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How does Rental Investment work?
Rental Investment is investing in real estate where you buy a property and manage all the expenses such as repairs, renovation and market the property for tenants. Rental investment provides both monthly passive income from the tenant's rent and long term capital from the appreciation of the property. You also get tax benefits from mortgage interest, repairs, depreciation of the property. Rental properties can be single-family, condos, multi-family, commercial buildings such as Restaurants, shops or an office or an entire apartment.
Benefits of Investing in Rental Property
Tax Benefits:
There are numerous tax benefits in investing in rental property where you can get tax breaks from deducting expenses such as mortgage interest, property tax, repairs and maintenance, depreciation of the property from your taxable income.
Control and management:
You have better control in the decision making, control and management of the property. You can decide what kind of property you wish to invest in, what kind of renovations to be done to increase marketability.
Leverage:
You can Leverage your investment, by investing only 20% of down payment and closing cost, you get 100% of rent (which helps cover the mortgage payment) and 100% value appreciation.
Flexibility and Predictability:
As an owner of the property, you have the flexibility to decide what kind of rental property you want to invest in (Residential, Commercial, Condos etc). You will be able to handle the market conditions unlike REIT and plan your investment accordingly.
Cash Flow:
Rental investment gives regular cash flow as a monthly rent which can be used to pay monthly mortgage, repairs & maintenance or to payoff mortgage early.
Knowledge and Skill:
Rental property investment can be used as a creative project by renovating the home such as adding an additional bedroom, updating curb appeal, adding in extra storage space, remodeling Bathroom, upgrading Kitchen which helps generate increased monthly rent which in turn increases cash flow.
Drawbacks of investing in Rental Property
Time Consuming:
Investing in rental property can be done with property management company or managed by yourself, which could be time consuming as a lot of market research & analysis, best rental ratio, planning renovation costs, knowledge on occupancy rate and rental growth, planning operational costs, advertising as to be taken care. There might be a need to deal with Tenant issues and liability issues.
Non-Liquidity and Non-Diversified Investment:
Rental properties are not easy to liquidate during emergency situations as there may be leases or contracts which cannot be broken. Selling the property is also an extensive process. The rental investment is usually less diversified compared to REIT.
Upfront Capital, maintenance costs and legal work:
Rental properties need a huge upfront capital, around 25% for the down payment, closing costs, proper planning for the repairs and maintenance. It also involves lot of legal work such as signing the lease, maintaining deposits, dealing with tenant issues.
How does REIT work?
REIT is an acronym of Real Estate Investment Trust. It is a company that owns or finances or manages different sectors of real estate. Investors can invest in REIT just like buying shares where their Investor's risk is diversified by investing in a portfolio of income generating assets such as offices, malls, shops, hotels, apartments. These assets are leased and the generated profit is distributed to the investors. It is an indirect way of investing in real estate without managing the properties on your own.
Benefits of investing in REIT
Easy to buy and sell:
REIT is very easy to buy and sell, they are just like Mutual funds and Stocks which can be bought in a click of a button. This is a quick and easy way to invest in rental property indirectly without going through the extensive process of buying rental property.
Liquidity and Risk factor Diversification:
REIT can be easily liquidated for emergency purposes, it can be bought and sold daily, monthly or quarterly depending on the type of REIT. As this investment is not tied up to a specific property and the growth depend on a number of collective properties, the risk factor is diversified.
Minimum Capital needed:
Investing in REIT doesn't need a large down payment, acquisition, operational and maintenance costs. The minimum capital needed is much lower than the down payment required in investment property.
Minimum Expertise and Management required:
REIT investments doesn't need an extensive market analysis and research. There is a very minimal management needed on the investment and it is a hassle free investment.
Drawbacks of investing in REIT
No tax advantages:
Unlike rental investment where there are numerous tax breaks for mortgage interest payment, property tax, depreciation of the property, REIT doesn't have those. So, the returns from REIT have higher tax rate compared to the rental property investment.
Leverage:
While the rental investment has the benefit of leveraging, REIT rate of return and profit solely depend on the amount of money invested. Therefore, the growth potential is diminished compared to rental property investment.
Lack of Control:
You don't have any control over choosing the type of property to be invested or any renovations that can be made according to the needs of the market . The rental investment has full control over the asset as you are the owner of the property.
Slow in overall growth:
As the REIT are supposed to pay out at least 90% of it's taxable income to the investors, they are left with only 10% for their investments and growth. This might impact the overall growth of the REIT.