Buying a house or investing in REIT

Question

Which is better, owning and leasing a house or investing in REITs? Most of my colleagues eventually either buy their own home, or buy a home as part of their investment portfolio.

My intuition is that buying a residential REIT with exposure to your city will be better than buying a house, due to the following reasons -

1. You don't need to pay lawyer fees and brokerage on the house. The REIT could have full time staff that should do this faster and cheaper.
2. Real estate is a field in which expertise is very rewarding. Knowing which types of houses fetch how much money in each neighborhood.

I haven't found a rigorous comparison between REITs (assuming you reinvest dividends) and home ownership (simulating reinvesting the rent in some way).
Was any such comparison done?
Am I missing any reason why home ownership may be better?

Answer 1

REITs are derivatives

With a derivative, you tend to be vulnerable to whiplash as your value is influenced by the change in a thing's value rather than its core value.

Here, let's take a look at the first random REIT's I checked, and see if their market behavior makes any sense.

^^ Vanguard VNQ domestic RE. Also paid $16.46 total dividends in that 5 years. *

^^ SCHH Schwab US REIT ETF. Also paid $2.40 in dividends. *

^^ SRET, an index fund of the Solactive Global Superdividend index, which just got mauled and never recoverd. Mind you this contains some international real estate. Paid $12.02 in dividends, a high outlier in proportion to value, which might explain some of the flaccid performance. *

^^ VNQI Vanguard Global ex-US Real Estate ETF mostly international. Paid $6.54 dividends *

^^ SRVR Pacer Data & Infrastructure REIT. Paid $3.17 dividends *

* Dividends are the total over 5 years. Divide by 5 for average annual dividends.

Do ANY of these look like the housing market???? WTH???

(that's not a headline. I'm yelling.)

In all these, look at the blip in March 2020 (COVID lockdowns). Think about that time. Real estate was mad as everyone was stuck at home, thinking about the limits and imperfections of their home, and doing their level best to move up or at least remodel/add-on. It was an exciting almost bonkers time in real estate. So if you owned a house, it was alright. Construction supplies went crazy in price because of remodeling and demand for new construction, coupled with production interruptions due to lockdowns and sick-outs as half a company got COVID at once... but the cost of building materials is not the largest part of overall home value.

There was a problem with evictions being suspended since "having a home" is the best way to slow down infection rate - very hard to contain COVID at shelters and food kitchens. But there were still severe consequences for renters who refused to pay rent, and if your rental business had prudent financial reserves, you should be able to weather it.

So if you were sitting on actual real estate, you were alright. That real estate was not going to drop in value, let alone by 70% for Pete's sake like that REIT did.

Land has intrinsic value even if the house falls down. An REIT has no intrinsic value, and can go to zero.

WHY THE F****? Well, right off the bat, what is an REIT? It's an investment that is traded. What is the fundamental characteristic of an investment that is traded, the most basic thing people who choose that investment are looking for? ROI - Return On Investment in the form of "income stream". REITs do not exist to answer YOUR question of "how do I secure equity in real estate?" They compete for investor dollars with other forms of investment, and investors are all about ROI on their time frame, which is relatively short. So the intrinsic value of the assets held do not get proper credit. The value of a house is what you can get for the house, from a home buyer. The value of the REIT share is what you can get for the share, from an investor. Investors have different motivations than home buyers.

On the upside, I've never had to replace a leaky toilet on SCHH.

Answer 2

Let's first answer a simpler question: Is it better to put 500k into a house, or a collective 0-cost fund where many investors pool their money to purchase a basket of different real estate assets?

Of course it is plain that the advantages of the pool are:

• Diversification
• Less work - the manager of the pool (not you) has to go to all the house viewings, read through the inspector reports to filter out lemons, sign the paperwork and so forth
• Expertise - since there's many people involved in the pool, probably whoever is chosen as the manager is the most knowledgeable (more than you) about real estate

However, the disadvantages are:

• You can't live in the pool's houses and customize them to your liking
• You don't save on rent by owning a house (although the rent taken by the pool might cancel out what you pay your landlord)
• Home renovations are easier to deduct from taxes than with the pool
• There are more legal protections of your own home than the pool's asset

As it is, you can already see that there may be some obvious reasons why you would pass on the pool. For example, say you decide that instead of buying a house with 500k and living there, you'll put it into the pool and yourself rent some equivalent place. But in many areas, there just isn't much of certain types of house listed fore rent. There might be a lot of apartments, but no detached houses with yards, and maybe you really don't want to live in an apartment.

But in a purely financial sense, the upside of the pool is obvious, but there are still caveats such as the tax situation. So even then it's not a foregone conclusion.

This imaginary pool I described is very utopic. You rarely see random strangers setting up open ended funds where someone volunteers to manage them for free. REITs are a lot worse than such a fund:

• They're a publicly traded derivative so price can decouple from net asset value and earnings
• They don't all pay dividends so the return on investment is less direct (not just an annual check for a % of proceeds from houses sold and rent collected)
• Managers are in it to make lots of money and this can easily be at your expense, for example they will charge a large fee which must come out of the REIT's profits
• The organization who creates the REIT is not trying to mutually aid fellow investors, but is trying to extract value from "dumb money" (ie. retail investors with small capital)
• The administering org may have ulterior motives, such as using the REIT to manipulate the market or engage in financial engineering, which compromises your interests as an investor

So there are a lot of additional things that can go wrong with a public REIT, and the upside is not always there as you can see by examining the historical performance. You would have to carefully vet the REIT before investing, but even then a quality REIT may still get undervalued by an irrational market when you need to exit. You'd be better off in a private REIT which focuses on paying dividend than speculation.

Given this, shopping for your own house starts to seem not so bad, and the fees could be a lot worse. And most people lead lives where they gain a lot of experience with houses, but not so much with investment fund management.