Deciding Between Purchasing Rental Real Estate or Investing in a REIT

April 18, 2013

With the bursting of the housing bubble came a series of resulting conditions that brightened the spotlight on residential rental real estate, including the influx of foreclosed homes on the market, as well an influx of consumers needing homes who could no longer afford to buy. The increased focus on rental real estate has also raised the profile of a related product: real estate investment trusts (REITs). It has also ignited a debate about the relative advantages and drawbacks of investing in REITs versus buying a rental property.

REITs are business entities that own and operate a portfolio of properties and mortgages. Real estate assets must comprise at least three-quarters of their holdings, and they must pay out at least 90 percent of their taxable incomes to their shareholders each year. The rental properties a REIT owns may be residential, commercial or both. Shares of publicly owned REITs are traded much like any other stock.

These investments offer certain potential benefit to shareholders. REITs allow shareholders to invest in the rental real estate market without requiring the substantial up-front expense of buying a rental property, or the ongoing cost (or stress) that goes with working as a landlord. Additionally, REITs offer greater flexibility than direct rental property ownership because, as noted above, a shareholder can buy and sell REIT shares with great speed and relatively little hassle.

REITs also offer greater potential stability. “There is a lot of idiosyncratic risk associated with … buying a rental property,” Christopher J. Mayer, a professor of real estate, finance and economics at the Columbia Business School, told the New York Times. Even if nothing goes wrong more often than it usually does, a lot of different things can go wrong with a rental property, Mayer stated.

Direct rental property ownership may, however, offer larger potential returns to some investors. Tom and Ana Vogel, a retired couple who paid cash to purchase a five-bedroom house in Maryland, told the Times they expected to realize a 6 percent return on investment. The couple acknowledged the high risk potential, though. “It is high risk, you just have to be careful,” the husband said.

Owning rental real estate also offers tax advantages. For landlords who mortgage their rental properties, they may deduct their mortgage interest just like homeowners. Additionally, the tax deductions applicable to a landlord’s expenses are extremely broad, making everything spent on the rental property deductible, from property taxes, management fees, insurance and utilities, down to minute items purchased ostensibly for the property. The tax code also gives landlords a depreciation deduction for their rental properties.

In today’s world, those interested in tapping into the financial benefits of rental real estate have a variety of options at their disposal. Before deciding, one should carefully analyze their situation, including how much time and money one can commit, as well as how much risk can be tolerated. For thoughtful, personalized advice on your options for entering the world of rental real estate, consult the real estate attorneys at Samuel C. Berger, P.C. Our New Jersey real estate attorneys can provide you with detailed analysis and careful opinions to help you craft a plan best suited for your needs and goals. Contact us online or call (201) 587-1500 or (212) 380-8117.

Blog Posts:

Business Owners Contemplate Alternate Corporate Structures to Lessen Tax Liabilities, New York & New Jersey Business Lawyer Blog, Feb. 22, 2013
Tax Court Rejects Homeowner’s Investment Interest Strategy on Mortgage Loan Interest, New York & New Jersey CPA Tax Lawyer Blog, Feb. 19, 2013
New Limited Liability Company Act to Take Effect in New Jersey in 2013, New York & New Jersey Business Lawyer Blog, Oct. 26, 2012