Introduction
Investing in real estate has become one of the most popular ways to receive regular cash flow as an investor. Normally the investor buys a property and rents it out to tenants. The investor usually takes out a loan to fund this, and is looking to profit from the difference between the monthly mortgage payment and the rental cash flow coming from tenants. Real Estate Investment Trusts (REITs), more specifically equity REITs are a similar type of investment. They purchase and manage different types of income-generating real estate. Investors can buy shares in a REIT on public stock markets and receive regular cash flow through dividends. I personally invest in REITs as opposed to buy-and-let residential properties. I have outlined the benefits and advantages of REIT investing in the article below.
Income from REITs is truly passive, unlike buy-to-let private investment
When making a direct real estate investment, you are in charge of maintaining the property, finding the tenants, handling their complaints, dealing with evictions etc. You are compensated for that active work through regular rent payments.
However, as a REIT investor, receiving that income requires zero effort from your part. REITs pay high dividends, because they are legally required to pay out at least 90% of their earnings to shareholders. Professional management operates the business side of it and you just collect the cash flow through dividends. That is truly passive income.
REITs perform better then private real estate
According to the 20-year CEM Benchmark Study, REITs returned an average of 2.8% more per year then private real estate. During the 20-year period between 1998-2017 private real estate investments returned around 8.1% net of fees. That is a very good return on your money. REITs performed even better though, with net returns of 10.9% during the same time period. Of course you might come across a great real estate deal and you achieve a better return on it then the average. But with passive REIT investments generating a better return over a two-decade time period – I see no reason to take on extra active work and stress to invest in real estate directly.
Excellent diversification options
When buying real estate directly an individual investor, you are most likely contained to just one type of real estate – residential. Real Estate Investment Trusts on the other hand allow you to be invested in a large variety of real estate sectors. This includes cell towers, data centers, warehouses, timberland, offices, hospitals, malls, housing, storage units, and farmland. Those assets are very hard for an individual investor to invest in directly as they require large sums of capital. REITs allow you to own a part of those assets.
Lower barrier to entry
Directly buying a property as an individual is a large financial commitment. To make that six-figure investment you require a large down payment, and will most likely need to take on a loan. Not only is it stressful owing the bank large amounts of money – you are also losing investment returns to interest payments. When it comes to REITs, you can invest in all types of real estate with small sums. That means investing only as much as you are comfortable with and not paying any interest to the bank.
Superior liquidity
Closings costs for a real estate deal can vary, but buyers usually pay 2%-5% for an average of $3700 according to Zillow. That is a significant drag on your returns. Buying and selling shares in a REIT is as simple as buying any stock in the public markets. With more and more brokers moving to a commission-free model, you are likely to pay nothing or a single-figure sum for investing for passive income through REITs.
Reduced risk
When buying a property as a single investor, you are taking on a lot of risk. Firstly, your cash flow is dependant on finding and keeping tenants that respect the agreement – rent is paid on time and property is kept in good shape apart from usual wear-and-tear. Secondly, investors tend to need to take on a large amount of debt. You don’t need to take on a six-figure debt burden to invest in REITs. You can invest as much money as you like. No leverage needed, which eliminates the stress of finding money to cover mortgage payments when the property is vacant. Investing in REITs on the stock market comes with risks as well – stock prices might decline and business might perform poorly. But by investing in a diversified portfolio of REITs from various real estate sectors, you are spreading out the risks.
Conclusion
Real estate is a fantastic physical asset for generating income. Investors can take on a more active role by scouring the market for bargain deals, taking on a loan to fund that purchase and managing the properties. For the reasons outlined in this article, I believe REITs to be a better alternative for the passive investor. I hold various REITs as a part of my diversified investment portfolio.
