Pros and Cons of Investing in REITs vs. Direct Real Estate

Man investing in commercial real estate
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While the housing market has been volatile and uncertain over the last three years, real estate is still a valuable part of an investor’s portfolio, writes Jeremy Pagan for the Morning Star.

Each investor should ideally allocate anywhere between five and 20 percent of their portfolio to real estate.

REITs are a very popular investment option, with close to 45 percent of American households owning REITs.

They can be a good choice as buying and selling REIT shares is significantly easier than when it comes to physical property. REITs also remove the need for market-specific knowledge as well as property management while also making it easier to diversify a real estate portfolio.

Additionally, you will not have to start a mortgage on an investment property.

However, while they also enjoy favorable corporate tax treatment as they do not have to pay any if an adequate share of earnings is passed along directly to investors, they have large dividend yields. This is not the best option because dividends are unfavorably taxed in relation to capital gains for high-income investors.

Meanwhile, owning, managing, or “flipping” a property comes with substantial tax benefits. Depending on how active you want to be in handling your investment, you may receive additional tax breaks for passive losses.

Investing in direct real estate also offers a wider range of potential outcomes compared to diversified REITs.

Fred Hubler, CEO and Chief Wealth Strategist at CCWMG and contributor, also uses private rents for his accredited investor clients. Private REITs, which are not publicly traded and are sold directly to investors by the REIT’s management team, can offer several benefits to investors:

  1. Lower volatility: Private REITs are not subject to the same market volatility as public REITs since their shares are not traded on a stock exchange. This can potentially result in lower volatility for investors.
  2. Tax advantages: Private REITs may offer certain tax advantages to investors, such as the ability to defer taxes on capital gains through a 1031 exchange.
  3. Potentially higher distributions: Private REITs may distribute a higher percentage of their income to investors than public REITs, which can result in higher distributions.

It’s worth noting, however, that investing in private REITs also comes with some potential drawbacks, such as less liquidity, less transparency, and higher risk.

Private REITs are not subject to the same level of regulatory oversight as public REITs, which means that investors may have less information about the company’s financial health and performance.

Additionally, private REITs are not publicly traded, which means that investors cannot easily buy and sell their shares. Investors should carefully consider these potential drawbacks before investing in a private REIT.

Investing directly in real estate can be financially rewarding, but has a high-cost entry. It also requires due-diligence work and time. You can use a property manager, however this will affect your profit margins.

Also, if you need cash, it may take a long time to sell a property and the whole process could be costly.

This investment is the best option if you have extra time and cash.

Read more about investing in REITs vs. direct real estate in the Morning Star.

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