Rental properties vs. REITs
Hello everyone,
Without having a biased opinion, let's discuss owning property versus owning stocks in a REIT.
I would like to hear the pros and cons of buying real estate directly (rentals), versus buying shares in a Vanguard REIT for example which are returning approx. 12% since inception.
If I buy a property for a 6 cap today and Reits are returning 10% without the headaches of owning a property (managment, lawsuit risk, vacancy, etc.) which would you invest in and why?
i would invest in a property than a reit. while reits provide a 10% return, a long term property holder will get a 20% plus return. the acquisitions/Asset Management firm get paid the big dollars while the financial advisors and deals folks at the REITS get all the rewards.
REIT model isn't sophisticated. just peeps buying class A core buildings in strong markets and tenants. relatively little risk and some leverage provides for strong upside to get a 10% yield.
also, you might be comparing apples and oranges here. a 10% yield assumes the REIT is constantly selling so the appreciation of the asset allows them to hit the 10% yield while a private property owner might buy at a 6 cap and sell at a 6 cap 5 years later but due to rent growth, they can also hit a 12 to 15% IRR which gives them a higher yield.
on another note, when does it make sense to look at a multiple over an IRR or vice versa? I am used to looking at IRRs all the time.
Yeah a lot of people don't realize that REIT returns are very transaction driven.
Interesting topic, and one we debated in b-school quite often.
VNQ, which I also am invested in, provides a nice fixed income like return that is relatively guaranteed. You own a piece of the best core real estate in the US and across all product types since if I recall correctly VNQ is market cap weighted. This provides you and I with a chance to own product types (i.e. class A office/hotels/etc) that we could otherwise never afford on our own. The issue with all REITs is that you're susceptible to market noise, such as when Trump spouts off or North Korea fires a test missile. With REITs, your management teams are best in class and their only objective is to generate returns for shareholders. If you want to be passive in real estate, this is the way to go.
Private investment, or "buy rentals directly" as you mentioned, requires more capital up front in almost all cases. Your diversification is limited to the number of assets you hold equity in, and your property management team most likely doesn't even touch the expertise that their REIT brethren possess. While the VNQ allows you to focus on other endeavors, direct investment typically requires you to be involved around the clock...i.e. what if your tenant's toilet breaks in the middle of the night or you discover termites are eating away your structure? (extreme scenarios but stuff we might have to deal with nonetheless). The benefit I see of direct investment is being able to generate positive cash flow after debt service while your tenants reduce your equity basis with every rent check they send you. Owning a property (or three) free and clear 30 years from now is appealing, but a lot of CapEx and replacements will be injected over that time horizon as well. The 1031 exchange is a beautiful thing and another benefit to the private investor. Your VNQ dividends will be taxed at your income tax rate as will your income from tenant rent, though you'll also have the benefit of mortgage tax deduction.
What you are really asking it seems is should I go private vs. public? Many white papers have been published on the subject and REIT's have historically outperformed private real estate over longer term time horizons. The biggest difference in my opinion is if you have the ability/skill set to buy right, improve asset value, raise rents (i.e. market value), and sell. This is what BX does. The near term gain one can get from buying right (i.e. low) and putting in elbow grease will nearly always generate higher total return than from buying stabilized core properties. Exercising prudence in your search is key in my opinion, as you don't want to overpay and you do want to buy something in the 'value-add' category. In summary, I think if you have the time/knowledge/capital/ambition to buy distressed properties in the right parts of town where the growth is headed, you can outperform REIT total returns in that given period. If you are a buy and hold investor, I think it becomes more of a tossup, though it would be critical to evaluate 1) what your leveraged cash on cash return + 2) your equity basis over time, compared to the VNQ's annual dividend yield you would receive.
Beautiful response.
Great analysis. I am in a position with some time and money and looking at some of these private investment groups as well as individual SF or Multifamily units pruchased. I can take risk but analytical risk.
To me the biggest benefit of owning real estate direct comes down to the favorable tax structures and depreciation benefit.
As far as returns, my team is seeing clients selling their properties for 2x what they bought them for several years ago. Industrial assets primarily in secondary US markets.
I'm not a sophisticated investor, so please excuse my lack of financial terminology. But I'll give you an opposing point of view on the REIT vs. private ownership question.
I have two rental properties. One I've owned for 19 years. I bought it as a personal residence and put $5K down (first time home buyer). Lived in it for a couple years and then turned it into a rental. Since then, the rent has consistently paid my mortgage and has almost paid off the house. Rents grew steadily over time. In 2018, rents are more than double what they were in 2001. I've consistently reinvested the profits into extra loan principal payments, maintenance and upgrades on the property. This very nearly paid off the property in 18 years of ownership.
Then I re-financed and paid cash for another property that is generating more rent. After the mortgage payment, the properties generate roughly $24,000/yr before expenses, and this grows with inflation. Expenses run between $3,000 to $6,000 a year, depending on how much we're upgrading. The equity gains have been modest YOY, but over the long term, they've added about $200K to the asset value.
I don't think you can find a REIT that will generate those kinds of returns (on an initial capital outlay of $5,000 and no further investment). If you can, please tell me so I can put money there!!
In terms of time investment - I manage the first property myself. That requires me to find and supervise contractors when I need to make updates or do maintenance (e.g., hire someone to replace siding, find a plumber to fix the toilet, etc.). I've done some cleaning on the property myself when I prepare it for a new tenant, but all the other work is hired out. I've never snaked a toilet or fixed a leaky faucet in the middle of the night. I have a plumber who's very reliable.
I screen tenants myself, using a service from Transunion along with my own reference calls and employment verification. I'm extremely picky about tenants. So the process of leasing it takes about 10-40 hours every 2 years. I always require 2 year leases so I minimize my pain. Tenants are responsible for yard care. I probably put in around 5-10 hours a year for managing the property while it's leased.
The other rental is handled by a professional property manager (for 6% of the rent), so that's completely hands off for me.
So again, while there is some time involved, and I have to be picky about tenants, it's not a huge time investment. And I'm currently netting enough that it's worth the hassle, in my opinion. Of course, these profits didn't happen immediately, and if you buy an investment property (not a personal residence), you'll need to put 20-25% down (rather than 5% like I did). But I still think the long term return on cash is pretty darn good if you choose the right location and property.
Of course, it took 18 years to get to this point. So you can't take this approach and expect short term gains. This is definitely a buy and hold strategy.
If I contributed $5,000 today to one of the REITs paying 12%, what would it pay in 18 years?
Incidunt consequatur quidem illum harum dolorum soluta doloremque. Iure vel dicta error incidunt a consequuntur porro illo.
Veritatis et consectetur est velit debitis non. Autem sed ut aut consequuntur impedit.
Atque voluptatem omnis assumenda commodi recusandae rem aliquid. Necessitatibus et rerum quae ad aspernatur. Alias praesentium ex ipsa ex illum natus.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...