Buying Rental Property Vs. Investing In A REIT, Part I

One of the most common questions I get from aspiring real estate investors is whether to buy property directly or purchase shares in a real estate investment trust, commonly referred to as a REIT.

For those who aren’t familiar with REITs, these vehicles allow individuals to buy shares in companies that own real estate as their primary business activity. While some REITs are private or non-traded, in this article we’ll focus on the publicly traded REITs, which are the most visible and can be purchased by any investor with a brokerage account. I used to run one of the largest publicly traded single-family rental REITs called Starwood Waypoint (now part of Invitation Homes), which I took public in 2014. Today, I’m the CEO and co-founder of a marketplace for buying, owning and selling single-family rental investment properties — so I’m pretty familiar with both sides of the argument.

While both methods of investment allow investors to achieve real estate exposure, it’s a bit like comparing apples and oranges. One represents direct ownership, while the other is characterized by owning shares in a company whose sole purpose is to own and operate a portfolio of real estate assets. I own shares in several REITs as part of my personal equity portfolio, as well as some real estate directly. I view both of those investments differently and see the advantages and disadvantages to each.

To help you better understand the appeal of investing in brick and mortar real estate versus a publicly traded REIT, here is a list of considerations. In the first half of this two-part series, we’ll explore situations when direct investing comes out on top:

Investing Goal: Hedge Against Stock Market Risk

Real estate is cyclical, as is the stock market. But the two do not generally move in lock-step — meaning they are not directly correlated. In order to have a diversified portfolio, by definition, it is important to hold investments that react differently at the same point in time. This is perhaps the most compelling reason to own real estate directly as opposed to owning REIT stock, especially during periods where equities may be fully-priced and potentially facing more near-term downside risk than upside potential.

Investing Goal: Greater Ability To Use Leverage

Buying property directly often gives you the ability to use a higher level of debt financing than is typical in the REIT universe, as institutional investors frown on REITs that employ more than 40% leverage. By contrast, an individual investor buying an investment home can borrow up to 80% of its value through Fannie and Freddie programs. So instead of putting $20,000 into a REIT, you could use it as a down payment and obtain $80,000 in financing for a $100,000 investment property and reap the gains of the entire asset appreciating in value over time. All things being equal, greater leverage can lead to higher returns on equity in upside scenarios.

Buying Rental Property Vs. Investing In A REIT, Part I curated from Forbes - Real Estate