# REITs vs Owning Rental Real Estate



## underemployedactor (Oct 22, 2011)

I almost posted this in the RE subforum but then I thought this was more of an investing question than a Real Estate question, so herein follows my tale.
A nice little duplex came up for sale near me, and I thought about buying it and renting it out for a nice little income stream with the possibility of some capital appreciation, you know, the usual reasons, and then I woke myself out of my stupor and remembered how much I _despised being a landlord the last time I owned a rental, even though I had zero problems with my tenants. Being a landlord just ain't in my nature I guess. But I miss the income stream and the diversity it added to my overall portfolio and all those other good things that go with it.
So here is my question REIT experts: Does owning an apartment REIT fulfill the same portfolio needs as owning a rental property? If I can make some room in my TFSA and put the the money I would have put down for a down payment on the rental property into a REIT that owns a portfolio of residential rentals, am I doing pretty much the same thing ie creating a rental income stream?
All thoughts welcome and thanks in advance._


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## Synergy (Mar 18, 2013)

By no means am I an expert, but I don't view REIT's and rental properties to be one in the same. If you want an "income stream" I would lean towards REIT's. After expenses, etc. with you're rental property I doubt there will be much left in terms of monthly income. If the RE market cooperates, then rental properties can be a great long term investment (capital). I'm not a big fan of being a Landlord and I've decided to invest into some REIT's to satisfy my desire to own RE. However, I still don't think they are one in the same...


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## Just a Guy (Mar 27, 2012)

I suppose it really boils down to the REIT and how you, as an individual investor, work. 

With a REIT, you abdicate control and input (for many, this is a good thing). There are many good REITs, but they control a lot of money, so they can lead some into corruption. Having owned real estate for decades, as well as companies, I know there are many legal ways to adjust the books, and then there are the not so legal ways...you, as a shareholder of course, would never know until it's too late. 

Also, I'm not all that impressed with single digit returns in this time of INCREDIBLY low interest rates. I know how much revenue I generate from my rentals, so REITs should be cash cows and they are not, which leads me to think the controllers of the REITs are making a killing. 

If I were to run one, I'd buy a building, let's say for $1,000,000, which generates $100k/month. In good times, with low interest rates, I'd go to the bank, and mortgage it for 80% at the 3-4% (current rates) and pay the down payment from the REIT investors (5% return on 20k) rince, repeat, and bank the difference. In bad times (rates higher than 5%) I'd use more REIT investor money to finance a larger portion of the building and less of the bank's more expensive money, and bank the difference. Either way, no money out of my pocket, but plenty going in...the benefit of leverage. Heck, if I had to, I suppose I could increase the yield...there's plenty of room using my numbers. Do the debt servicing calculation for yourself. 

Meanwhile, you as an investor are locking in real cash, no direct leverage to increase your profits. The leverage is benefitting the REITs controllers, ensuring they can pay you your 5% return. 

Personally, I've never seen a REIT that can come close to generating the returns I make on my rentals, but then I don't buy $300k places and rent them for $500/month. I buy places for under $100k that rent for significantly more than $1000/month, then I leverage the place 100% or more, generating, technically infinite ROI (I invest $0, but generate income and pay down principal). Of course, I don't kid myself, I do WORK for my money, being a landlord isn't easy, but usually it isn't that hard (and even when it's hard, the difficulty is only temporary). 

Then again, it takes a certain mindset to be a landlord, it's definitely not a job for everyone, but then you could always hire people like Berubeland to manage things for you.


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## Synergy (Mar 18, 2013)

Here's an articles listing some of the pros & cons (REIT's vs Rental Properties)

http://www.milliondollarjourney.com/owning-rental-property-vs-owning-reits.htm


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## MoreMiles (Apr 20, 2011)

With a REIT, I can sell your property trying to make money even if I don't own it. I can short it or buy put option. So I don't agree that REIT is the same as a real house. You can lose 10% in just one week with a REIT from the gamblers that have no interest in ownership. These people cannot touch your apartment rental in comparison.

Also, look at the value of REIT vs. real houses this past summer, they did not correlate well. They act more like preferred shares / fixed incomes.


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## Just a Guy (Mar 27, 2012)

I should also point out, that with these margins, most REITs aren't buying places that generate the cash flow of my example, since they can make profits at lower ratios, so I fear what happens when interest rates go up, or real estate prices go down...just because REITs are "professionally managed" doesn't mean they don't buy properties that barely make money in these times of low interest rates. I keep seeing listings bragging about 5% cap rates when the mortgage is 3% and shake my head.


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## Jaberwock (Aug 22, 2012)

I chose the REIT route because I don't have the mentality to be a landlord, and I don't want the hassle.

Among all of my investments, REITs have provided the highest returns over the past fifteen years. I realize that a lot of that return has been capital appreciation as a result of a general lowering of interest rates, which tends to increase the value of interest paying investments. REITs will not be so good in a rising interest rate environment.

The big difference between the property purchase and the REIT purchase is leverage. Suppose you have $50,000 to invest, you can buy a property worth $200,000 with a $150,000 mortgage at 3%. If you can get a net rent of 5% you are making $5,500 ($10,000 net rent minus $4,500 interest on your mortgage) which is equivalent to 11% on your initial $50,000 investment. In addition, you will be getting the capital appreciation if the property value rises.

The big drawback with property ownership is the very high cost of buying and selling - you have to be in it for the long term


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## brad (May 22, 2009)

It seems to me that REITs and rental properties are two entirely different things: sure both are "real estate," but rental properties are particular bits of real estate in particular locations, whereas REITs are much broader, exposing you to a broader range of real estate in many parts of the country. It's a little like saying you have exposure to equities if you own five or six individual stocks versus saying you have exposure to equities if you own shares in an index fund that invests in thousands of companies.


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## liquidfinance (Jan 28, 2011)

MoreMiles said:


> With a REIT, I can sell your property trying to make money even if I don't own it. I can short it or buy put option. So I don't agree that REIT is the same as a real house. You can lose 10% in just one week with a REIT from the gamblers that have no interest in ownership. These people cannot touch your apartment rental in comparison.
> 
> Also, look at the value of REIT vs. real houses this past summer, they did not correlate well. They act more like preferred shares / fixed incomes.


This is true. 

But on the other side if you need your cash you can sell today and have the cash in you bank by the end of next week. Not so easy being tied up physical RE.


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## SpendLessEarnMore (Aug 7, 2013)

Reits are more liquid than rental properties. If you need the cash quick for another great investment opportunity that comes up it would be much harder to sell off the rental property with your tenants occupying it.


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## kcowan (Jul 1, 2010)

I don't think you can directly compare them just like gold mining companies are different than gold. Think of REITs as real estate mining companies. Their asset allocations would be different than anything you could acquire and manage. We all know how important asset allocation is to portfolio construction.

So the question is what kind of portfolio of RE assets do you want to hold? If it lines up with a particular REIT then you have a comparison. Then the question is do you want to have hands-on involvement or not.

(In some ways it is similar to the question of owning a resort property or just renting. The answer is: It depends!)


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## doctrine (Sep 30, 2011)

You can potentially get a lot more leverage out of a rental real estate. As soon as you start putting 3-4% capital gains on top of rental income versus your original down payment, its rare that it won't look like a really good return on your cash, especially if you're doing it in a lower priced housing market. 

But then again, you lose a lot of liquidity and you do assume capital risk as that 3-4% is not guaranteed and could be eaten up by a problem house. 

If you like to fix up houses and be a landlord though it might be for you. You could always borrow for a REIT to try to mimic the much higher leverage you get out of a big mortgage; if you can get a 3.5% secured LOC, for example, you can be immediately cash flow positive on a 7% yielding REIT. 50% capital plus 50% borrowed money on a REIT would have as good long term returns as a rental without any hassle.


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## Mall Guy (Sep 14, 2011)

Synergy said:


> Here's an articles listing some of the pros & cons (REIT's vs Rental Properties)
> 
> http://www.milliondollarjourney.com/owning-rental-property-vs-owning-reits.htm
> 
> ...


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## underemployedactor (Oct 22, 2011)

thanks for your input everyone. And thanks justaguy for the real life examples.
What tends to happen to the unit price of say an apartment reit if a real estate correction happens and the underlying assets drop significantly in value. With bricks and sticks rental the income would be unaffected. Is this the same with reits? Can the NAV drop significantly without the payout being affected?


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## brad (May 22, 2009)

underemployedactor said:


> thanks for your input everyone. And thanks justaguy for the real life examples.
> What tends to happen to the unit price of say an apartment reit if a real estate correction happens and the underlying assets drop significantly in value. With bricks and sticks rental the income would be unaffected. Is this the same with reits? Can the NAV drop significantly without the payout being affected?


Real estate corrections don't happen uniformly across the country, right? So unless you somehow own a REIT that only invests in properties in Vancouver, for example, corrections would have a much smaller effect than if you owned real estate in one city.


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## Canadian (Sep 19, 2013)

I think it comes down to the investment objectives. If you're looking for the income then REITs are the way to go. REITs allow the flexibility for you to deloy as much capital as you desire; there's no minimum down payment and you can reduce your investment if you feel your portfolio is too RE focused. I don't own any property right now but I have a lot of friends who own rental properties and I've talked to them many times about the prospects of being a landlord (as I've debated whether I want to enter this market one day). In the city where I live, real estate prices have increased significantly over the past few years (especially downtown). These friends say that properties they bought in the 90s are now producing a good return, but the ones purchased in recent years are really just building them equity - they are just breaking even or they are paying in a bit to cover costs.

Aside from investment return objectives, I think two significant factors in this decision are risk and flexibility:

REITs really boil down to equity risk, interest rate risk, and management risk (management risk in the sense of how is senior management doing in their fulfillment of fiduciary duties to shareholders). Equity risk would be common to the rest of your stock portfolio - so you have to consider how much of this risk you can tolerate. Interest rate risk has more of an immediate effect on the REITs share price (as we've seen in recent months). Between equity and interest rate risk, the value of your capital will be much more volatile than owning a tangible property. Interest rate risk is also inherent in owning a property, but only becomes apparent when renewing the mortgage (can you still afford the mortgage if interest rates go up by X%?, though this is also a risk with REITs being can they afford the payout if their financing costs go up). Another two risks of owning a tangible property are surrounding the quality of the property and the tenant. Property - meaning what hidden deficiencies will be uncovered after purcahse and how much will it cost to upgrade or repair? Tenants - well, there's the risk of tenants trashing the place and/or skipping out on rent.

Finally, flexibility: Owning a tangible property allows you to pick the property, tailor it to your desires, pick your own tenants, and manage it your own way. You don't have these decisions with a REIT, unless you become a very significant shareholder and/or board member, really. At the same time, if you choose to move or you decide that you don't want RE in your portfolio anymore, a REIT is much more liquid and usually less costly to sell (assuming you aren't carrying a large paper loss).

I don't know if I did a good job playing devil's advocate here or if I managed to bring up any points you have yet to consider - but hopefully some of this is useful. Myself, I am more towards REITs, simply because I don't have the time or interest to deal with tenants and renovations at this stage in my life. I understand REITs in which I invest well and have more tolerance for equity risk than I would if the value of my property significantly declined.


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## doctrine (Sep 30, 2011)

> Can the NAV drop significantly without the payout being affected?


Yes. There are some REITs actually with very large amortization expenses and have drops in NAV but maintain payouts. If the REIT has valuable properties (there are such thing as non-slum apartments), then they will tend to report more net asset gains over time. A major correction wouldn't affect payout but could affect book value and the share price, but that would be a clear buying opportunity if rents are not dropping. REITs will report average rents quarterly so you can keep an eye on this.


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## Canadian (Sep 19, 2013)

doctrine said:


> Yes. There are some REITs actually with very large amortization expenses and have drops in NAV but maintain payouts.


+1

NAV and payout for REITs are essentially independent functions with similar components. Similar items go into their respective calculations, but unlike NAV, payout isn't affected by non-cash items (such as amortization or impairment losses) if you look at it from the common REIT's AFFO perspective.


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