, making REITs a great option for the new investor.
REITs vs. Rental Property: Which is the Better Bet?
So, which is better? Rental property or REITs?
The answer is simple: it depends. If you’re looking for a safe investment that will generate passive income and allow you to diversify your portfolio, then rental properties may be the way to go. On the other hand, if you want exposure to real estate without having to deal with tenants and renovating properties every few years—or if you just think it’s time for something new—REITs might be worth considering instead. They offer similar benefits without all of the hassles that come with being a landlord!
No matter what you choose, investing in real estate is almost always the right choice!
If you’re ready to take the next step in your investment journey and have decided on going the rental route, check out our article on the Best States to Buy Rental Property to learn more.
REITs vs. Rental Property FAQs
Still need more answers on the REIT vs. rental debate? These commonly asked questions may be able to help:
Yes and no. The answer really depends on what you’re looking for in your investments. If you want to make passive income or build wealth over time, then yes! Investing in REITs can be just as good as investing in rental property. But if you’re looking for something more hands-on, where you can force appreciation and build wealth faster, then rental properties might be better suited for you.
Yes! Investing in REITs can make you rich over time. As long as you’re investing in a good REIT and holding onto it for the long haul, you could see some nice returns on your investment.
This is a tough question. While both real estate and REITs can make you rich, they’re very different investments with different risks and rewards. If you want to build wealth with full control, then rental properties might be better for you. On the other hand, if you want something more hands-off that allows passive income with less hassle, then investing in REITs could be a great fit!
