A common question I get is how does traditional real estate (including syndications) compare to REITs, so we’re going to learn about REITs. What they are and the benefits and drawbacks. If you’d like to watch the video version on this post, click here.
What is a REIT?
Real estate investment trusts (or REITs) are companies that own, operate or finance income-generating real estate. The concept of REITs was first established in 1960 when there was a desire to allow retail investors like you and I to buy and sell shares in real estate like we invest in mutual funds or stocks. It was a very novel concept which looking back was ground-breaking. Today, REITs hold over $4.5 trillion in assets overall and can be found listed on various stock exchanges like the NYSE.
REITs typically specialize in a specific asset class, such as multifamily, healthcare, retail, industrial, etc. They also must follow some specific guidelines in order to be called a REIT, including these two biggies:
- 75% of their gross income must come from rents, interest on mortgages that finance real property, or real estate sales.
- Must pay a minimum of 90% of taxable income in the form of shareholder dividends each year.
In this video, I wanted to compare REITs to Real Estate Syndications. If you don’t know what a real estate syndication is, I made a video that walks through the basics so click at the top right if you want to check it out.
Both REITs and syndications are similar in that they both pool the money of investors to purchase real estate. However, REITs use that money to purchase many properties that fit their investment criteria, while a real estate syndication usually purchases one specific property.
Now let’s compare the two and see how they stack up. Is one better than the other? Note that these are my personal thoughts and you should decide for yourself what’s most important in your investing strategy:
Starting Capital Needed
- One of the big advantages of REITs is that is takes very little money to buy into one. Today, I can find many REITs that are priced as low as a few dollars a share, which makes the barrier to entry very low.
- Contrast this with a real estate syndication (or real estate in general) where you typically need much more money to participate. Syndications often have a minimum investment amount of $50k and up. Even buying an investment home would require many thousands of dollars, so this is a big difference.
Ease of Entry
- Ease of Entry just means ‘how easy is it to buy?’ Many would argue that a REIT is super easy to buy… you just go to an online brokerage house and buy as many shares as you want. Simple right?
- Well, you would certainly want to conduct some good research to see which REIT is the best for your needs. That takes time and analysis of all the hundreds of options available.
- Real estate syndications also take time to analyze and understand. However, in my view. actual real estate is a bit easier to analyze because the fundamental concepts are fairly straightforward.
- Then, once you decide to invest, you sign the paperwork and wire the money. That’s it.
- So… to me, these two are fairly equal in this regard.
Tax Advantages
- Real estate syndications win out on tax advantages hands down. Why? Because they get the same advantages as buying your own investment property. You can deduct depreciation, you can accelerate that depreciation, and utilize strategies like the 1031 exchange to allow you to defer your capital gains tax.
- Dividends from REITs do not have that benefit, because what you own is a share in a company, not a piece of the actual property. Therefore, dividend income from REITs is taxed at ordinary income tax rates, which can range from 10% to 37% and can eat away a large portion of your income.
Diversification
- REITs definitely have the upper hand when it comes to diversification, as the REITs typically invest in properties throughout the country and the world. However, you do need to pay attention to the type of REIT you’re investing in.
- For example, American Tower is the second largest REIT in the country and they invest in cell towers. Now, they hold towers across the entire country, but they still focus on cell towers. So if the tower industry suffers for some reason, so does your REIT investment.
- Real estate syndications typically focus on one specific property, so you’re all in on that location, property type, etc. That’s not necessarily a bad thing, just something to be aware of.
Predictability of Income
- REITs are known for their regular dividend distributions, so they certainly have predictability. However, the per-share value of a REIT fluctuates on a daily basis (just like the stock market), so it’s difficult to tell what will happen long-term.
- A solid apartment complex can also have a predictable cash flow based on the business plan used by the general partners. I would argue that there’s more predictability with an apartment complex because there is a forecasted return profile to expect in the coming years.
- However, because they both have aspects that are predictable, I note them here as the same.
Liquidity
- What I mean by liquidity is… how easy is it to get your money back into the form of cash.
- REITs definitely have the upper hand here, as shares in REITs can be bought and sold whenever you’d like. This makes it easy to sell shares when you need the money.
- Real estate syndications are not liquid. In other words, once you invest your $100k, that money is locked into the investment until it is returned later with additional profit on top. This is usually detailed by the general partnership team, so you would know this going into it.
- If you’re not too concerned about having your money available quickly, then syndications are a great option but you need to know this going in.
Own a Physical Asset
- Real estate syndications allow you to have a stake in a real property. One that you can touch and see. You are not owning a share of a company.
- To me, this is a biggie. I feel more at ease knowing that my money is tied into a real property versus a piece of paper who’s value can swing like crazy.
And finally, Return on Investment
- REITs really focus on purchasing Class A properties, which are the newest, highest end, and easiest to maintain. This allows REITs to provide steady, predictable cash flow to investors via the dividend payments.
- With real estate syndications, there are a wide variety of strategies that can be used. The syndications that I participate in focus on Class C or B- properties that have a strong value-add component to them. Why is that? Because your returns can be substantially higher than a REIT. Making improvements like renovations to a property can drastically increase the income, which in turn increases the return considerably. Add in the tax benefits and it makes syndications much more attractive to me.
- Now, it’s important to note that this syndication strategy does have a higher risk to it, but with good operators it’s a solid approach.
There are some other intangible factors that I like about syndications, such as the fact that there’s always a name and a face behind each one. Someone I can contact if I have questions or want to learn more. This just isn’t possible with a REIT. It’s a company, not a person.
I also have no idea what the strategy is for a REIT. How are they approaching their investing? Which assets are underperforming? Who knows. In the syndication, all of that is clearly spelled out ahead of time.
In summary… if you have say a few thousand dollars, a REIT may be a good option for you. But if you have more money and would like to take advantage of all the benefits owning real estate can provide, then a real estate syndication would probably be better.
What do you think? Do you agree to disagree? Let me know in the comments!
