Most investors realize why they should invest in real estate for the long-term. Income-producing real estate can create a good, reliable stream of income, and often requiring little maintenance from the investor. Trouble can arise, however, when deciding on the BEST way to invest. When considering real estate investing opportunities, many average investors consider rental properties and REITs.
Each of these options carries a set of advantages and disadvantages. Depending on your situation, some may suit you more than others. Let’s consider the pros and cons of rental properties and REITs.
Investing in Rental Properties
Rental property investments can be lucrative for those interested in taking an active role in their investments. They can generate a good monthly cash flow in addition to long-term appreciation. They also offer the benefit of direct ownership, which presents tax advantages. However, with these benefits come some ongoing landlord responsibilities that require continual hands-on attention.
Rental properties do offer many benefits to investors with the knowledge and time to manage them. When a rental property is running the way it should, it can offer the owner the benefit of:
1. Regular Cash Flow
Rental properties have the opportunity to offer steady and reliable monthly cash flow through rental income. Unlike public market investments, which can fluctuate every second of the day, a landlord can have peace of mind that income from tenants comes at the beginning of every month. Also, when you have multiple income streams it provides additional diversification, which reduces risk and can increase overall income.
2. Property Appreciation
In addition to monthly payments from tenants, rental properties earn money through the property’s appreciation. Property ownership gives the investor the benefits of equity as well. If the property value increases it can have considerable profit for the investor upon the sale.
3. Tax Deductions
Rental property owners deduct the majority of expenses that they incur in managing their properties. Things like insurance premiums, legal fees and maintenance costs paid in operating the property can all be written off. You may not be able to deduct the costs of property improvements in a single year on your income tax returns, it’s possible to report the improvements of the property and then depreciate the costs over the life expectancy. When you add value to the property by updating the kitchen with new countertops to get a higher monthly rent, you can depreciate the costs over several years. With every deduction, your net income is lowered, and will potentially lower the amount of taxes that you will owe.
4. Freedom and Flexibility
The nice think about owning your own rental property is that you are in charge! You get to make all of the calls on your investment. You can determine how much to charge for your lease, what improvements to make and when, who to work with, and the property’s eventual sale. However, with this freedom comes more responsibility and pressure to make the right decisions.
What About REITS?
Real Estate Investment Trusts (REITs) are designed to offer investors not only exposure to cash-producing properties, but they are structured to offer diversified exposure to the asset class of real estate. This exposure reduces the risk taken by each investor, unlike direct property ownership. Also, REITs typically offer a much lower investment minimum than direct property ownership.
How REITs Work
REITs are formed when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, like other stocks. Corporations have to pay out 90% of its taxable profits in the form of dividends in order to maintain its REIT status. For more information on REITs, contact us!