8 Reasons Why Owning REITs Is Superior To Owning Rentals

Jussi Askola2020-10-10

SummaryI invest in both, REITs and rentals, to generate high income and superior total returns.Yet, in most cases, I favor REITs because they offer superior risk-adjusted returns.Especially today, it ...

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Spark_2095
2020-10-12
Spark_2095
Amazing! So it's a good time to buy REITs now?
Spark_2095
2020-10-12
Spark_2095
这篇文章不错，转发给大家看

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What’s a perfect investment? That’s a subjective question, but if you are looking for high income, long-term appreciation, with only reasonable risk, you will certainly want to consider real estate investments. 90% of millionaires credit real estate as a major contributor to their financial success, and past returns have been exceptional:  source Therefore, it's a no-brainer for most people to invest in real estate, whether it's for:  Above-average income Market-beating total returns Inflation protection Or even diversification  The more challenging question to answer is: “How should you invest in real estate?” When confronted with this question, most investors consider two main options:   Option 1: Invest in rental properties  Option 2: Invest in publicly-traded REITs   source I have done both. I have owned a rental property and helped manage larger-scale real estate investments back in my private equity days. But I also invested a considerable portion of my portfolio into REITs over the years. Readers often ask me: “Which is a better investment: REITs or Rentals?” Here again, it's a very subjective question because personal preferences need to be taken into account. Both can be great investments and a specific person may do better with one than the other.\n To this day, I continue to invest in both and it's not an “either/or” question. However, nine times out of 10, I favor REITs over rentals for new investments. Below I present eight reasons why REITs are likely to produce better results for the great majority of investors. Reason #1: No Tenant, No Toilet, No Trash Rental investments can be very profitable, but they also can ruin your life, and that’s a big risk to take. When I say ruin, I really mean it. The fights, the stress, the legal battles, the property damage… can be truly devastating to an individual investor who isn’t a professional full-time investor. In most cases, things will go smoothly. But it only takes one bad tenant to ruin many years of consistent returns. Some won’t pay. Others will sue you. And finally, even if you win, they may trash your property as a final \"thank you.\"  source You may think that you can avoid bad tenants with good screening, but people change, and screening is never bullet proof. If professionals cannot avoid occasional poor tenants, you won’t either. This brings us to our next point: Reason #2: Professional Management Adds Value You may have read a few books on real estate investing. Maybe you bought an online course, and even got some hands-on experience working on a rental. That’s certainly better than nothing, but it does not make you a professional. REITs attract the best talent in the real estate sector. These are people with decades of experience, Ivy League education, and long track records of strong performance. Professional management truly adds value to real estate. As an example, apartment REITs have managed to collect 97%-98% of rents during the pandemic. In comparison, private landlords have collected only 80%-90%.\n source It highlights the value of professional management. They are better at screening and managing tenants. It boosts your returns, mitigates your risk, and best of all, saves you all the headaches. Reason #3: Significant Economies of Scale Here you might say: “Yes, but the REIT managers take large salaries and so the returns suffer in the end.” That would ignore the massive scale of REITs. Sure, it costs money to manage a REIT. But when you own $100s of millions, or even billions, worth of real estate, there are significant economies of scale that must be taken into account. Consider the following examples:  The cost of managing 100 properties instead of just a few. The cost of changing 20 roofs at once instead of just 1. The cost of selling a property yourself instead of using external brokers. The cost of debt when you raise billions and have an A-rated balance sheet. Etc…   source The point here is that REITs are able to save money on many fronts. Moreover, because REITs are so large, the management salaries are allocated over a large pool of assets. In the end, management is very efficient in most cases. Reason #4: Leverage, Without Personal Liability  Another misconception is that REIT investors do not enjoy the benefits of leverage. Rental investors claim that they can buy a property with little money down and boost returns with cheap debt. The reality is that REITs also are leveraged investments. When you buy shares, you provide the equity, just like you would make a down payment for a rental. The REIT then uses leverage and you enjoy its benefits.\n Example: if you invest 50k in a REIT, and the REIT has a 50% loan to value, then you indirectly control 100k of properties.  However, the big difference here is that with REITs, you enjoy all the benefits of leverage, but with lower risk because you do not give up personal liability. source Leverage is a double-edged sword. It's great when things go well, but it's also the number No. 1 reason why hundreds of rental investors file for bankruptcy each year. They take on too much leverage, they are personally liable for it, and often, they end up losing it all when things go south. With REITs, you can only lose what you invest. You are not personally liable for the debt. It's often forgotten, but it greatly improves your risk-to-reward. Reason #5: No Transaction Costs When you buy a rental property, you commonly lose 5%-10% in day 1 in fees and closing costs. Investors never think about it this way, but if you put 20% down, you essentially, lost 25-50% of your equity on day 1. The day you sell, you are likely to incur more costs as you do repairs and prepare to put it on the market. With REITs, you pay $1-2 per transaction with Interactive Brokers (IBKR). That’s a massive advantage that most investors ignore when they compare REITs to rentals. Reason #6: Diversification Across Sectors and Locations Today, there exist ~200 REITs. Most of them have a clear strategy focusing on a specific property type or location. As such, you can easily build a diversified portfolio of 10-20 REITs, providing you exposure to:  Apartments Single-family houses E-commerce warehouses Data centers Timberland Etc…  A diversified REIT portfolio will always be safer than a concentrated rental portfolio. When you lack diversification, a single accident can ruin your performance. With REITs, your risks are well-mitigated to optimize risk-adjusted returns.\n Reason #7: Ability to Boost Growth and Total Returns Rental investors are generally happy if they manage to maintain their current rents and avoid vacancies. At most, they will grow annual cash flow by a few percentage points per year. On the other hand, REITs are commonly able to grow cash flow at 5%-10% per year. That makes a very big difference in the long run. source How is that possible? REITs are publicly traded, and therefore they have access to public capital markets. It allows them to regularly raise more capital, which they then reinvest at a higher rate of return, profiting existing shareholders. Example: REIT A raises $50 million of equity at a cost of 7% per year. It also raises $50 million of debt at a cost of 3% per year, for a blended average cost of capital of 5%. It then buys a property at 7% cap rate – earning an immediate 200 basis point spread. The cash flow per share then goes up, even despite the increase in total shares. It profits all shareholders. This is the primary reason why REITs outperform rental investors in the long run. It brings us to our next point: Reason #8: Higher Total Returns with Lower Risk REITs have historically generated up to 4% higher annual returns than private real estate investments:  source This makes sense when you think about it:  REITs enjoy significant economies of scale They are professionally managed They are able to grow cash flow at much faster rates They have access to public capital markets And finally, investors pay very low transaction costs \n Another data point shows that REITs earned 15% per year on average over the past 20 years:  Rental investors will often claim that they are able to earn far more than that. I often read in comment sections that they can earn 20%-30% annual returns with ease. That’s nonsense if you ask me. Warren Buffett from Berkshire Hathaway (NYSE:BRK.A) (BRK.B) became the richest man on earth by compounding at ~20% per year. If rental investors beat even Warren Buffett, why aren’t they billionaires? The reality is that most rental investors underestimate costs, overestimate returns, and do not consider the impact of recessions. They are quick to brag about a good deal, but also quick to forget about their losses.  Bonus Reason: Opportunity to Buy at Below Fair Value and High Passive Income   Especially today, it makes much more sense to invest in REITs than in rental properties. This is because the REIT market is historically undervalued after the recent crash. Today, you can buy high-quality REITs at pennies on the dollar. Below, we list a few prominent REITs and their valuation discount relative to the true value of their underlying properties:   Federal Realty Trust (FRT): 40% discount to NAV  Simon Property Group (SPG): 65% discount to NAV  Equity Residential (SPG): 35% discount to NAV  Boston Properties (BXP): 50% discount to NAV  You are essentially given the opportunity to buy high-quality, conservatively-financed, and professionally-managed real estate at 50 cents on the dollar. That's two rentals for the price of one:  \n source The last time REITs were so cheap, it was after the great financial crisis, and they nearly tripled in value in the following two years:   If you missed these gains, now is your second chance. The REIT market is again deeply discounted and offers high upside potential in the recovery.  At High Yield Landlord, we estimate that our Core Portfolio has at least 50% upside potential, and while we wait, we earn a passive 7% dividend yield. We could not achieve that with rentals, and this is the main reason why we favor well-selected REIT investments in today's market. \nWhat Are We Buying?\n\nWe are sharing all our Top Ideas with the 2,000 members of High Yield Landlord. And you can get access to all of them for free with our 2-week free trial! We are the #1 ranked real estate investment service on Seeking Alpha with over 2,000 members on board and a perfect 5-star rating!\nYou will get instant access to all our Top Picks, 3 Model Portfolios, Course to REIT investing, Tracking tools, and much more.\n\nWe are offering a Limited-Time 28% discount for new members!\nGet Started Today!\n\n\nDisclosure: I am/we are long FRT; SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.","kind":"news","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":309059386,"gmtCreate":1602506124345,"gmtModify":1703826754994,"author":{"id":"3564894655150839","authorId":"3564894655150839","name":"Spark_2095","avatar":"https://static.tigerbbs.com/c3f95c8d86a16ef457dcad9afb1300ac","vip":1,"crmLevel":1,"crmLevelSwitch":0,"idStr":"3564894655150839","authorIdStr":"3564894655150839"},"htmlText":"Amazing! So it's&nbsp;a good time to buy&nbsp;REITs now?&nbsp;","listText":"Amazing! So it's&nbsp;a good time to buy&nbsp;REITs now?&nbsp;","text":"Amazing! 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