Investing in real estate is a great way to supplement your income. When considering real estate investment, many only consider purchasing a rental property. However, there’s another option available to invest in real estate: REITs.
What is a REIT?
A REIT (real estate investment trust) is a company that invests in real estate directly through property or mortgages. These companies own the properties, collect rent, and distribute the revenue to shareholders. REITs are securities that can be bought on the major exchanges just like stocks. In essence, investors get the share of the profits produced by rental properties without buying and managing the properties themselves.
How Do REITs and Multi-Family Investments Compare?
Both REITs and multi-family investments have benefits and drawbacks for investors. In order to choose the best one, carefully consider what each has to offer. We’ll explore what both mean for potential investors.
1. Liquidity: An important aspect of investing is determining whether or not an investment can be liquefied. If an investor happens to be strapped for cash, a liquid investment can easily be sold. Some investors consider this factor a priority. As we said before, REITs are securities. It’s extremely easy to buy and sell them. If a REIT you own goes up $4.00 per share tomorrow, you will have no problem liquidating it and gaining a profit. On the other hand, multi-family buildings can be hard to liquidate. Selling a property can take a long time and be costly. It would have to be listed by a realtor, and then there’s closing costs and other fees. Because there’s a much smaller market for multi-family buildings, it can take longer to sell than a normal rental property.
2. Risk: Many investors are also concerned when it comes to the level of risk that are associated with certain types of investments. REITs can be bought and sold on the stock exchange, and, therefore, are subject to the strength of the market. Even if the share is strong, a weak market can decimate the share’s price. Investors have zero control over the market and its strength; the risk of losing money will always be there. Interest rate risk is also present. There’s the risk of interest rates climbing high enough that the REIT no longer brings investors a profit.
Owning a multi-family building has its own set of risks that need to be assessed. When you own any property, there’s a liability risk of someone (a tenant or third party) getting injured. However, an appropriate insurance policy with the correct amount of coverage can protect investors should anything happen.
3. Return on Investment: One of the most important components of an investment—the one investors care about the most—is the potential rate of return the investment (ROI) will give them. REITs have a good track record; they’re reliable and appreciate over a long period of time if left alone to grow. They have provided investors with an attractive ROI—most yield 5% or more. If real estate starts to suffer, though, in either the commercial or residential sector, you can still stand to lose a lot of money without physically buying the property yourself.
As for multi-family buildings, ROI can be dependent on a few factors. A general rule of thumb is that the less money an investor puts into a real estate deal and the more they mortgage, the better their ROI will be. If an investor puts more money down and mortgages less, their ROI will be lower, but their net income will be greater. There’s also a number of ways that investors can increase their ROI through strategic business decisions. Certain upgrades to a multi-family building, such as providing better amenities, and sprucing the building up, can increase the building’s ROI and overall value.
REITs and multi-family buildings are two options investors can look at to get into the real estate game. Both have benefits and drawbacks. Investors need to assess their personal risk tolerance and investment needs to determine which option is better. If an investor needs to have the control of making the decisions themselves, a multi-family building would be the most suitable investment avenue.