To Have or to Hold: The Pro and Cons of Investing in Real Estate (Either Directly or Indirectly) 
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The following is a guest post. If interested in submitting a guest post, please read my
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Thank you MM for the opportunity to write my first guest post.
Who am I? I’m a professional starving artist in both the music and photographic world trying to find financial freedom on a pauper’s income.
After many years of financial floundering I decided to take advantage of my time and start investing for my future. I would love to jump off on a tangent here and talk about how financial advisers aren’t in it for you (they are in it for themselves first,) but that would be a whole post unto itself. (Thankfully for you I’ve recently written one: http://thestarvingartistcanada.blogspot.ca/2012/08/financial-advisers-or-diy.html) But the long and the short of the matter is that for anybody who is not from old money the only way to financial freedom is through investing.
So, you’re a recent graduate and either in debt or nearly broke. You have an erratic to non-existent income, or you just landed your first entry level job, but live in a city where that doesn’t even cover basic needs. You’d love to have a steady income stream but you don’t know how to do that aside from already owning a home and renting out a basement apartment or having an additional rental property.
If you could come up with a down payment and think you’re the person who likes to be hands on and wants to take on the responsibility of a rental property yourself. What could happen? Lets say your furnace exploded on Christmas Eve and you weren’t able to source a new furnace, have it installed and tested until 3 days later. Thus causing your pipes to freeze and then burst. As a result, your tenants decided to take you to the housing tribunal for arbitration for failing to provide heating, all the while living on your property WITHOUT paying you anything. You are left with the financial burden of keeping up with your mortgage, gas, water, electric, and insurance payments until the arbitration process has concluded, which can take up to 6 months! At which you’re left with a judgment in your favour but the tenant decides to move on leaving you with nothing for the 6 month period they lived on your property. If you couldn’t make all your payments for repairs the contractor might have put a lien on your property. If you all of a sudden needed to sell the property then getting the lien cleared would slow down your closing time.
But if you’re like me you don’t have enough money for the down payment on a home (Median home price where I live is $550k) what can you do? Aside from selling pint after pint of blood, or striking up back-alley deals you will be happy to know that there are companies out there, both public and private called REITs. REIT stands for Real Estate Investment Trust. These are businesses that quite simply buy properties, build buildings and rent them out. They take care of all of the business of renting and send you your slice of the profits every month. This of course frees you from the panoply of glamorous jobs that come along with owning rental properties.
Private REITs often require that you have a significant sum of money to invest so that leaves you with publicly traded REITs. (Full disclosure: I own several different mostly Canadian publicly REITs) Yes, this does require that you have a brokerage account (get a discount-brokerage account and do it yourself!) and buy units (shares) of these companies on the open stock markets. The minimum requirements for a discount brokerage account in Canada are quite small, (around $1000 or so) so it’s not all that hard to get into it. And, because the best online brokerages are publicly traded it’s very easy to sell your shares and cash out.
There are many, many different REITs in Canada. Most of them try to pick their desired customer and stick with it as the stock markets seem to prefer “pure-play” type companies. Pure-play simply means you do one thing and you do it well. Some deal entirely with industrial tenants, some like retail, some like office properties, and some deal expressly with medical professionals. So you get to choose what sort of customers you want.
How much do they pay? Typically most REITs in Canada, (the healthy well run ones) pay somewhere in the neighbourhood of 4-8% annual yield. No, it’s not guaranteed, but that’s where a bit of research is required on your part to make sure you’re comfortable with a company like this. Thankfully there are wonderful research tools available online you will be able to figure out which ones are right for you.
Lastly, most REITs are very tax-friendly for investors of ALL tax brackets. (Even the low/no tax bracket like mine and other starving artists!)
If you’re still leery of investing, I strongly urge you to read my post: http://thestarvingartistcanada.blogspot.ca/2011/01/get-that-money-out-of-mattress-young.html as you have only a lifetime of financial servitude ahead of you if you don’t invest for your future.
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I have a portion of our portfolio in REITs and the returns on some of them have been outstanding over the last couple of years. The difficult part to them is that sometimes your money is locked up for multiple years and you never really know the value of the REIT as it’s ultimately determined by the appraisal amount of the property the REIT owns.
Saying that, I will definitely own real estate on my own at some point in my life. I simply feel I could do a better job at finding “deals” and I wouldn’t lose some of the profits that the REITs suck away.
For sure, renting out property directly could be far more profitable, but it could also carry more risk and much more work. As much as I’d like to own a rental property at some point I just don’t think I’m handy enough. So going the REIT route might be better, although it probably wouldn’t be my first investment choice.
Sounds like you own some privately owned REITs.
I only stick to the public ones as they trade on the stock markets and you can see the value instantly. (Or with a 15 minute delay depending on your brokerage).
Additionally I can sell all my holdings in seconds if necessary.
As for profits getting sucked away, what happens if own your own rental property, but your insurance company refuses to pay out a claim as they say it was an “act-of-god” like a tree falling through the roof, or a flood, or a drunk, uninsured driver decides to take a tour of your living room with his car? You’re out of pocket with a big part of the profits you haven’t yet earned.
I’m not saying that direct ownership isn’t generally more profitable, but it also comes with greater risks than buying REITs.
I’m right there with you. “Profits being sucked away” = “Time I don’t have to spend managing the property.” This is just as if you purchased a property and then paid someone to manage it for you, and also paid a bookkeeper to handle the accounting and taxes work. REITs provide a great way to invest in the real estate market and create a more-diversified portfolio without the downfalls of actually owning property yourself. REITs don’t suck the profits out any more than the overhead of any other company sucks the profits outs.
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Thanks for the post. REITS can be a great way to provide income if you’re looking for a good dividend play. There are many available, you just have to do your homework as you suggest. They’re required by law, in the US, (not certain for Canada) to return at least 90% of their taxable income to investors. If you can find a good one, then you can generally count on a handsome dividend in return.
Hmm that’s a pretty good law. With something like that in place it makes it a lot more tempting. I assumed the company would keep more profit to themselves.
In Canada it’s not required by law. But the tax structure is setup so that they are encouraged to do so. The accounting determines what portion of the payouts are “income” (fully taxable), “dividend” (somewhat taxable), and “return of capital” (which is taxable later as a capital gain)
REITs are a good way of investing in real estate without the need for a down payment. In the long term (maybe not the short right now), I think real estate in Canada is a good investment, so I’m all for it!
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I guess it’s just a matter of doing the proper research to find a good company in a strong market. I’m going to have to talk to some of my investing friends about mixing some of this into my portfolio.
I found this post VERY interesting. IF they do this in the U.S. it may be something worth looking into. Great post!
I agree about the US part! Super interesting article.
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I’m sure it’s available in the US since John mentioned above how there is a US law about how much of the income has to go back to investors.
There are some very high dividend paying REITs in the US. I have owned “IVR” (investco real estate).
Additionally, I’m looking at Annaly Capital Management (NLY-N).
Both offer some very very attractive returns.
I’m not sure that we have this in the UK. Personally, we used equity out a parents house to help pay for the downpayment and ‘unlock’ better interest rates!
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Yeah I don’t think it would be the best option right when you are trying to build up a decent sized down payment for your own home. It might be worth looking into when you have some money to invest down the road.
You most certainly DO have REITs in the UK.
http://www.londonstockexchange.com/specialist-issuers/reits/reits.htm
I do NOT know how the tax laws pertain to them though. I suspect there are similar advantages as there are in the North American Markets.
I have a REIT and some rental property. It’s been pretty happy with both. I’m a big fan of real estate, especially of the rental variety if you can take the occasional headache…
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That’s a good idea to have both. Then you get some stress free REIT income as well as the more profitable but potentially stressful direct rental income.
I have never invested in an REIT, and I’m not really sure that I would. Personally, I want to be able to be in total control of the real estate in which I invest. Luckily, I have had the money available to purchase some rentals – which I understand not everybody can do. However, for me, part of the value of owning real estate is that it is actual real property, not paper money. If it were me, I would use the REIT’s as a savings vehicle in order to buy actual real property.
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It sounds like the rental property route is working out for you and Holly. You would definitely have a lot more control in that situation. I think REITs are more suited for people who don’t want the burden of all that control. Some people would rather have someone else manage it all.
Owning directly exposes you to DIRECT risks of tenant default, lawsuits, and more.
Having a REIT diversifies your tenant base, diversifies your number of buildings, and has a professional management team to look after everything for you.
While you may think it’s only “paper” you do actually own a percentage of the business and all those properties. If they ever do have management troubles, the value of the company is still nicely propped up by the value of the properties.
We’re lucky that real estate is affordable in our area right now. I would rather invest money in something I can choose and see. However there is an appeal in not having to deal with maintenance or other unseen expenses that come with owning properties.
It really depends on your personal investing preferences as well as factors such as whether you are handy or have good contractor contacts. With rental property you do need flexible enough finances (and time) to be able to cover those unexpected expenses.
All the reits I own have listings on their websites so you can see what properties they/you own. You can go visit them any time!
My favorite part of a REIT? You can own real estate without having the landlord hassles. I have both, and REITs are so much more fun most of the time!
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Yes landlord hassles don’t sound like much fun. Unless you happen to get lucky with landing really good tenants, there could be so much time and effort going into maintaining the property and occasionally finding new tenants. Plus there’s the random stuff like paying property taxes, collecting rent, etc.
That’s why I love them!
Good tips. Investing is certainly an excellent way to gain passive income while you’re pursuing other things that bring you joy, like photography and music.
Or if you’re any good at photography or music, you can also develop passive income streams there. REITs would be a lot more passive than actually renting out a property.
Very interesting! It’s good to know there’s a way to invest in real estate without all of the hard labor that goes into owning your own rental property!
It would take out so much stress, work and time. When you really think about all of that, it’s probably a pretty good trade off for the lack of control and lower profit.
Or the capital!
You can start with some of the smaller REITs. Pure Industrial REIT is a core holding for me. (I own about 2000 units) But the unit price is only $5.
So $500 gets you 100 shares which lands you $2.50 per month in income. Additionally I can see them creeping up gradually in value (share price) just as consistently as they have in the past 3 years. They dropped in value during the 08//09 crash, but they CONTINUED to pay the distribution.
You can of course buy only 50 shares, or 10 shares, but then the brokerage commission starts to take a bite into your average cost.
I have a friend who used to have pretty much his entire portfolio in real-estate. I’m not opposed to REITs, but if I’m not mistaken when the market collapsed they tanked and haven’t recovered? I guess that’s actually the entire real estate market…so their lack of a recovery should be expected.
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I would think it would depend on what kind of property the REIT was invested in and in which market. Since the REIT properties are being rented out instead of resold I’m not sure how much they were affected by the housing collapse. The ones that were invested in business property probably would’ve been fine.
Most reits followed the market prices down. This is because the value of their real estate holdings went down with the market forces.
Everything in Canada (that I own) has been more than fully recovered for 2+ years. My US based REIT is just starting to look like it’s fully recovered. But considering it’s paid out it’s dividend all the way through, I’m really ahead even though the share price isn’t quite up to what I paid for it. (market value + dividends received – cost = POSITIVE)
I have been keeping my eyes on REITs for a while. They should be a nice indicator.
Your post is very informative on REITs. Thanks.
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REITs in North America should be great until at least 2014 or longer. It all depends on how long borrowing costs (for mortgages… they have mortgages too!) stay so cheap.
If they’re worth keeping, they will continue to do well even as interest rates climb.
I’m looking to hold about 1/2 of my portfolio in REITs for a very long time. (probably forever)
I’m far too lazy to be a landlord – REITs sound like a better option for someone like me.
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Yeah being a landlord just isn’t for everyone. You have to be willing to always be available to deal with any problems and do lots of other running around.
Good to know. Seems like a smart investment for those that cannot afford a rental property and the risks of it!
I think it’s pretty smart too. For many people real estate investment is just beyond their reach, but a REIT is a lot more doable.
If I were going to own an investment property, I’d do it to prove that being a landlord isn’t as difficult as people make it. My last (ever!) landlord would frequently take 3 weeks or more to cash our rent checks.
I think it really depends on the type of tenants you are dealing with and the condition of the building. Some landlords do have a very easy job, but I could see how it could be full of headaches in the wrong situation.
I like the idea of investing in real estate, but I know I’m not handy enough to be a landlord. It sounds like REITs are a good lazy man’s alternative. There’s less control, but also less hassle. I think it’s probably avoid idea to include real estate (rental property or REITs) as part of your investment portfolio.
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I’m the same way. I wouldn’t consider myself handy enough to do all the random maintenance often expected of a landlord. Having to contract out that kind of work would just take too much from the profits. So REITs are a solid alternative.
With home prices and mortgage rates down, many people are snatching up houses with the idea of renting them out for a long term investment. As long as you don’t get too greedy, there are some great deals to be had other there…
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That strategy makes a lot of sense, especially if you luck out and finding solid long term tenants. The monthly rent as side income is nice and you’d also be building up equity.