Real estate investment trusts (REIT) are a low-cost way to invest in the real estate market and are becoming increasingly popular. Ernst & Young reports that the global REIT market has grown to $1.7 trillion in 2017 from $300 billion in 2003 and the number of countries now offering REITs has almost doubled to 37 in the last decade. (Learn more about REITs with this video.)
A REIT is a corporation, trust or association that owns and, in most cases, operates income-producing real estate and/or real estate-related assets. Modeled after mutual funds, REITs pool the capital of numerous investors. This allows individual investors to earn a share of the income produced through commercial real estate ownership, without having to go out and buy or finance property or assets.
REITs Vs. Direct Real Estate
Advantages of REITs:
Lower entry costs – You can invest in a fund for as little as $500 or $1,000 rather than having to buy a property for six-figures with a hefty down payment.
Increased liquidity – Like stocks, you can sell REITs shares whenever you like versus a home purchase which can take time to sell depending on market conditions.
No muss, no fuss – If you own a rental property, you are subject to tenant complaints; late payments; broken appliances; and yard, driveway, and home maintenance. With REITs, you'll just track your investments on a reasonable and regular basis.
Investment flexibility – With REITs, you can invest in commercial properties, shopping malls and even a marina or a group of camping site vacation homes – all at a reasonable entry price. That’s much harder to do as a direct investor where up-front capital can often be a challenge.
Advantages of Direct Real Estate Investment:
You call the shots – As a direct real estate investor, you won't answer to a fund manager. You decide on the rental price, the number of properties to buy and who lives in and rents your property.
Potentially fatter investment returns – A bigger investment may equal more earnings. If you invest $100,000 on a property and it increases in value 10%, you'll potentially earn $10,000. A $1,000 invested in a REIT with a 10% return nets $100.
Should You Invest in a REIT?
Due to the smaller size of individual real estate parcels, they don't necessarily reflect all available information because it's costly to perform due diligence on individual properties. In contrast, a REIT conforms more closely to the efficient market economic theory that states that asset prices fully reflect all available information described by Nobel Prize winner Eugene Fama. Since, in theory, a REIT's share price is more likely to contain all available information about the REIT, investors may have a better chance of getting a higher return.
REITs can also be a good choice for investors who don't want to operate and manage real estate as well as for those who do not like the risk associated with owning real estate. REITs can also be appropriate for new investors with limited experience in real estate who want to diversify their portfolio.
The Bottom Line
With the U.S. real market on the upswing again in 2018, real estate investing grows more appealing. When considering whether to invest in a REIT or through direct investment, consider the amount of risk and responsibility you can handle.