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I want to shift part of my portfolio away from stocks into real estate. I've found that if I bought real estate directly I could expect about 10% in yearly returns.

The problem with buying physical properties is that they are illiquid so if I invest $60K in some property I can't use them for anything else. And there is no guarantee I can even get any of the money back.

I also don't want to waste my time kicking people out, getting them to pay, etc.

Logically, I looked into REITs. They sound as if they have almost all the benefits of real estate with fewer complications. I can also lend their stocks for additional income and use them as margin.

However, they list a few risks that sound really fishy and I don't think I should be bothering about.

I can't see why a rise in interest rates should affect returns and face value in any significant way. They cite leveraging, but if they are using leverage, then returns should be far higher than what they actually deliver which is about the same as physical properties.

Is there any variety of REIT that works more like actual properties? Meaning it is only vulnerable to real estate prices and rental demand.

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    Not clear that country is necessarily crucial to this question. Other countries besides the US have REITs or REIT-like instruments, and the general question of how to invest in real estate in a more liquid way is relevant anywhere.
    – BrenBarn
    Apr 28, 2015 at 6:57
  • @BrenBarn true, but not all countries have specific legal requirements for the term or preferential tax treatment.
    – littleadv
    Apr 28, 2015 at 7:08
  • REITs, Property Funds and IT's tend to invest in commercial property - I would start with those before the much less common residential equivelents
    – Pepone
    May 20, 2015 at 20:21

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Similarly to buying property on your own, REITs cannot get to good returns without leveraging. If you buy an investment property 100% cash only - chances are that 10% ROI is a very very optimistic scenario. If you use leveraging (i.e.: take out a mortgage) - you're susceptible to interest rate changes.

REITs invest in properties all around all the time. They invest in mortgages themselves as well (In the US, that's the only security REITs can hold without being disqualified). You can't expect all that to be cash-only, there have to be loans and financing involved. When rates go up - financing costs go up. That brings net income down. Simple math.

In the US, there's an additional benefit to investing in REIT vs directly holding real estate: taxes.

REITs pay dividends, which have preferential (if qualified) taxation. You'll pay capital gains taxes on the dividends if you hold the fund long enough.

If you own a rental property directly, your income after all the expenses is taxed at ordinary rates, which would usually be higher.

Also, as you mentioned, you can use them as margin, and they're much much more liquid than holding real estate directly. Not to mention you don't need to deal with tenants or periods where you don't have any, or if local real-estate market tanks (while REITs are usually quite diversified in kinds of real estate they hold and areas).

On the other hand, if you own real estate, you can leverage it at lower rates than margin (with HELOCs etc), and it provides some safety net in case of a stock market crash (which REITs are somewhat susceptible to).

You can also live in your property, if needed, which is something that's hard to do with REITs....

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  • Thank you. I guess what I'm asking is if there is a REIT style that speculates less and still provides some significant income. Mortgage REITs sound dangerous.
    – gengren
    Apr 28, 2015 at 6:59
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    @gengren REITs generally don't speculate. You'll need to read the prospectus to see how much mortgages the trust holds, if at all, but for most parts its considered a more conservative type of investment.
    – littleadv
    Apr 28, 2015 at 7:07
  • Great answer. Though I would note that there are multiple tax advantages to owning leveraged real estate in the US. Still REITs are the preferred choice for most investors.
    – rhaskett
    May 21, 2015 at 17:20
  • @littleadv Can you elaborate on "You'll pay capital gains taxes on the dividends if you hold the fund long enough." Is that a REIT specific thing?
    – d_dd
    Jun 1, 2015 at 4:45
  • @d_dd no, but having rental income taxed as dividends is a REIT specific thing.
    – littleadv
    Jun 1, 2015 at 4:59
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  1. I've had solid returns over time with VGSIX, Vanguard's REIT index fund. It mitigates individual REIT leverage legerdemain or regionality.
  2. Consider MLP pipeline companies. They're a kind of industrial real estate.
  3. There are businesses that finance and collect rent on government-created monopoly rights including taxi medallions, liquor licenses, and I suppose this also includes so-called "patent trolls".
  4. Some physical real estate can be hands-off. My parents did well over 20 years with an oceanfront beach house managed by a local real estate office. In a different state I have stayed in what for all intents and purposes was a beachfront hotel, with a pool/sauna, reservation website and staffed front desk, that was technically a condominium building with individual owners of the units.
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