Buying REITs has often been seen as an alternative to buying physical properties. Which is better for investments? What is the difference between the 2? This article explores the differences between buying REITs and actually owning the physical properties.
While REITS have the similar exposure to real estate market, they are somewhat different when considered from a investment portfolio point of view. First, we will look at the advantages of REITs versus physical properties.
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Advantages of Investing In REITs
One of the main advantages of REITs is that entry and exit is relatively easy since they are traded just like stocks on the stock exchange. On the other hand, properties may take a while to find a buyer at the right price and transaction process generally takes a few months.
Invest with Minimum Capital Outlay
The minimum cost of most property investments is substantial, for example a $500,000 property with 80% loan to valuation will require $100,000 down payment not including other extra costs such as legal fees, stamp duty etc. For REITs, the minimum outlay is 1,000 shares and some REITs may cost less than $1,000, for example Starhill Global costs $800+ at current prices.
Management Team Handles Tenants and Maintenance
One of the most troublesome aspects of managing physical properties is dealing with tenants and maintenance of the property. There are many stories of bad tenants, tenants who don’t pay rent, damage your property etc., bad tenants can cause a lot of problems. It is also important to maintain the properties such as the roof, plumbing, painting etc. since the properties age over time.
Diversification into Office, Retail, Industrial, Healthcare
While it is easy to buy residential properties, investing in commercial properties take a lot of more knowledge and experience. Investing generally in office, strata retail and industrial properties are common for a commercial property investor, but buying actual retail malls will be very tough due to the high costs. REITs not only allow investors to take part in the largest shopping malls, but also hospitals, prestigious office buildings and more.
Disadvantages of REITs
Volatility of REIT Price
Since REITs are traded on the stock exchange, the stock price of the REIT is subject to market volatility like any other stocks. Physical property valuations are generally more stable and unlikely to experience wild swings on a daily basis.
While you save a lot of hassle with REITs, the management team does charge a handsome management fees which reduce your returns. Management fees are paid not only on the basis of asset valuation, but also each time a property is acquired or divested by the REIT.
In general most REITs have a leverage cap of 35% without a credit rating and up to 60% with a credit rating. Physical properties on the other hand can easily get 60% to 80% loan to valuation ratio. hence the returns can be much higher.
REITs Are a Good Addition to Any Portfolio
The combination of management fees and lower leverage means that returns from REITs are unlikely to beat returns from property investments. However, the high leverage in property investments also means it is more risky as a bad property investment can seriously damage a person’s financial wealth. All in all, REITs provide an easy, low risk manner to gain exposure to diversified portfolio of properties.