Which Investment Is Right for You – REIT vs. Direct Real Estate Investments

Investing , finance , money

Many investors looking to diversify their portfolios with real estate may compare a direct real estate investment or direct deal with an investment in a REIT. Each type of real estate investment has its benefits and upside for investors, but deciding which type is best depends heavily on the individual investor.

For some investors, the idea of investing in real estate is appealing, especially if they’re looking to manage a property or tenants, or they have access to capital assets or funding to invest in larger-scale investments.  

For other investors, the idea of diversifying their portfolios with a real estate investment is appealing, but they may not have the knowledge, desire, or capacity to manage properties, tenants, and the struggle of managing physical properties. They may also not have the time or resources to complete thorough due diligence on a real estate investment, which could put their investment at risk.  A REIT may be a better option for these investors, providing them with the benefits of investing in real estate without the headaches and hassles. 

What is a “direct deal” real estate investment 

A direct deal real estate investment usually refers to purchasing a specific property (or a share in one), such as an apartment complex or retail shopping center. This investment type produces returns for the investor through rental income and property appreciation.  

A distinct benefit of this type of real estate investment is its potential to generate cash flow for investors, mostly when investors make improvements to the property and rental income.

Investing in a physical property also comes with tax breaks to help offset the income. For instance, there is the potential to deduct management or operational costs or any improvement expenses over the properties’ useful life. 

Owning a property outright or even owning a share in a property allows you to maintain decision-making control over the property, including location, function, cost, improvement schedule, and financing. Owning a physical property enables you to tap into your areas of expertise and directly guide the scope and details of your investment, including setting rental prices, selecting specific types of tenants, choosing how many properties to add to your portfolio, and determining when to sell or exit from your investment. 

One of the disadvantages of direct real estate investing is that it requires a significant amount of time and energy to succeed. Because you can make the decisions and have more direct control over your investment, you have to make critical decisions and react to changes in the marketplace. Managing tenants, emergencies, and liability all come with authority to direct the details of this type of investment. Outsourcing some of the day to day management can help alleviate this downside, but it can’t eliminate the reactivity that comes with a direct real estate investment.  

Financing can also be tricky depending on your financial circumstances or access to different types of capital resources. Many investors need to finance either through a mortgage, or other loan product, to begin their investment. If the market makes a sudden shift and the cash flow from your investments declines unexpectedly, there’s a chance you could default on your loans and lose your investment. 

When you decide to exit from a direct deal real estate investment, you may be unable to “cash-out” immediately. Your investment is not liquid; you may not be able to sell it quickly if you need emergency funds. 

What is a REIT 

Real Estate Investment Trust (or REIT) isn’t particularly new or rare. A REIT is a corporation that owns, operates, or finances income-producing real estate or real estate assets. The REIT allows investors to own shares in a portfolio of real estate assets.  

REITs are modeled after mutual funds, where funds from multiple shareholders are pooled together and invested in the portfolio’s assets. 

There are currently over 200 REITs registered with the Securities and Exchange Commission (SEC). 

Possibly one of the most substantial advantages of a REIT is providing individual investors with access to institutional-quality investments that, until recently, have been reserved for high-net-worth individuals and larger financial institutions.  

Investors can access real estate investment profits without owning, operating, or sourcing financing for investment properties. REITs can offer a lower entry cost investment into real estate deals. 

Another advantage for individual investors looking for an alternative to direct real estate options is that, by law, REITs have to pay at least 90% of their taxable income to shareholders, and the dividends from these investments could be 5% or greater depending on the market or specialty of the REIT. A REIT also has the potential for capital appreciation as the physical assets held in the trust appreciate over time. 

To qualify as a REIT, the company must: 

  • Earn at least 75% of its income from rental income or other real estate activities 
  • Have 75% of assets in real estate 
  • Have at least 100 shareholders 
  • Be no more than 50% owned by five or fewer individuals 
  • Pay at least 90% of its net income as dividend 

REITs also offer shareholders liquidity. Some REITs are publicly traded, so they’re easier to buy and sell than traditional real estate investments. Depending on the classification and holding restrictions agreement of the REIT, shareholders can exit their investment quickly, even though REITs by nature are a longer-term investment vehicle. 

The Upside Avenue REIT has a three-year holding period, but after this year, you’re free to liquidate your investment without penalty. If an investor needs to exit the investment before the three-year holding period ends, there is a 2% premium for liquidation between years 1-2 and a 1% premium between years 2-3. 

Before jumping into a REIT investment, there are other factors you should consider.  

REITs typically specialize in one property type – such as office buildings, shopping centers, or multifamily housing. Depending on the asset specialization of the REIT, market fluctuations could impact the dividends and demand for that asset class and the REIT as a whole.  

REITs have a lower financial barrier to investment but still, require minimum initial commitment. The minimum investment required can vary from REIT to REIT.  

All REITs aren’t created equal; within this type of investment option, REIT classifications determine how investor shares are traded, holding periods, and risk tolerances. 

Public REITs 

Traded on the open market and highly liquid, public REITs allow investors to enter and exit investments quickly. They’re accessible to all types of investors and are registered with the SEC, increasing operational transparency and reducing investors’ risk. 

Public REITs can be volatile and are subject to swings in market performance. Because shares are purchased and liquidated quickly, they’re not designed for more extended holding periods and aren’t likely to weather economic changes and shifts profitably. 

Private REITs 

This type of REIT may offer higher returns than other publicly available investments. They have longer holding periods to allow the REIT to invest in long-term strategies to boost dividends.

Private REITs aren’t registered with the SEC, which means they could offer lower operating costs but at the expense of reduced operational transparency and increased investor risk. 

These REITs are only available to accredited investors, require large minimum contributions, and could be hard to liquidate due to restricted redemption requirements. 

Public Non-Traded REITs (like Upside Avenue) 

Public non-traded REITs are potentially higher-quality investments for individual investors. They’re registered with the SEC, which means increased operational transparency and possible reductions in risk. They’re also subject to state regulations.

Public non-traded REITs have longer-term required holding periods vs. their publicly traded counterparts, but the longer terms help the management company invest and execute longer-term strategies, resulting in higher dividends for investors. 

These REITs require minimum investment contributions, and there are usually brokers’ fees and commissions charged to investors. 

Considerations for investors deciding between a direct deal and REIT investment 

There is no one size fits all ideal real estate investment for individual investors. Every investor has different investment goals, available time and energy, and access to financial funding sources.

Before choosing between a direct real estate investment or REIT investment, investors would be wise to evaluate the following fit criteria for their potential investment: 

  • Minimum investment & funding – What is the minimum investment required by each type of investment, and how would you access the funding to activate your investment? Whether you self-fund, acquire traditional financing from a bank in the form of a mortgage, or tap into alternative investment sources like an SDIRA, funding is the primary consideration for potential investors. 
  • Hold times – How easy is it to enter and exit from your investment, and do economic shifts play a role in when your entrance and exit happens? Short term investments are more sensitive to market fluctuations, and longer-term investments tend to weather economic impacts more gracefully. How long will you need to hold your investment to see returns, and how will timing impact your return? 
  • Diversification –  Many real estate investors are looking for diversification. Purchasing a single-family home could be a big step in diversifying your investment portfolio, but investing in a REIT with a portfolio of multiple properties could even further diversify your portfolio and possibly reduce your investment risk. Determine what diversification means and looks like to you and your portfolio. 
  • Personal involvement – How much time and energy do you have to give to a real estate investment? Flipping a single-family home may look easy on TV, but when it comes time to swing a hammer, how much do you want to be involved with a real estate investment? Even if you don’t want to get your hands dirty and hire out your investment management and operations, there are costs and energy expenditures associated with a direct deal. The time required for the upfront research and due diligence, as well as the paperwork required for financing, can add a significant amount of time and effort to your investment. A REIT reduces your overall time commitment to a real estate investment, but it also takes control out of your hands and keeps it centralized with the management team. 
  • Risk – On the other side of leverage is risk. Higher leverage means higher risk. Ask yourself honestly how risk-tolerant are you? Direct real estate investments tend to be a higher risk; if something goes wrong and you don’t have tenants to deliver rental income, your investment could be at risk. A REIT is professionally managed and takes precautions to mitigate that risk, including adding multiple properties to the portfolio. REIT shareholders invest in the portfolio as a whole, which includes multiple properties or real estate assets. The benefit to this structure is if one of the properties or assets struggles to provide anticipated revenue, the others can cushion any impact to shareholders. No investment is without risk, but there are levels, and not every amount of risk is appropriate for every investor. 

How to pick the real estate investment solution that’s right for you 

Both direct real estate investment and REITs have their pros and cons.  

If you’re looking for cash flow, tax breaks, and potential for appreciation while accepting a little more risk, a direct real estate investment may be the right choice for you. 

If you’re looking for a more hands-off, longer-term approach to a real estate investment, with a lower financial entry point and reduced risk, a public non-traded REIT like Upside Avenue may be a better selection for your investment dollars. 

About Upside Avenue

For decades, the ultra-wealthy and financial institutions have been putting their money to work in real estate—now with Upside Avenue, you can too. We provide access to a professionally managed, diversified portfolio of income-producing multifamily real estate for as little as $2,000. Learn more about the Upside Avenue Multifamily REIT with targeted returns of 10-15% IRR.