Physical properties have been seen as a solid investment choice, offering the potential for steady rental income and property appreciation.
At the same time, real estate investment trusts (REITs) provide investors with a more liquid and hands-off way to gain exposure to the market.
But which of these two options is the better investment? In this guide, we’ll explore how each works, compare their risks and returns, and help you determine the appropriate strategy. Keep reading!
Physical properties as investments
Investing in physical properties means purchasing real estate directly, whether for rental income or long-term appreciation.
This approach offers more control but also comes with responsibilities.
Buying rental properties for passive income
Owning rental properties can generate consistent cash flow through tenant payments.
However, the term “passive income” can be misleading, as managing tenants, maintenance, and repairs require effort unless you hire a property manager.
Appreciation potential over time
Real estate often appreciates in value, which makes it an interesting long-term investment.
Nevertheless, appreciation is influenced by market conditions, location, and economic factors, meaning not all properties will see significant price increases.
Responsibilities and costs of being a landlord
Those properties come with additional costs, including property taxes, insurance, maintenance and repairs, and vacancy risks.
Investors must consider whether they have the time and resources to manage these expenses.
What are Real Estate Investment Trusts?
REITs are companies that invest in and oversee income-generating properties, offering investors a way to access the real estate market without owning or managing assets.
These trusts generate revenue through rent, mortgage interest, or property sales.
To maintain their special tax status, they must distribute a significant portion of their earnings to shareholders, making them an interesting option for those seeking passive income.
Types of REITs
Real estate investment trusts come in different types, each with its own risks and return profiles.
Equity REITs mean that the investor owns and manages income-producing properties like apartments, office buildings, or shopping centers.
On the other hand, mortgage REITs, also known as mREITs, involve investing in real estate loans and mortgage-backed securities (MBS), profiting from interest payments.
Finally, hybrid REITs combine both equity and mortgage strategies, offering a mix of rental income and loan interest.
Liquidity and ease of investment
The main advantage of REITs is their liquidity. Since they’re traded on stock exchanges like regular stocks, investors can easily buy or sell shares without the long process of selling a property.
This makes them a more accessible alternative for those who want exposure to real estate without the hassles of direct ownership.
Comparing returns and risks
When deciding between physical properties and REITs, it’s important to analyze their risk factors and tax implications.
Risk factors
Both investments come with risks. For instance, real estate investments can be more volatile since they’re tied to the stock market, while physical properties tend to be more stable.
Besides, higher interest rates can reduce property values and rental income, at the same time that they affect REIT performance.
And selling properties can take months, whereas REIT shares can be sold instantly, as we mentioned before.
Tax implications for both investments
REITs pay little corporate tax, but investors pay income tax on dividends.
Alternatively, physical properties offer tax advantages such as depreciation deductions and mortgage interest write-offs.
Investors should consult a tax professional to understand the best option for their situation.
Which one is the best option for you?
The right alternative depends on your financial goals, risk tolerance, and time commitment.
Investment goals
If your priority is capital appreciation, physical properties may be the better choice.
But if you seek consistent dividends, REITs provide a reliable income stream.
Risk tolerance and capital availability
Real estate investment trusts allow for diversified, low-barrier investments with less capital.
On the contrary, buying properties requires significant upfront investment and carries more financial risk.
Time commitment
REITs are hands-off, demanding no property management. In contrast, owning properties needs active involvement unless managed by professionals.
Conclusion
Physical properties and real estate investment trusts have their own strengths and weaknesses.
While direct real estate ownership provides greater control, tax benefits, and long-term appreciation potential, REITs offer liquidity, diversification, and passive income.