Including real estate investments in a portfolio can provide additional diversification from the usual mix of stocks, bonds and mutual funds. To add real estate, an investor can buy into a real estate investment trust (REIT) or he can directly buy real estate, such as land or a building or home. Each way to invest in real estate has its pros and cons.
Shares of a REIT trade on the stock exchange like any other stock. This feature makes it easy for an investor to add real estate through buying shares in one or more REITs. A REIT is a professionally managed company that owns a portfolio of investment properties. REIT investing lets investor choose specific sectors of the real estate market, such as shopping centers, apartment buildings, medical buildings or commercial properties. REIT shares typically pay dividends with yields higher than the typical stock shares.
Direct Investment Pros
The biggest advantage of buying investment property direct is the control the investor has over the physical property. Direct investment allows the investor to take advantage of local real estate opportunities. Certain property types like land, or single family homes will be direct investments. Property investors can also leverage the capital invested. With $100,000 to invest and an 80 percent mortgage, an investor can buy a property worth $500,000. There are tax advantages to direct property ownership that are not available to REIT investors.
The biggest negative to REIT investing is the value of REIT shares often follow the trend of the rest of the stock market. This tends to somewhat negate the diversification benefits of investing in real estate. Also, the dividends earned on REIT shares are fully taxable. Dividends from ordinary corporations are taxed at a lower rate, so a portion of the higher yield from REIT shares can be canceled out by tax rules. A REIT is also required to payout at least 90 percent of earnings as dividends. This reduces the flexibility of REIT management.
Direct Investment Cons
A big disadvantage of direct real estate investment is the large amount of capital which must be invested to buy just one property. To own several properties requires an even larger amount of investment money. The costs to buy and sell real estate property will be significantly higher than buying REIT shares. Owned investment properties are significantly less liquid than securities and it may take months or even years to sell a property.