By Ee Hsin Kok. Edited by Arjun Chandrasekar.
A REIT is a company that raises capital from a group of shareholders in order to purchase and manage a portfolio of real estate properties such as shopping malls, offices, warehouses, and hospitals. Unlike normal property, most REITs are publicly traded, making them highly liquid, and they are most commonly bought for their high dividend yields. In this article, we will go over the main differences between REITs and Physical Properties.
How Do REITs Make Money?
REITs pool together capital from a large group of investors in order to act as a mutual fund for Real Estate. The dividends generated by the properties purchased are then given back to shareholders in the form of dividends, this is what allows many REITs to have high dividend yields in the range of 4 to 8%. In addition to that, REITs also take a management fee which is usually less than 0.5% of deposited properties.
REITs vs Physical Properties
There are 6 main reasons why one might buy REITs over physical properties, they are:
- Low Capital Requirements
- Access to prime real estate
- No need for mortgage loans and transaction fees
- Do not need to manage tenants and properties
- High liquidity
- Diversification of risk
Low Capital Requirements
Imagine that you wanted to buy a rental property. Chances are, you’d need to fork out tens of thousands of dollars for a downpayment, and have to take on a couple hundred thousand dollars of mortgage debt. Unfortunately, it takes most people a lot of time to procure that much capital. On the other hand, REITs give you the opportunity to buy into real estate with as little as a couple hundred dollars!
Access to prime real estate
This is related to the last point, but imagine you wanted to buy a piece of prime real estate in the city center. Unless you’re very wealthy or know the right people, you probably won’t be able to afford it, nor will you have access to buy it. On the other hand, you can easily purchase a REIT that owns a piece of that prime real estate!
Mortgage Loans and Transaction Fees
There’s no need to go look for a mortgage, no need to hire a real estate agent and pay him/her commissions. All this is managed by the REIT. REITs make buying real estate a lot less stressful and time-consuming.
Do not need to manage tenants and properties
Another big issue people have with owning physical properties is dealing with tenants. Finding and vetting tenants is a tiring process, and then managing their complaints, hoping they won’t destroy your property, and that they’ll pay rent on time… it can be exhausting. But with REITs, you can take a backseat and sleep with peace of mind because all your properties are being managed for you.
While physical properties can take months or years to liquidate, REITs are highly liquid because they are often traded publicly. This means if you needed cash to redeploy into a different investment, or to cover emergency expenses, it would be a very quick and easy process.
Diversification of risk
Owning physical real estate requires a lot of capital. Even wealthy people aren’t able to own more than 5 to 10 properties at any one time. This means that a lot of one’s wealth would be concentrated in a certain market or location. If the market in that area or country crashes, for example, there were natural disasters or political problems, your investments will be significantly affected. On the other hand, REITs allow you to own hundreds of properties all around the globe, bringing your unsystematic risk to a minimum.
In this article, we covered the basics of what REITs are and the benefits of buying them over physical properties. So if you’re someone who’s looking to get into real estate but have not yet pulled the trigger on any physical properties, you might want to consider REITs instead!