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Owning Rental Property vs Owning REITs

A reader emailed me recently about the benefits and pitfalls of owning a rental property versus owning a dividend stock.  As both aren’t on a level playing field, I thought comparing owning investment real estate to owning a real estate investment trust (reit) would be a more fair comparison.

Being a real estate investor was something I dabbled into upon graduating from University.  As it’s a popular and proven way to build long term wealth, I jumped in with both feet.  I soon realized however, that while managing properties was tolerable, managing tenants wasn’t as fun.  As a result, I eventually realized that the real estate rental business wasn’t for me and gradually sold off my rentals.  Today, the only real estate that I own is my principal residence.

What is a REIT?  A Real Estate Income Trust is a company that owns property, collects rent, and distributes the profit to shareholders.  It’s an easy way to get real estate investment exposure without getting your hands dirty or managing tenants.  However, the investor has no control over properties, purchasing/selling decisions, and especially the market.  Even if the REIT is strong, a weak market can irrationally decimate share prices (see crash of 2008) thus potentially reducing portfolio value.

Rental Real Estate

Advantages

There are advantages of owning rental real estate directly.

  • To start, you get control over the property, cash flow and tenants.
  • The investor can pick and choose which properties to purchase, as well as which repairs/upgrades to create value.
  • There’s something to be said about having capital in a physical property that’s more “real” than having money in the market.
  • There are many tax deductions when owning rentals and if you own multiple units, you can claim a portion of your vehicle and home office.

Downside

As with any investment, there are also drawbacks.

  • Owning rental real estate is a business and can be time consuming.
  • Working with non-paying tenants can be challenging and stressful if cash flow is tight.  Of course, this can be partially alleviated by hiring a property manager which of course eats into monthly cash flow.
  • Owning rental real estate directly is illiquid and quite costly to dispose of should the need arise (real estate, legal fees, time on market etc).
  • Leverage (mortgage) may be required along with the now minimum 20% cash down payment.

Real Estate Investment Trusts (REITs)

The Good

  • What I like most about REITs is how “hands off” it is and how picking strong REITs can provide a steady passive income source.
  • The investor can get real estate investment exposure without directly dealing with clogged toilets and late rents.
  • The barrier of entry is much lower where  any investor with a brokerage account can get REIT exposure.
  • One of the major advantages of REITs over rental properties is the diversification possibilities.  Instead of having a large portion of your capital in a single property, you can have them spread out over many properties across the country via a REIT.

The Bad

Sounds like a no brainer to go with a REIT instead of owning property directly, however, there are drawbacks.

  • For those of you who like the “control” of owning rental properties, REIT performance depends on the management of the company.
  • Your investment capital will be at the mercy of the volatility of market which can fluctuate significantly (see 2008).
  • Leveraging REITs can negatively impact the tax deductibility of the investment loan.

Final Thoughts

There are many advantages and drawbacks of both owning rental properties and investing in REITs.  Either can be successful depending on your aptitude and interest.  What do you think?  REITs or rental real estate?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 63 comments… add one }
  • Steve R May 6, 2010, 10:08 am

    Give me the REIT any day. I’ve heard horror stories here in Ontario about landlords getting the shaft by tenants that know the Ontario board is skewed in their favour.
    With the REIT, I buy in, get a nice regular payment (so far so good) all without leaving my home. No calls at night with regards to a clogged toilet, no excuses why rent can’t be paid, no fuss.
    If the markets go down, yes I’ll lose a bit; however, I can always sell my units easily and not have to worry that they’ll get trashed by a disgruntled tenant.

  • Gerry May 6, 2010, 11:06 am

    Excellent article.

    You emphasized that the value of the REIT is at the mercy of the market but didn’t really mention that the value of real estate is at the mercy of a market, too. So, no real advantages or disadvantages here either way.

    We thought about buying a few rental houses a while ago but went with a few good REITs. So far, it’s been better for us. Mainly for the reasons Steve R emphasized above.

  • Balance Junkie May 6, 2010, 11:14 am

    Thanks for the information. We have considered buying real estate, but I don’t think I could deal with the headaches associated with tenants, maintenance, etc.. I like the idea of REITs a lot more, but don’t forget that the larger an organization becomes, the more it may be susceptible to corruption. There can quite a bit of palm-greasing when it comes to construction and maintenance contracts. That’s got to be a drag on returns as costs for simple projects become inflated.

    As unacceptable as this is, it seems to be unavoidable and I don’t necessarily think it would keep me from investing in REITs. I have used the XRE for this purpose in the past for diversification.

  • willfly May 6, 2010, 11:34 am

    As a past owner of rental property; I cannot stress enough first posters comment that Ontario Landlord Tenant Board and their processes are extremely biased towards tenants. Just ask someone whos been through this once – evicting a tenant legally is as fun as getting tooth pulled out.

  • Ed May 6, 2010, 12:10 pm

    Have a rental which is two apartment house, is this considered having multiple units, can I claim a portion of my vehicle and home office?

  • STone May 6, 2010, 12:23 pm

    This is just for informational purposes, but another option on the REIT side is a Private REIT. These REITs are not subject to as many of the market fluctuations as Public REITs. Their value is based solely on the value of their assets and the revenue they can bring in.

    The downside is they are not as liquid as a public share and care and due diligence must be taken with any private investment.

  • Mike 4P May 6, 2010, 12:47 pm

    I think the main differences between REITs and real estate investing are:

    Time – If you don’t value your time very highly then real estate investing might be for you.

    Leverage – Typically real estate investors are highly leveraged whereas REITs investors are not. I think this factor has skewed the bias towards real estate investing since RE has gone up so much over the last 15 years that pretty much any real estate investment (bought on leverage) has outperformed equities/REITs without leverage.

  • Rezeau May 6, 2010, 1:31 pm

    This is a very good topic!

    I think people are more familiar with renting out real estate and don’t realize that REITs can be another option. I was thinking of doing the same (i.e.: renting out a condo in Ottawa), but from seeing some of my family’s personal experiences with their rentals, I think I’m going to look more into investing into REITs.

    Can anyone suggest some good REITs for Canadian investors? Or, where someone can get more information.

    Keep up the good work FT!

  • FT FrugalTrader May 6, 2010, 3:37 pm

    On the topic of leverage – while most investors may not leverage to purchase the REIT, the REIT itself most likely leverages to purchase their real estate assets.

  • FT FrugalTrader May 6, 2010, 3:38 pm

    Rezeau, here is a list of Canadian Reits.

  • martyfitz May 6, 2010, 3:57 pm

    Forgetting risk, time and leverage, what option give you best bang for your buck? I’m thinking owning real estate. Opinions?

  • The Passive Income Earner May 6, 2010, 5:02 pm

    Great Post! Both are interesting for me. I have REIT but no Real Estate yet.

    REIT are still a ‘stock’ investment. It usually pays good dividend for passive income but you are subject to market fluctuations. It’s much easier to get in than Real Estate.

    Real Estate can provide stronger income in the long term. Some of the pain of dealing with tenants can be mitigated by hiring or contracting out that work. I know someone in Vancouver that buys condos in Edmonton and Calgary and simply contracts out the services. You just need to factor that cost in your expense/revenue spreadsheet based on your cost and income from rent. You need to factor in an average occupancy as opposed to 100% in order to make it a viable income stream. Anything above the average is profit for the rainy days.

    I think Real Estate is more work than a REIT but the potential for ROI is also greater. You can use amortization deduction and expense out different cost. It should be treated like a business even if you don’t incorporate.

    Cheers!

  • KZ May 6, 2010, 6:23 pm

    I’m not sure if this is true, but I was under the impression that many (most?) REITs tend to rent commercial property rather than residential, exposing you to a different segment of the rental market.

    Thanks for the blog! It’s a must-read for me.

  • Ms Save Money May 6, 2010, 6:23 pm

    Very informative! I never really understood how a REIT worked but I certainly understand about it a little more! It’s always nice to learn something new.

  • FT FrugalTrader May 6, 2010, 6:56 pm

    marty, there is no right answer. It takes a certain skillset to be a successful real estate investor.

    KZ, it really depends on the reit itself. I believe that boardwalk concentrates on apartments, riocan is commercial, chartwells does seniors housing. Best to read the individual websites to see their coverage.

  • Rachelle May 6, 2010, 8:06 pm

    I don’t really think that REIT’s and real estate investments are directly comparable.

    REIT’s are valued according to the stock market. What will someone pay?

    Real Estate properly bought is valued according to cash flow. Experienced investors expect their property to pay them. None of these crappy condos with owners that subsidize their tenant’s rent several hundred $$ per month.

    I think a lot of the reason that many people have bad experiences with real estate is because they don’t buy the proper type of property. They also buy too quickly and pay too much. Then when they have a property they don’t have any property management skills.

    There’s a big difference between buying an investment property and buying a house you are going to live in.

    Furthermore in real estate as in the stock market there are a lot of sharks just waiting to devour the neophyte investor. You pay for your experience in the real estate market. It’s called the school of hard knocks and it’s as expensive as hell.

    Funny thing is whenever people talk about rental real estate they usually consider residential real estate. Even for beginning investors it is possible to buy commercial or industrial properties. I can assure you the laws governing these types of properties are much less onerous than the Landlord & Tenant Board.

  • M. Taylor May 6, 2010, 9:52 pm

    Are REIT’s way overpriced these days? Just like real estate.

  • Arlechino May 6, 2010, 10:22 pm

    Has anyone thought about using REITs as a medium-term vehicle for saving up a down payment? (for either a primary home, or investment property)

    Obviously, it’s too volatile for a short-term place to put your money. But over3 or more years, it might be a good idea, since it would probably hedge a bit against property price increases.

  • Doug May 7, 2010, 8:19 am

    Real estate has a diversifying function in portfolios. Morningstar in the USA recently did an analysis of REITs, and came to the conclusion that they no longer act as a diversifying agent. I haven’t heard of any similar Canadian analysis.

  • Doug May 7, 2010, 8:36 am

    From David Swensen’s book:

    “Although exceptions exist, for individual investor, pulbicly traded real estate securities generally provid reasonably low-cost exposure to relatively high-quality pools of real estate assets. Unfortunately, with few exceptions, privately offered retail real estate partnerships provide exposure to real estate at such obscenely high cost that the individual investor stand no chance of earning fair returns.”

  • Jason May 7, 2010, 9:14 am

    I think the key is due dillengence on the matter. I agree with Rachelle above. If you pick and choose your commercial and industrial properties well, the returns are far higher, and the onerus landlord/tenant act doesn’t apply.

    I can say on our commercial properties, our gross returns are upward of 12-13%, with a net of about 7%. That doesn’t include the appreciation of the property of itself, which if we’re conservative is about 3%. So our returns have been averaging about 10%. Of course, you need the cash upfront to pay for the downpayment, and qualify for a mortgage, if you need it.

    Furthermore, there is wisdom in incorporating to keep the business arms’ length away from your own personal wealth. However, if you structure your holdco wisely with appropriate dividend payments, there may be a tax benefit for a couple with a lower income earner.

  • FT FrugalTrader May 7, 2010, 12:37 pm

    Rachelle, that’s interesting that you mention commercial real estate. It’s something that has piqued my interest as of late, perhaps you can write about investing in commercial real estate in a future column.

  • Thicken My Wallet May 7, 2010, 1:38 pm

    Commercial real estate has a different analytical approach than residential real estate (and there are subsets of commercial real estate that have different characteristics as well). I would be interested in hearing what Rachelle has to say as well.

    I would mentioned liquidity risks in both. For REITS with large trading volumes, liquidity risk is relatively low. It is harder to sell real estate quickly.

    You are right- it really comes down to interest and mind set. As usual, know yourself and decide accordingly.

  • gpsguy May 7, 2010, 2:26 pm

    What about investing in Real Estate is through a MIC, Mortgage Investment Corporation? There are many good ones out there offering steady returns.

  • Aury (Thunderdrake) May 7, 2010, 4:49 pm

    When you own property, you have a lot more control. A sophisticated investor would know all the advantages of owning property. If it goes down, liability drops due to lower taxes. If it goes up, greater potential for capital gains. There’s all kinds of approaches and angles to owning property, as well as tax deductions. Arguably among the lowest.

    But it’s a very high maintenance investment. It’s a business pretty much, and you can’t keep it simple like you could with paper investments. Though I see a lot more potential for profit in owning the property itself. REIT’s lack the level of control that you could have on property.

    Though I would personally stick with REIT, if I wanted to invest in real estate. Namely because of it bearing similar properties to a stock, along with it’s low-maintenance hands off approach, as aforementioned in this article. It’s better suited for me. The only question now is.. Can I dabble in options with them?

  • Homeowners Insurance Agent May 7, 2010, 9:27 pm

    Whether it’s a REIT or an actual building, real estate is an important part of any serious investor’s portfolio. Remember too there is some middle ground between the hassle of owning property and the hands-off nature of owning a REIT. There is money to be made in (relatively) hands-off property like coin-op car washes, or tracts of land that are zoned for commercial billboards.

  • Financial Cents May 7, 2010, 9:42 pm

    @Frugal

    Personally, I have a hard time comparing REITs to rental property ownership, but I can see why you’ve tried to make the comparison. As you’ve written concisely on your own site, REITs are companies that invest in real estate assets and distribute their income (primarily from rent) to their shareholders. Investor-owned rental properties, on the other hand, are not companies at all and you (the investor) do not get paid in the form of dividends or return of capital but rather, your take is rental income after expenses.

    REIT’s are valued according to what the market says they’re valued at whereas your rental property is valued from the local economy.

    Having owned both, still owning REITS, I like the latter much better. There isn’t any glory to being a landlord and many things can go wrong with this investment – even if you are mostly hands-on and buy to what Rachelle says, the right type of property. We bought the right type of property, in a moderately new building, with minimial maintenance, and had a few bad years with horrible tenants. They weren’t crooks, criminals, mean, uneducated or unprofessional. They held upstanding government jobs. Simply, they didn’t care for the place as much as we, the previous owners, and in the end, we sold because we couldn’t stand seeing the unit depreciate so much from what it once was. So many things about being a landlord are beyond your control.

    While you don’t have much “control” over REITs, the educated financial investor always knows what he/she is getting into. With so many variables, I’m not convinced the same is true for the educated rental investor.

    In closing, an insight post Frugal!

  • wayne May 8, 2010, 2:12 am

    Do you have any insight into avg return on investing on rental properties? After all that’s a major indicator of which investment to take on.

  • Rachelle May 8, 2010, 12:58 pm

    There is no average return on investment properties. Most investors like to see a 10% capitalization rate. This is a rare animal indeed in Toronto.

    You would calculate this rate by taking your gross annual income and substracting all expenses (property management, vacancy loss, utilities, taxes, maintenance) then dividing by the purchase price.

    For example lets take a condo rented for $1000 per month

    Income 12000
    Property management 5% = 600
    Maintenance fees = 1800
    Vacancy 5% = 600
    No utilities
    Taxes = 2000
    Maintenance 5% = 600

    Your Net Operating income then becomes $6400/200000= 3.2% cap rate.

    This is unlikely to cover your mortgage expense unless you put a huge down payment on the property.

    Then you also evaluate your cash on cash return.

    If you have an income generating property unlike the one above you can evaluate how much you will make on the amount you had to put down on the property.

    For example lets say you buy a property for $1,000,000 but you only have to put down $100,000. The vendor takes back a mortgage and that’s how you do it. Lets say after budgeting for all prudent expenses as above plus your mortgage payments your income is $12,000 per year. Your rate of return on the actual money you had to deploy is 12% and that is cash on cash return.

    Problem is when you buy the property the current owner often fudges the actual expenses. You as the buyer want to inflate those numbers as much as possible so you can build yourself extra profit and breathing room.

  • Nat May 8, 2010, 2:50 pm

    We bought our first rental property (fourplex) almost 2 years ago. We have a monthly cash flow of about 1300 from the property after paying all the expenses/mortgage when it is fully rented, or dp was 34k. My husband lost his job a year ago and is still looking right now. If we didn’t purchase this we’d be in real trouble.

    If we bought a reit we’d have to pull out our investment and live off the 34 k, this way we have appreciation of about 20k so far plus we have a monthly income of 1300. We have excellent tenants, we make them fill out a 5 page application, do credit checks, call all their job/personal/previous landlord references. The tenants that are too lazy to fill out this huge application are not even looked at. We prefer excellent tenants and all gave us postdated checks. Take your time finding good teants, that’s in your best interest.

    It took us 1.5 years to find the right property, they are extremely rare. We bought it after it had been on the market for only 24 hours (we gave 24 hour notice to view it as soon as it hit mls and we made our offer immediately). I had a real estate agent email me all new properties that hit mls as soon as they were listed, this is how we were first in line. Do your research. On the property, the tenants, the realtor, the financing, the landlord and tenant board, the area where you are investing and chances of getting burnt are way lower.

  • qmanrei May 8, 2010, 11:30 pm

    I usually don’t waste my time commenting on these real estate posts because the view of 97% of the population is looking for the easy route when it comes to investing in real estate.

    REITs are focused on cash flow, purchasing large commercial or multi-family properties, and paying dividends. REITs are a product that can be easily consumed by the masses. As far as I’m concerned equivalent to mutual fund investing, another marvelous middle class investment tool. Are you really expecting anything different than your big name mutual fund investments? REITs vs Real Property is an apple and orange comparison.

    So why would anybody do the same thing over and over again and expect different results. Mutual Funds, REITs …

    With a REIT you are at the mercy of someone else controlling your investments. Management and expenses are dictated to you. You have no control over cash flow, entrance and exit strategy, the day to day operations, and actually seeing the type of returns that real estate offers over the long term. Another words in order to be successful in real estate you have to be able remove your emotional attachment to the property and treat it like a business. This isn’t easy for most people, neither are they ready to run a business.

    We have a number of rental properties (condo townhouses, freehold townhouses, semi-detached and detached homes – all starter homes) and do much better with them, than any investment or business than we have had in the past 20 years.

  • qmanrei May 8, 2010, 11:41 pm

    A really nice feeling is taking your original investment out of a property tax free, and then trying to calculate your ROI or cash on cash, with no money in the deal. But it takes time and hard work to run a Real Estate business.

  • David May 9, 2010, 4:05 pm

    Rental income qualifies as eligible income for purposes of calculating RRSP contributions whereas REIT income does not.

  • Play with the odds May 10, 2010, 3:29 pm

    I’ve gone down the executive condo rentals because I have more faith in the appreciation prospects of actual property then I do one thousand arms lengths.properties that REITs represent There’s something to be said about controlling your destiny.

    I specifically shy’ed away from anything but condo rentals because I wanted to avoid the headaches of repairs. I’m relatively young though – 28 years old – so this may play into as well.

    That being said, any TFSA investments that I can afford to make are the REIT investments (haha).

    I think that REITs are great for people looking for steady, and relaxing cashflow – i.e. those looking to retire. For longterm capital gains, I have abundant faith in owning my own properties.

  • Darren May 10, 2010, 3:59 pm

    Personally, since I don’t think I can put up a down payment and possible mortgage, investing in REITs is the route I would go. Also, I don’t think I’d enjoy the process of dealing with tenants and managing the property itself.

  • Play with the odds May 10, 2010, 5:05 pm

    “Personally, since I don’t think I can put up a down payment and possible mortgage, investing in REITs is the route I would go. ”

    VERY good point.

  • uncle pirate May 10, 2010, 10:46 pm

    Real estate did very well for us in the past years, but sold out after too many hassles with tenants. That said, now REIT ETFs have done very well for us over the past 10 months.

    If real estate drops significantly I’d entertain being a landlord again.

  • Ryan May 13, 2010, 1:32 am

    I work in the financial industry and see people make this decision every day. Frankly, I cannot imagine why anyone would ever choose physical property over a REIT.

    Whenever a property owner comes in to see his accounts, they are always stressed and busy. What are interest rates doing? Is my mortgage going to go up? The tenants keep pouring oil down the drains and I need to completely redo the plumbing… There are so many possible disasters and hidden costs.

    I’ve asked people what their approximate returns are on their property and it is generally goes from losing money into the 4-6% range.

    I can buy a REIT instantly, give you upwards of 8% yield, capital appreciation and not force you to tie your capital up in an illiquid market. That’s not even counting the savings you will make in time and stress.

    Frankly, unless you are willing to devote significant amounts of time into what will essentially become a second job the choice is brainless. Even if you are willing to devote yourself 100% into managing property, there is still a hard decision to be made.

    What generally happens is people jump onto the train during a bubble and then become too emotionally invested in their decision to get out. I would never invest in real estate directly, nor would I ever recommend it to others.

  • Nat May 13, 2010, 9:32 am

    Ryan, here are our numbers:

    Our Downpayment: 34k
    Cap rate: 9.52%
    ROI on our downpayment: 27.66%
    ROI using cost to purchase (this is the bank’s money + our own): 19.44%
    NOI: 23792
    Vacancy: 5% (we have not had one yet but we say it’s 5% to do our calculations)
    our monthly cashflow income after we pay ALL expenses including our FIXED mortgage (we never worry about interest rates!) $1176
    Appreciation: about 4-8% per year

    Obviously we have a much better return then you ever could even dream of. Oh, it’s also guaranteed.. the bank could put interest rates at 12% and we would have a -$11 cash flow (if we depended on their rates), but of course we have a fixed mortgage…

    Like I mentioned above, the tenants are not the problem, the landlord’s approval process is.

    Nat.

  • sunnydee07 May 14, 2010, 2:05 pm

    Does anyone have a good source to learn more about REITs? I currently have a rental property which currently houses excellent tenants, so our experience has been good to date. We also are planning on keeping this condo as a long term investment.

    As an additional investment though, we’d like to consider REITs but need more info.

  • Nick May 15, 2010, 8:28 am

    There’s no free meal ticket. If you want to sit back and make money without any risk or heartache then get in line with millions of other people with billions of dollars who will bid down your return to nothing.

    Whether its stocks, REITs or rental properties to make the most money you need to take the most risk and make the right decisions. Simply buying a dog REIT and hoping it beats the market isn’t exactly the right decision just like buying a cheap triplex with great numbers isn’t the right thing to do either. You get what you pay for so you have to really know what you’re buying regardless of what it is. Usually the “best looking” investments, ie safe, making money, etc, have the lowest returns because everyone wants them. Your job as an investor, whether its oil paintings, stamps or bank stocks, is to find those investments that for some reason aren’t priced correctly or have the ability, given the right conditions, to provide above average returns.

    I buy properties in good rental locations (not cheap) but have problems like bad tenants, low rents or poor condition. These are temporary conditions that I can fix. Buying in the wrong location, a structurally bad building or paying full price with no room to increase rents in the future are things that I can’t change and will result in poor returns. The same concept applies to stocks – but, as pointed out, you have no control over these decisions as a tiny shareholder.

    I like that most of the commenter’s here don’t want to deal with tenants. With less people interested in getting their hands dirty, I can make better returns. Its a lot of work but if you research you local market, know your rights, are a strong, fair person then you can enjoy well above market rates in your investment. Six years ago with $30K I bought my first 4-plex. I’ve moved 4 times since then and lived in buildings with tenants until 2 years ago. Was it difficult? Yes. Was it a lot of work? Tons. Do I have debt? Tons, but like the 10 different hammers I have, its something you need to get the job done. Having no debt in a low-interest time like now makes zero sense. Would I do it again? In a second. Did I beat REITs? Well I have rental income of $180K/yr (which after paying my wife, cell phone, truck internet, home office, etc, I can whittle down to $2000 or so for income tax), own over $3M in property, a net worth around $1.2M and have $200K ready for my next purchase. If I put my $30K in REITs? Well I would have had more time to drink beer, spend money and hang out…

    Oh, I did all this while having a career that required me to be overseas for almost a year. Also found a girl and got married, travelled 2-3 weeks a year and renovated 2 homes. Sounds like a dream but I also worked on average about 60 hours a week. Nothings for free.

  • Ron August 27, 2010, 3:18 pm

    I own a small 2 unit rental property in Newmarket, Ontario. Aside from the tax advantages, equity growth we net $500.00 a month. Would for example selling the property and investing 30K in a REIT (considering market fluctuations) yeild us more than 6K per that we currently get and when you consier tax advantages and equity growth would a REIT put us futher ahead in the long run?

    Thanks.

  • Cam August 28, 2010, 8:57 am

    For all of you that are trumpeting your excellent returns on rental properties, here are a few things to think about:
    1) Legal Liability – Your tenant falls down the stairs because a handrail comes off or says a stair is too narrow and sues you – you could lose 20 years of gains overnight

    2) Costs of getting out – not only is real estate less liquid, but selling often costs you 6% in real estate agent’s fees. So, you buy a $50k property that goes up 3% a year for 10 years, which isn’t bad. That makes the property worth $65k, but then you pay $5k to sell it, reducing your gain to 20%.

    3) Unrealistic expectancy for vacancy rates – many of you quote 5%, but if you have a fourplex and have just 1 unit vacant for 12 months over a 5 year period you have hit that. So, let’s say the average tenant is there for 2 years. During that period you go through 10 tenants, if you have only a month vacancy between replacing tenants you are nearly at that 5% rate.

    4) Many of you say that REITs don’t offer you the appreciation: Check out Annaly Partners – a large REIT. In 10 years the price has gone up 100% and the average annual dividend yield is over 10%. EQR has gone up 88% over 10 years and pays out about 3.7% on average… not as good, but still reasonable.

    For me, REITs seem like the way to go for now… I can get in an out of the market when I please for very little cost, I don’t have to worry about tenants, property conditions, hurricanes/floods/fires, lawsuits, etc.

  • Cam August 28, 2010, 9:08 am

    Ron – would selling your property and putting that 30K into a REIT yield better returns? Maybe, maybe not.

    Part of that depends on your “luck” with the property and how you value your own time.

    LUCK:
    How do your tenants treat the place? What type of condition is the place in? What is the Aircon/heating dies, the roof leaks, or a pipe bursts? Maybe you own the property for 10 years with no problems, but then maybe next month you get hit by all three problems. This is where diversification comes into play. REITs diversify you, owning two units does not.

    The other thing to consider is how do you value your time? If your job pays you $20/hour and you have to spend 10 hours a week “working” on managing your property then you have spent $200 of your time… multiply by 50 weeks a year and you are at $10,000. Maybe you don’t want to view it that way, but I really value my free time because I already work long weeks. However, with a REIT you spend 30 seconds a day checking out the share price… that’s 120 minutes/year = $40.

  • Cam August 28, 2010, 9:28 am

    Nat & Nick (+ others) – you two seem to be serious real estate investors, so here is my question to you:

    How do you value your own time and is property management your full-time job? How long did you actively spend searching for your property? How much time per week do you spend on managing your property? How much time do you spend hunting for you next investment property?

    I think this is important as “time is money”, as the saying goes. Let’s say you were efficient and only spent 1-2 full weeks searching for your property: 40-80 hours. Your property is low maintenance so you only spend 1 hour/day managing it (you take some days off): 200-300 hours/year.

    That is 40-80 hours of sunk time before you buy (1 time expense – numbers below use 60 hours) and 200-300 hours/year managing your property (continuing time expense – numbers below assume 250 hours).

    If you value your time based on what your job pays you, this is how much of your TIME you spend costs you (assuming 40 hour work week, 50 weeks a year for calculations below).

    $40k/year salary ($20/hour):
    60 hours = $1200
    250 hours = $5000

    $75k/year salary ($37.50/hour)
    60 hours = $2250
    250 hours = $9375

    $150k/year salary ($75/hour)
    60 hours = $4500
    250 hours = $18750

    That calculation above, and the value I place on my time, is why I see REITs as the investment for me.

  • Draino September 3, 2010, 6:13 pm

    Cam: If you are spending 40-80 hours a week looking for an investment property then you need a new real estate agent. Poor tenants can lead to a lot of hours spent at the rental unit, as can the purchase of a fixer upper unit. If you have a good agent who has a fixed criteria to meet before bringing you a new property to view then you can cut your time significantly. If you buy a property in good condition and get the proper tenants you can also cut more time.

  • Cam September 7, 2010, 5:18 pm

    Draino,

    I’m talking amount of time/year, not per week. How much time do you all spend tending to your rental units?

  • Dave October 17, 2010, 7:05 pm

    Wow – interesting comments on this comparison. And while it’s very difficult to compare investing in REIT’s with owning rental property (very much like apples and oranges), it really comes down to the investors willingness to understand what they are actually investing in.

    qmanrei ,Nick, and Nat were right saying that you have to work at the investment (vs. just handing your money over to a REIT). The absolute best investors are always the ones that take the time, take THEIR time learning, researching, understanding the investment vehicle. It doesn’t matter the vehicle so much as the investor and the time and energy they are willing to commit to being a great investor.

    No one is going to become super wealthy, rich, retire easily if they invest in actual real estate OR REIT’s/Mutual Funds/Stocks unless they take their time understanding the investment. If you hand your cash over to someone else to manage it for you, in most cases, you will not do nearly as well over the long run as if you had invested it yourself. Why do you think it’s the case that all the richest people in the world invested in businesses and/or real estate? They didn’t hand their money to a REIT or mutual fund manager or stock picker. They got involved with a business or real estate and went from there.

    We have taken a bath on a couple of our real estate investments over the years because we got into a property or a location without researching it thoroughly. Let’s call it a $20,000 lesson. But guess what, with each property we buy now we are making consistently great returns because….we took the time to understand and get better at investing. Our returns on our cash and our Joint Venture Partners capital are consistently very strong. And the number 1 reason why that’s the case is because we understand HOW to invest in our particular vehicle.

    The lazier you are when it comes to your investing, likely the worse your returns. It’s as simple as that.

  • Nat October 17, 2010, 7:53 pm

    Cam, at the start we only spend maybe 10-20 hours to find the property, viewing only the ones that we’ve analysed prior to viewing, and interviewing the listing agent by phone.

    Management doesn’t nearly take 250 hours/year, right now around 1 hour a month and that’s being generous.. Definitely worth my time.. each time we buy one we add 1k of monthly cash flow. And if it gets too much of our time we can hire someone to manage it, there are lots of people looking for work.

    Prior to starting though you need to spend a lot of time to learn all the rules and how to analyze a property/business unless you want to learn the tough way and quitting like many people do.

  • Nat October 17, 2010, 7:55 pm

    Dave, totally agree with you. If people invest in REIT’s go ahead :D We might eventually start our own and sell it to you guys keeping most of the profit of course..

  • Dave October 17, 2010, 8:18 pm

    Nat, good call. We have discussed creating our own reit or syndicate too. It may happen, but right now we are just enjoying making consistent, solid, and predictable double (and sometimes triple) digit returns for ourselves and our JV Partners.

    I can’t recall if it was mentioned in the article or any of the comments, but one HUGE advantage owning real estate over a REIT or other “liquid” investment is leverage. Where else can you acquire and control a, for example, $300,000 asset with only $60,000 (or less if you get creative) cash? That $300,000 asset appreciates only 3% in one year and just like that you have a 15% ROI on your $60,000. And that ROI doesn’t include any cashflow or principal paydown. How do you acquire and control $300,000 worth of mutual funds, reits, stocks, gic’s? You pay $300,000 out of your pocket. OR, as the banks like to suggest, you borrow $300,000 as an investment loan to buy those units/shares. But, who pays for that loan? YOU do. So, you borrow $300,000 at say only 4% interest. The REIT, with dividends returns say 12%, netting you a whopping 8% ROI. Meanwhile, my tenant is paying for my borrowed $240,000 mortgage plus all my other expenses and I get cashflow too.

    Personally, I just don’t get why people invest in anything other than real estate or a strong business, but that’s just me. And I guess I like it that way, like you Nat, because that means more profit for us.

  • Nat October 17, 2010, 8:47 pm

    You are 100% right Dave. I do try to help people but I think fear holds them back. Knowledge is kind of the opposite of fear, because you can learn from other people’s failures and history. And if they want to be ‘safe’ and invest in mutual funds etc instead, that’s their choice. Some think we’re crazy, but living through a job loss, collecting rents and living off them, is so much better then cashing out your savings and drawing those down, then paying penalties etc. Plus you didn’t mention that our investment (plus the bank’s) is protected by insurance…

    Also, say the value of the real estate goes down, since it’s cash flow positive I wouldn’t really care. I’m in it for the cash flow and the appreciation ROI of 15% you mentioned is kind of like a nice bonus that you don’t really notice until/if you sell much later. Good luck to you :D

  • Andy May 11, 2011, 11:24 am

    How does this conversation change if you have the opportunity to buy a building that your business will occupy – so that eliminates the tentant headache…because it is my business of approx. 80 total employees. In this instance, is owning the building better than a REIT? Our group has the option to pursue either choice. Which is better?

  • Rachelle May 11, 2011, 11:37 am

    In this case I would just give you some examples of companies who have used this strategy extremely effectively. McDonalds for instance has a sizable percentage of it’s net worth in it’s well located retail spaces.

    Google is also following this strategy.

    Leasing commercial space for your company starts to have some problems for a few reasons, first any changes you make or anything attached to the walls and floors belongs to the owner, second at the end of the lease the owner can raise the rents as much as they like or refuse to negotiate entirely if they want to change the use. A ten year lease sounds long but isn’t that long when you consider the possible expense of moving.

    Then there’s a possibility of buying something bigger and leasing out a part of the space to provide for future growth.

    In your case, I would consider buying for other reasons not just the rent/REIT situation.

  • Nat May 11, 2011, 11:39 am

    I would talk it over with an accountant.. if you occupy the building yourself w. employees you will get many tax writeoffs plus appreciation, but if you invest in the REIT you will not have a tax advantage I believe. An accountant can calculate the benefit either way.

  • onemillionby35 November 3, 2011, 5:50 pm

    Can someone please explain to me how it can be possible for Nick to have a rental income of $180k/yr after all the expenses he stated above given that he has about $3.0 million in real estate properties and $1.2m in networth?

    That works out to be 15% ROI in +ve cashflow! That number obviously doesn’t include any appreciations on properties themselves.I don’t know any where someone can buy properties that gives you that much return in cashflow.

    I own four units of rental properties so I understand how numbers work but his numbers seems to be quite high for rental income. I would love to know and learn if it is actually achieveable.

  • Rachelle November 3, 2011, 6:34 pm

    If the numbers are correct and he has property valued at 3 million and his new worth is 1.3 million then his properties are about 40% equity. Which means they will definitely cash flow. However if you keep reading he also mentions that his net for the tax man I’d about 2 k but he pays his wife too.

    Depending when he bought this is entirely possible. Keep in mind that inflation and improvements can substantially increase your rents while you are still paying the mortgage on the original purchase amount.

    A lot of being in real estate is a waiting game.

  • onemillionby35 November 3, 2011, 6:43 pm

    Rachelle,

    You are right, I must have misread what he meant by $180k/yr is actually gross rental income and not NET. What I’m interested is knowing what his net profit (after paying taxes and all other expenses like mortgages, strata fees, property taxes…etc) would actually be.

  • BeachBoy November 13, 2011, 9:43 am

    Time is money. Recently I have invested in a private REIT – Centurion (8.5% DRIP compounded return + expected 3-5% appreciation) and at the same time have been looking at a real estate joint venture for properties in Barrie. After dropping off a cheque, the Centurion folks take care of everything, even paperwork and setting up trust accounts (RESP, etc) – just sit back and collect returns. Most returns are return of capital which is an advantage for some.

    With this REIT I can spend time with my kids, teach them The Wreck of the Edmund Fitzgerald on guitar, help research high schools, spend time with an aging parent, volunteer with Scouts Canada, etc – priceless.

    Of course the ROI for Barrie rental properties is greater … but trekking up there for a home inspection during November’s first snow storm after work? Not so appealing. My read on some REIN types is they absolutely love real estate and don’t mind the time they invest in all the research, doing the books, or fixing toilets. For others who value time, consider the certain exit costs as noted above, and the certainty of big one-time repairs in the property life-cycle (roof, furnace), not to mention the longshot slips & trips liabilities, the real estate ROI is certainly eroded.

    [ I also think Rachelle has shown how some of the general REIN ROI numbers broadcast on BNN for places like Hamilton have been “pumped up”. So unless you put in the time you could end up with a mediocre property.]

    My first house purchase had 2 rental units and I’ve lived through the good and the bad tenants, the spring melt/flood etc and it is all part of the gig. If you are ready for that, are beginning your “journey” and need the potentially higher ROI, have no significant opportunity costs for your time (maybe think broader than your day job pay rate) then real estate is for you. If not, you can invest in a private REIT (accreditation depends on your province) and still enjoy the benefits of holding real estate assets … albeit at safe distance that doesn’t require snow tires!

  • Jc November 29, 2011, 10:07 pm

    I am surprised at all the negativity towards Rental property, I actually own 2 semis and so far so good. I put 5% down of my own money, and now a tenant is paying off my house for me. So yes, if you only look at the $200/net income I make , it seems quite small. However the point here is that out of say $20K in mortgage payments per/year 12K goes towards principal aka EQUITY which a tenant is paying for me. So above the $2400 net income/year I also build 12K in equity which will only get bigger every passing year.

    I was one of those people skeptical especially with so many “horror” stories you hear about tenants, but figured I would be patient , do really good screening and take a chance. Glad I did. The best part is that in 15 years both places will be paid off through tenants.

    And all this talk about repairs, you would have to change the roof, windows if you lived there anyway.

    REITS are definitely a good option if you have TONS of money. The Canadian reits payout roughly 7% /year so in order to make what I do through income/equity from my property roughly 14K, I would need to invest 200K in a REIT. Yes the housing market can crash, but it would take the stock market with it.

    This is a great article, I think people discussing investments in general is great. Just wanted to share my experience. Passive income is GREAT no matter what the source.

  • Retireby55 March 13, 2012, 4:24 pm

    after seeing the recent valuation of REITs, is price already at/near the top?

  • Gregg November 20, 2014, 2:34 pm

    I’m surprised that the main difference between RIET and Rental Real Estate has been left out……Return On Investment!

    With a rental property your return is three pronged: 1. Monthly cash flow 2. Mortgage pay down 3. Property appreciation(percentage of full value of the property not just what you intially invest). Your ROI on a REIT is simply just a percentage (usually quite low) of what you invest.

    Compare your ROI on an investment of $20k in a REIT with purchasing a rental property with the same $20k. REITs do not even come close to the ROI of a rental property.

    If you buy a REIT you might as well just walk down the street to your local bank and buy a Mutual Fund….waste of time

  • cristine reyes September 2, 2016, 5:13 am

    Helpful comments ! I loved the analysis ! Does someone know if my business might access a blank OREB No. 16 form to use ?

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