A recent Forbes article claimed to prove investing in an REIT was better than actually buying real estate. The article made some valid points about the advantages of REITs but left out most of the advantages of buying houses, apartments, or commercial properties. Investing in REITs is much easier than investing in real estate, and I have invested in REITs in the past. With an REIT, you miss out on several things, including the ability to buy below market value, depreciation, control, and better financing options. I no longer invest in REITs because I make so much more from buying houses. Real estate is also my full-time career, and I have the time to make sure I am buy the right properties. Buying property may not be the right investment for everyone, but hopefully this article can help you choose the best investment for your situation.
What is an REIT?
REIT stands for Real Estate Investment Trust. REITs are like a mutual funds, but they have different rules and must be used primarily for real estate. An individual investor can can buy one or many shares of an REIT, which makes the barriers to investing in them smaller than buying a house. 75% of funds invested in an REIT must must be in real estate and must pay 90 percent of the earnings back to investors as a dividend. REITs exist that specialize in land, apartments, malls, office space, and even single-family homes.
A lot of people claim investing in a REIT is like buying a house but without all the disadvantages. I disagree because you are really buying a fund and hoping the people who run that fund make good decisions. You have no input on what is bought or how it is managed, and an REIT is much more similar to owning a stock than a house. An REIT’s’ value can go up or down based on market conditions, no matter how the REIT is actually performing. This is one reason I think investing in real estate is much better than investing in the stock market.
Why did the Forbes article feel that REITs made paid better than real estate?
Forbes offered many arguments for REITs over real estate. I will list the most valid (in my opinion) argument first:
- REITs are more liquid than real estate. I completely agree that both REITs and the stock market are more liquid than real estate. Selling houses takes time…and it costs a lot of money as well. In fact, you can safely assume it takes 8 to 10 percent of the selling price to pay agents, closing costs, and title companies (or attorneys). If you may need your money right away, real estate may not be the best investment.
- REITs make more money than real estate. The Forbes article argues that REIT rates-of-return have historically ranged from 9 to 12 percent, while real estate has returned 8 percent. I have no idea where they came up with 8 percent. This could be based on historical housing prices, rent increases, or any one of a thousand other sources. Later, I will explain why you can make much make than 8 percent from real estate.
- REITs offer more diversification. Forbes also argues that REITs allow an investor to invest in hundreds of properties at one time, which could be less risky than buying a few houses outright. I agree that an REIT offers more diversification, but you also have no control over what is bought and how it is managed.
- REITs are easier to invest in than real estate. I would also agree that REITs are easier to invest in. It takes less money, less time, and less management than buying a house. However, you can get a property manager to greatly reduce the time it takes to manage rentals.
The article would be pretty convincing if REITs made more money. However, real estate returns can actually be much higher than REIT returns. Plus, with real estate, you have much more control, better tax advantages, and better financing options.
How can the returns from real estate out perform a REIT?
Since 2010, I’ve bought 17 rentals, and since 2001, I’ve flipped over 130 houses. The Forbes article also argues that house flippers don’t make much money. They say 40 percent of people who flip a house break even but again provide no sources for this info. I have averaged profits of over $30,000 on my flips, and while I have more experience than most, I believe the Forbes numbers are way off. I am assuming the article used stats from national publications that pull data on “flipped” houses. That data includes any houses that were bought and sold in a short period of time (6 to 12 months). The problem with that data is it includes houses that may have been wholesaled, bought and sold by owner occupants, or bought and sold by hedge funds. No one really knows how many of those houses were actually flipped. Here are some more articles that contain information on flipping houses and that cover how much money you can make:
- How much money can you make flipping houses?
- How easy is it to make money flipping?
- How much money do you need to flip houses?
- How to flip houses with no money.
Flipping houses is actually more of a job than investing anyway, and in my opinion, not a good comparison to investing in an REIT. Rental properties are a much better comparison. I have made at least 15 percent cash on cash returns on rent income alone, but there are many other ways to make money with rental properties:
I bought all my rentals for at least 20 percent less than their worth. That means I made returns of at least 20 percent as soon as I bought the house, right? Actually, I made much more than that because I bought the houses using a loan (more on that soon). Houses can also go up in value, and rents can go up over time. I do not count on appreciation to make money, but it is a great bonus. It is also really hard to say what people make on rentals because of all the factors that go into the returns: rents, appreciation, buying below market…and the money you make is taxed differently!
Why are rentals a better investment tax-wise than an REIT?
Rental properties offer amazing tax advantages that an REIT does not. Always talk to an accountant or lawyer about specific tax questions. When you buy a rental property, you can deduct or depreciate almost all expenses associated with the rental including, interest payments on your loan. One of the biggest advantages is you can depreciate the structure of rental properties over 27.5 years, or possibly sooner. That means you can actually make money but either not pay any taxes or even show a loss on your taxes. You can read more about the tax advantages here.
Why do financing terms make real estate a better investment than an REIT?
One of the biggest advantages real estate offers is the ability to finance your purchases with long-term loans. Investors can finance most properties with down payments of 20 to 25 percent. The loans can be extended over 30 years, or in some cases with apartment buildings, even longer. When I said I made returns of much more than 20 percent from buying below market value, that is because I did not use cash to pay for the entire property. I put 20 percent down, which means I actually made an almost 100 percent return as soon as I bought the property (besides the down payment, there are other costs you should consider). I also buy properties that make me money every month, even with a loan against them.
It is tough to know exactly what I have made on my rental properties, but I also didn’t mention the ability to refinance properties. Thanks to refinancing, I have taken out almost all the money I used to buy my rentals. I own 15 rentals (I sold a couple last year), and they have made me about $7,000 per month, have increased my net worth by well over one million dollars, and I’ve recouped all of my initial investment. It is hard to calculate that return because it is basically infinite. I will admit that this does not happen for everyone! I am an expert in real estate investing, and not every market works well for rentals. It takes a lot of work, and I have been lucky with appreciation. Even beginners can make much more than the 8 percent mentioned in the article. On my first investments, I made much more than that. Plus, I loved having control over my investments, the thrill of finding good deals, and having a much better retirement vehicle.
For more information on how to find, assess, finance, and manage rentals, check out my best-selling book: Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely.