REITs vs Stocks vs Real Estate Investing - Pros and Cons

These are 3 methods that investors use to include different types of assets in their portfolio: REITs, stocks and real estate investing. So, which one should you settle for? This article will examine each one, along with their advantages and drawbacks, after which you can come to a conclusion. 

REITs (Real Estate Investment Trusts)

• What Are REITs?

REITs, short for real estate investment trusts, are nothing more than companies. These said companies allow investors to purchase high-quality real estate. REITs are the ones financing the real estate, and by giving investors ways to buy them, they are doing communities a great favor, as they aid them in their growth process.
A REIT portfolio may include properties such as hotels, warehouses, apartment complexes, office buildings, infrastructure, and many others. Investing in REITs can be done through a brokerage account in the same manner you would buy a stock or ETF, as they trade like stocks.

• Types of REITs  

1. Private REITs – These are basically offerings with shares that are not traded on national stock and are free of SEC registration.
2. Mortgage REITs – Mortgage REITs work through originating or buying not only mortgage but also mortgage-backed securities. Furthermore, income will be gained as a result of the investments’ interest rate.
3. Equity REITs – This is the most common type of REIT, and it is publicly traded. It works by operating or even owning real estate that generates income.
4. Public Non-Listed REITs – While being registered with the SEC, these are not trading on national stock exchanges.

 

• Pros
• They provide easy sales and purchases. As nobody likes to wait a lot when selling property, REITs can give you a successful sale in seconds. They act like stocks.
• With REITs, you will receive professional management. Unlike real estate investors who are always in fear of having to provide maintenance, REITs are the ones handling such issues if you settle for this method.
• REITs are not required to pay federal level corporate tax.
• REITs are required to pay a minimum of 90% of their earnings out as dividends.
• Have exposure to real estate with only a fraction of the capital (As little as one share of a REIT).

 

• Cons
• Some REIT dividends are taxed as regular income.
• REITs can be much more volatile than physical properties.
• REITs often have high levels of debt due to the high amount of dividends they are required to pay out.
• REITs often raise capital through share issuance, which dilutes shareholders.

Stocks

• What Are Stocks?

Stocks are quite easy to understand. Basically, when you buy shares from a company, you end up owning a part of the company, but you won’t be in charge of the whole company. For instance, if a business has 500 shares of stock and you end up purchasing 10 of them, 2% of the company will automatically be yours. But there are also times when a company can have millions of shares, in which case you barely own a percentage of the business.

In spite of this, the main reason why people are investing in stocks in the first place is that they want to earn some return. The return will either come when a stock pays dividends, or when the price goes up and you can sell the stock for a convenient price if you wish to.

Companies are engaging in selling stock shares in order to gain money. The money they raise can be used for investing in the business’s growth, a new product line, or for repaying debt. It’s essential to know that stocks are typically offered through IPO or initial public offering. Therefore, when you purchase a stock, it will be bought from another investor that sells it and not from the actual company.

• Pros
• You will gain some money from dividends. Basically, as companies share some of their earnings to shareholders, you can receive some income.
• Among long-term asset classes, stocks are known to be the ones offering some of the highest returns.
• You’re able to invest in stocks in various industries, sectors, and countries, adding to the diversity of your portfolio.

 

• Cons
• In case you end up choosing the wrong stock, you may lose your investment.
• Stocks are riskier compared to bonds, as in the short term they are volatile.
• You need to be knowledgeable in this area to be able to analyze a stock before picking it.

Real Estate Investing

• What Is Real Estate Investing?

Although it has to do with real estate too, this type of investment is different compared to REITs. Whereas REITs allow you to invest without actually owning the properties, real estate puts you in the ownership, management or sale of the real estate.
In other words, real estate investing is classified as the purchase, ownership, management, sale or lease of a property. The main purpose of doing this is for earning money.

• Types of Real Estate
• Commercial – This refers to real estate used for business reasons. It could be for restaurants, offices, apartment buildings, and more.
• Residential – Residential real estate involves townhouses, single-family houses, as well as multi-family houses and condominiums.
• Industrial – Industrial real estate is meant for industrial business purposes, like factories, storage or shipping warehouses and so on.

 

• Pros
• If your property’s value decreases and increases over time, you can receive tax incentives for being in ownership of the area.
• It can help you add to your retirement funds, considering it is profitable for the long term.
• You can earn passive income if you rent your property out.
• Real estate can be a hedge against inflation. As inflation rises, so does the cost of renting. This means people will pay more to rent your property and the value of the property will likely rise too.

 

• Cons
• You will have to deal with problems such as maintenance issues.
• There’s an increased liability in case accidents will take place there.
• If you want to sell or buy a property, it can take a lot of your time.

 
Comparing Their Long-Term Performance
Here’s a quote from investopedia.com that sums up their respective performance in one paragraph:

“Average annual returns in long-term real estate investing vary by the area of concentration in the sector. Average 20-year returns in the commercial real estate slightly outperform the S&P 500 Index, running at around 9.5%. Residential and diversified real estate investments do a bit better, averaging 10.6%. Real estate investment trusts (REITS) perform best, with an average annual return of 11.8%.”
(https://www.investopedia.com/ask/answers/060415/what-average-annual-return-typical-long-term-investment-real-estate-sector.asp)

Below you will see a 20 year chart of the performance of REITs compared to the S&P 500. As we mentioned before, REITs can be more volatile. The top in 2006 for the REIT index to the bottom in 2009 represented a roughly 70% drop. However, the gains were recovered rather quickly. Investing in real estate or REITs after a market crash is definitely a good idea. 

REIT index in red, outperforming the S&P 500 index in blue. Taken from stockcharts.com

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Final Thoughts
You decide which option is worth investing in. As you can see, all three alternatives – respectively stocks, REITs and real estate – have their own pros and cons. All of these have lengthy, proven track records in terms of return on investment over the long-term. In the short-term, anything can happen and it is best to do your research before buying.