Investing in REITs vs. Real Estate: Key Differences

Should you invest in REITs vs. real estate? The answer could be both for investors with time and willingness to gain in-depth market knowledge. Real estate investment trusts (REITs) offer liquidity and passive investment, while other real estate investments can offer more direct control. On average, REITs have outperformed the S&P 500 over the past 20- to 50-year reporting periods, offering stable returns and predictable growth. However, direct real estate investment may have greater long-term upsides. Read on to understand the pros and cons to each to build a personalized investment strategy.  

REITs are specialized investment vehicles that allow individuals to invest in real estate properties without owning them outright. REITs allow investors to access the income and potential capital appreciation associated with real estate while offering benefits such as diversification and liquidity. 

REITs may specialize in one type of real estate investment, such as hotels, resorts, commercial properties, office and apartment buildings, warehouses, hospitals, timberlands, data centers or storage facilities. Some REITs specialize in real estate debt like mortgages, but you can also find REITs that invest in a broad range of commercial real estate.  

One unique advantage of REITs for investors is that REITs must distribute dividends of at least 90% of taxable income annually to shareholders. REITs cannot retain earnings, and investors benefit from regular dividend payments.

If you’re ready to invest in REITs, consider the following.

Begin by researching different types of REITs, such as equity REITs, mortgage REITs (mREITs) and hybrid REITs. Understand their specific focus, such as commercial, residential or industrial properties.

To select REITs with strong returns, analyze the REIT’s financial performance, historical dividend payouts, management quality and the types and locations of properties it owns. Review the REIT’s annual report, prospectus and other available financial information.

You can invest in REITs by purchasing individual REIT stocks or investing in REIT exchange-traded funds (ETFs). With individual REIT stocks, you can buy shares of specific REIT companies through a brokerage account, just like you would with regular stocks. With REIT ETFs, you invest in a diversified portfolio of REITs by purchasing shares of an ETF that tracks a REIT index. This choice provides exposure to a broad range of properties and reduces the risk of investing in a single REIT, providing diversification.

If you’re investing in individual REIT stocks, you’ll need to open a brokerage account with a reputable brokerage firm. If you’re investing in REIT ETFs, you can also open a brokerage account to purchase shares of the ETF. 

Major brokerage firms include TD Ameritrade, Charles Schwab, Fidelity Investments, Merrill Edge, Robinhood and Ally Invest. Check brokerage fees and choose a brokerage with low or no fees to maximize investment returns. 

Once your brokerage account is set up, you can place an order to buy shares of the desired REIT or REIT ETF. To purchase shares, you’ll specify the number of shares you wish to purchase and the price at which you’re willing to buy. You can choose between market orders — buying at the current market price — or limit orders — buying at a specific price.

After purchasing REIT shares, monitor the performance of your investment over time. Monitor factors such as dividend payments, share price movement and news related to the REIT and the real estate market.

Regularly review your investment portfolio and consider rebalancing if necessary to align with your overall financial goals.

Direct real estate investing involves purchasing and owning physical properties for the purpose of generating rental income and potential capital appreciation. Unlike investing in REITs, crowdfunding real estate or other indirect methods, direct real estate investing entails becoming a property owner and actively managing the property or hiring a property management company to handle its operations.

There are many options for direct real estate investing including:

• House flipping
• Wholesaling
• Long-term rental properties
• Multi-family housing
• Commercial real estate

You can choose to master one type of direct real estate investing or spread the risk over multiple diverse properties. For direct real estate investing, additional market research, in-depth market knowledge and a network of real estate professionals and other investors can help drive success. For dedicated investors willing to build specific knowledge of target markets, direct real estate investing can offer stable, long-term returns.  

If you’re ready to invest in real estate directly, consider the following factors to build success.

Direct real estate investing involves purchasing properties such as residential homes, apartment complexes, commercial buildings, industrial properties or land parcels. You can purchase properties with cash, a mortgage, a loan or with other investors. The value of property ownership is in property appreciation over time and positive cash flow short term. Learn how to buy your first rental property here. 

The primary source of income in direct real estate investing comes from renting out the property to tenants. Rental income provides a consistent cash flow stream that can help cover mortgage payments and property expenses and generate profits. Real estate investors look for properties that can generate positive cash flow from the first month. 

Direct real estate investors are responsible for property management tasks, including finding and screening tenants, collecting rent, handling maintenance and repairs and addressing tenant issues. Alternatively, investors can hire a property management company to handle these responsibilities for a fee or commission.

Beyond rental income, direct real estate investors also aim to benefit from property value appreciation over time. The value of the property may increase from factors such as market demand, improvements made to the property and economic conditions.

Direct real estate investing often involves the use of leverage, where investors use borrowed funds (such as a mortgage or loan) to purchase properties. This process can amplify potential returns but also increase risk, as investors are responsible for repaying the borrowed funds regardless of property performance or vacancies.

Unlike investing in REITs or other passive investment options, direct real estate investors have more control over their investment decisions, property management strategies and potential improvements to increase property value.

Direct real estate investing comes with financial and operational risks. Property values can fluctuate, and vacancies or unexpected maintenance costs can impact cash flow. Additionally, active involvement in property management requires time, effort and expertise. However, the rewards for many real estate investors outweigh the risks and responsibilities.

Wondering whether to invest in REITs vs. real estate investments? For many investors, the answer is to invest in both. Here’s how the two compare.

REITs: Investors own shares in a REIT, which represents fractional ownership in a diversified portfolio of real estate properties.

Direct real estate: Investors own physical properties, such as residential homes, commercial buildings or land.

REITs: Instant diversification across multiple properties and property types, reducing risk.

Direct real estate: Diversification depends on the number and types of properties owned.

REITs: Shares are traded on stock exchanges, offering high liquidity and ease of buying and selling.

Direct real estate: Less liquidity. Selling properties may take time and effort.

REITs: Managed by professionals; investors are not directly involved in property management.

Direct real estate: Requires active management, including tenant interactions, maintenance and property improvements.

REITs: Passive investment; minimal involvement in property operations.

Direct real estate: Active investment; hands-on management and decision-making by investors or property managers.

REITs: Dividend income generated from rental properties is distributed to shareholders.

Direct real estate: Rental income and potential capital appreciation contribute to earnings.

REITs: Generally offer steady dividend income; potential for capital appreciation may be lower than direct real estate.

Direct real estate: Potential for higher returns through rental income and property value appreciation.

REITs: Some REIT dividends qualify for favorable tax rates; tax treatment depends on the country’s tax code.

Direct real estate: Offers tax advantages such as mortgage interest deductions, depreciation, and potential 1031 exchanges in the U.S. May offer additional tax benefits in other countries.

REITs: Low entry costs; investors can start by purchasing shares of a REIT for very little upfront.

Direct real estate: Higher entry costs, including property acquisition, closing costs and potential renovations.

REITs: Offers exposure to various real estate markets and sectors, reducing concentration risk.

Direct real estate: Provides specific exposure to the local market; market performance directly impacts investment.

REITs: Generally less volatile due to diversification; however, share prices may still be affected by market fluctuations.

Direct real estate: This can be subject to local market risks and specific property-related challenges.

REITs: Requires less time and effort compared to direct real estate ownership.

Direct real estate: Requires substantial time commitment for property management and decision-making.

Should you invest in REITs vs property? That depends on your time, financial goals, investment amount and willingness to actively invest in real estate. REITs can offer stable returns and diversification, while direct real estate investment has the potential to accelerate wealth building. For many investors with a diversified, long-term investment strategy, it’s not a question of investing in real estate vs. REITs, it’s how to capitalize on both.