Before making a decision, examine the advantages and disadvantages of both.
Jul 22, 2021
4 min read
Opinions expressed Entrepreneur the members are their own.
Real estate direct investment and real estate investment fund (REIT) investment are two of the most popular ways to invest in real estate. Choosing one of them requires examining their advantages and disadvantages.
Benefits of direct investment in real estate
Investing directly in real estate means buying a specific property, residential or commercial, and generating income from it. Income can be derived from renting out property, increasing its value or profits from commercial activities carried out on the property. With private equity, you have more control and decision making power. For example, you can choose which property and how much to buy, and decide on rental prices and tenants. In addition, there is appreciation. Both real estate and stock markets fluctuate, but real estate prices tend to rise over time, and you may end up selling them for a higher price.
Another great benefit of investing in physical real estate is the many tax breaks available to offset the purchase price. For example, the usual and necessary costs of managing and maintaining a property are deductible. There is also a large depreciation tax credit. In this case, you gradually reduce your taxable income by deducting the costs of buying and improving the property over its entire life.
Disadvantages of direct investment in real estate
Lack of liquidity is one of the main disadvantages of direct investment in real estate. If you are in urgent need of money, you may not be able to quickly sell the physical property. Another disadvantage is funding. Buying real estate requires a higher start-up capital and many investors resort to mortgages or other types of financing. However, if market conditions deteriorate or you cannot find quality tenants, you risk not repaying the loan.
Another disadvantage of direct investment in real estate is the higher so-called equity capital. Resolving tenant problems and maintenance emergencies requires a significant amount of time and energy. In addition, you are liable in the event of real estate accidents.
On the other hand, with a REIT, investors don’t need to buy any physical property. REIT is a corporation that acts as a mutual fund for real estate investment. It owns or operates income-generating real estate or real estate-related assets and pooles the capital of several investors. Basically, investors have the ability to generate income from real estate without having to own or manage the property.
REITs offer high overall returns, capital appreciation potential and liquidity. REITs are legally required to pay shareholders at least 90% of taxable profit, and often dividend yields can exceed 5%. Meanwhile, an increase in the value of underlying assets leads to potential capital gains. In terms of liquidity, REIT stocks are similar to stocks. As an investor, you can buy or sell them on the exchange whenever you want or as needed.
Disadvantages of REIT
High taxes are one of the main disadvantages of REITs. Most REIT dividends are taxed at a higher rate because they are not considered “qualified dividends”. Moreover, REITs can be extremely sensitive to fluctuations in interest rates. Typically, there is a negative correlation between REIT prices and Treasury yields: an increase in one leads to a decrease in the other, and vice versa.
Another disadvantage of REITs is the lack of diversification. They usually focus on a specific type of property, such as offices, shopping malls, or hotels. Thus, in the event of an economic downturn, REIT investors may be exposed to higher real estate risk.
The choice of one type of real estate investment over another depends on the investor’s willingness or lack of ownership to own and manage physical property and his or her seed capital.
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