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Let's say I want to invest in the real estate market because I am bullish on it. Consider two options: invest in REITs or actually purchase real estate.

My question is which option has a better overall return on investment for me, dollar for dollar, and by how much?

I suspect it has to be that owning real estate in a bullish market is better for one's bottom line rather than owning shares in various REITs... otherwise, no one would invest in real estate and everyone would buy REITs. Of course, owning one piece of property is riskier than owning shares in thousands of pieces of property...

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You've already hit on the big difference.

If you buy a property, you've made a big commitment, for better or worse. If you bought wisely, you'll be very happy. If not, you could go bankrupt.

An REIT spreads out the risk, but the reward isn't as great.

There's less barrier to entry in buying shares of an REIT than there is in buying an investment property: money, time, maintenance.

The answer for you depends on what level of effort you want to put into your investment. If you are all ready to pick up an investment property, make the down payment, get appraisal and inspection, clean up the house, and fill it with tenants, then go for it. Otherwise, research some REITs and buy some shares.

(Disclaimer: I have a rental property that's doing pretty well now.)

  • If you don't mind me asking, what made you decide to pick up your investment property vs investing that money in shares of an REIT that suited your fancy? – Jeremy Oct 27 '12 at 16:18
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    (a) I'd always wanted to try it, and this was an easy way to do it; (b) it was a buyers' market at the time (and still is) so it's not the best time to sell anyway; (c) it was a house I knew already, since I'd lived in it for nine years; (d) it's a nice "starter home" in a decent neighborhood; (e) the going rent easily covered my (already fairly low) mortgage payment. – mbhunter Oct 28 '12 at 20:24
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REIT's usually invest in larger properties (apartment complexes), individuals usually invest in small properties (single units, duplexes, fourplexes, etc). REIT's also invest in a lot of commercial properties - malls, commercial and business office buildings, etc.

These are very different markets.

Not to mention the risk spread, geographical spread, research, management and maintenance that someone has to do for REIT and it comes out of the earnings (while your own rentals you can manage yourself, if you want), etc.

  • +1 for pointing out the different real estate market segments. – Jeremy Oct 27 '12 at 16:19
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REIT is to property as Mutual Fund is to stock.

In others words, a REIT spreads your risk out over a greater number of properties, making the return safer, at the expense of both upside and downside risk. On average, both would average out to be the same. That said, you have a much wider range of outcomes when investing in a single property. As with stocks, over the long haul, unless you think you can somehow beat the market, divirsification is usually considered the better move.

Technically, your ROI is the same, but your beta is much better in a REIT.

  • Is the ROI really the same though? Can the (catch-all) expenses of an REIT be considered equivalent to the average catch-all expenses of running a rental property? – Jeremy Oct 27 '12 at 16:28
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    A REIT invests in properties, so, if you factor out management expenses, and if you select from the same pool, yes. Now, you can probably pick a property that outperforms the whole REIT, but over time and a large enough sample, if you look at the same population of houses, buildings, etc.. Theory says you'll only meet the average. again, you can probably pick one that will do better than average- but I doubt you can pick 100. – Affable Geek Oct 27 '12 at 17:41
  • @AffableGeek "If you factor out management expenses", I think that was precisely the question. How much do management expenses damage return? – Pertinax Oct 20 '18 at 14:34
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Your question may have another clue. You are bullish regarding the real estate market. Is that for your city, your state, your nation or for the whole world?

Unless you can identify particular properties or neighborhoods that are expected to be better than the average return for your expected bull market in real estate, you will be taking a huge risk. It would be the same as believing that stocks are about to enter a bull market, but then wanting to put 50% of your wealth on one stock. The YTD for the DOW is ~+7%, yet 13 of the 30 have not reached the average increase including 4 that are down more than 7%.

Being bullish about the real estate segment still gives you plenty of opportunities to invest. You can invest directly in the REIT or you can invest in the companies that will grow because of the bullish conditions.

If your opinion changes in a few years it is hard to short a single property.

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    Very good point regarding identifying particular properties or neighborhoods that will do better than average. An investor without local knowledge of individual neighborhoods and prices would likely be better off in an REIT for the purposes of decreasing risk. On the other hand, an investor who knows a specific neighborhood (theirs, perhaps) is up-and-coming and is tied into the local governmental happenings may have information about a particular property that is not available to the high-level investor, as such, that person might want buy the property itself. – Jeremy Oct 27 '12 at 16:24

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