You may have heard that real estate can be a solid investment option. But is it better to buy real estate properties or to invest in real estate investment trusts (REITs)? Whether you decide to become a landlord, buy and resell properties for a profit, or passively earn income through REITs, it’s important to first understand the requirements, benefits, and drawbacks of each real estate investment strategy.
We’ll walk you through what it means to buy real estate and invest in REITs, and help you weigh the pros and cons to better understand if either investment choice fits into your financial plan.
Buying Real Estate
Buying real estate is an active form of investing. You can buy property anywhere, but if you’re new to the real estate world, it’s generally recommended that you buy real estate you can see in person first. This can help prevent any unexpected surprises down the road.
There are two main investment strategies for earning a profit when buying real estate:
- Owning a rental property: In this scenario, you would buy a property (single-family home, multi-family home, apartment or condo complex, or commercial building) and rent it out to tenants. This would allow you to collect regular income and slowly earn profit over time. Payments from the tenant can help you grow equity in the property and/or provide an income stream.
- Flipping and reselling homes: Another way to invest involves buying properties, fixing them up, and reselling them—ideally for a profit. This scenario, often called “flipping,” gives you the opportunity to earn a profit quickly, but it is risky. You’ll need to properly estimate renovation costs and have a timeline for resale before you make a purchasing decision. You’ll want to time your sale to maximize the selling price.
You can find properties on a multiple listing service (MLS), which is the largest database of properties for sale if you’re a Realtor or working with one. Only Realtors have access to the MLS.
Otherwise, you can find listings online through platforms like Zillow, MIBOR, Realtor.com, and Trulia. You can also search for government properties on the U.S. Department of Housing & Urban Development (HUD) website.
Pros and Cons of Buying Real Estate
Regular income stream (for rentals)
Tax deductions (for rentals)
Control over pricing and tenant selection
Ownership of a physical property
Requires extensive research or expertise
Demands active involvement
Requires access to significant upfront funds
Can be subject to capital gains tax (upon selling)
- Regular income stream (for rentals): If you plan to become a landlord, you’ll be able to count on regular payments in the form of rent that can help pay for the property and provide a reliable income stream. This can be a more stable approach over buying and selling, which does not guarantee you a profit.
- Tax deductions (for rentals): Rental property owners can enjoy tax deductions for many of their business expenses involved in managing a property.
- Control over pricing and tenant selection: Whether you’re listing a property for rent or for sale, you’re in charge of the listing price and you have control over who you allow to rent or buy a property. Of course, you can only rent or sell for as much as renters or buyers are willing to pay.
- Potential to earn significant returns, quickly (for selling properties): If you buy a property and are able to upgrade or renovate it at or under budget, you have the potential to earn significant returns if you can sell the property within your planned timeline..
- Ownership of a physical property: For many investors, possessing a physical property over an intangible investment is more ideal than non-physical investments like REITs, funds, or stocks. When you own property, you have something tangible and somewhere you could live if you needed to.
To help screen rental candidates, you can hire a property management company that can conduct background checks, run credit scores, and more. Property management companies can also help you collect the rent and provide maintenance services. They do require a fee, which can eat into profits, so they may not be ideal for everyone.
- Requires extensive research or expertise: Any time you buy a property hoping to turn a profit, it’s important to do extensive market research to better understand the area. This can require working with a seasoned professional or spending many hours getting to know your local market. Gaining long-term expertise often means dealing with some losses as you learn what not to do.
- Demands active involvement: Whether you’re renting or reselling a property, as the owner, you’ll need to be actively involved in the process. While renovating and reselling requires a short-term, active commitment, managing a rental requires you to actively manage your property or hire an outside property management company. That could take up a significant amount of your time or add additional costs.
- Requires access to hefty upfront funds: In order to buy a real estate property, you’ll need to be able to afford a down payment and closing costs. Some multi-home properties require greater upfront expenses than single-home properties, which means if you’re planning on renting multi-family units, you’ll need access to capital to get started.
- Can be subject to capital gains tax (upon selling): If you sell a real estate property for more than you paid for the investment, you’ll likely be required to pay capital gains tax. While you can avoid this if you purchase a new property within a specified window of time (also known as a 1031 exchange), you’ll most likely have to pay capital gains at some point in time. Capital gains tax rates are generally 0%, 15%, or 20% depending on your income level, although in some cases rates may be higher.
Investing in REITs
When you invest in a REIT, you’re participating in a passive form of investing. REITs are trusts that allow you to invest along with other investors to potentially earn profit, without incurring the actual cost and time of buying and managing a property outright.
There are both private and public REITs, but unless you’re an accredited investor, you’ll only have access to public REITs. You can think of investing in a REIT as comparable to buying stock in a company. You’re buying a portion of the company, and you could earn profit or suffer losses depending on how it performs.
While some investors consider REITs to be a substitute for bonds, they are equities, not bonds. They are considered riskier than bonds.
Pros and Cons of Investing in REITs
Little to no time investment
Low minimum investment requirements
Less research and expertise required
- Little to no time investment: Since REITs are actively managed by a board of trustees, you can avoid the responsibilities of day-to-day management or buying and selling decisions. This can be a benefit if you don’t have the time to dedicate to managing or renovating a property.
- Low minimum investment requirements: You can begin investing in a REIT with much less money than you need to buy real estate directly. While you will typically need to invest at least $1,000 to get started (some minimums are lower), the amount is much smaller than you’d need for a down payment or closing costs on a property, which can be tens of thousands of dollars.
- Less research required: While you should always research an investment before contributing any of your money, you won’t need to research REITs as heavily as you would a property you planned to buy.
- Better investment diversity: REITS can help you achieve diversity in your portfolio more easily because they require less money and allow you to invest in multiple properties with one asset.
- Dividends: REITs are required to pay out dividends to investors. This amount can vary, but you’ll be able to expect distributions on a set schedule.
- Less control: When you invest in a REIT, you have little to no say in how the real estate properties are managed, which properties are purchased, and how much they’re sold for.
- More volatile: Publicly traded REITs will fluctuate in price and can be influenced by trends in the broader stock market. They tend to be more volatile than real estate or private or non-traded REITs.
- Tax considerations: You will still face tax consequences when you invest in REITs. You’ll be required to pay income tax on any dividends earned each year and you may also owe capital gains tax.
Should I Buy Real Estate or Invest in REITs?
Ultimately, whether you invest actively in real estate or invest through a REIT depends on your financial situation, availability, interest in property management, and overall comfort with the real estate market.
Both investment strategies are potential ways to grow your wealth, but buying real estate will require more time and money. However, you could gain more from this investment, depending on a number of factors. REITs, however, can be an excellent addition to a portfolio for a more hands-off investor because they are more straightforward and less time-consuming.
The Bottom Line
Real estate is often viewed as a great investment, even in times of economic uncertainty, because it allows you to generate steady income. Buying and reselling real estate for a profit may make sense if you have access to a lot of capital and don’t mind navigating the renovation process. Buying and renting property could help you earn a steady income through rent and allow you to purchase more properties down the line.
If managing or selling a property sounds like too much work, investing in a REIT might be a better option for you. This more passive form of investing requires less upfront capital and time commitment, though you won’t have as much control over managing the properties.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.