In Canada, it is a common investment strategy to purchase a property and rent it to a third party. By doing so, investors earn stable rental income and have the opportunity to profit on a capital gain of the property itself. Another popular investment in Canada is real estate investment trusts, or REIT for short. This asset is often publicly traded on stock exchanges and tends to yield high dividends. So which is better in the rental vs REIT debate?
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Both rentals and REITs have their corresponding pros and cons. The investment that is better for you depends on your preferences and what kind of investor you are striving to be. Continue reading to learn more about how REITs and rentals compare and contrast.
Rental vs REIT: What are they?
There are many different types of real estate investments. It can be confusing to navigate, especially if you’re new to the real estate market. Two of the most popular options are rental properties and REITs. Here’s the definition and characteristics of rental vs REIT.
What is a rental property?
A rental property is an investment vehicle that generates income through the renting of space to tenants. The owner of the property, commonly referred to as a landlord, also has the opportunity to profit on the value of the property through a capital gain. Rental properties can be either residential or commercial, and they can be either single-family homes or multi-unit buildings.
The landlord is responsible for maintaining the location, paying taxes and insurance, abiding by rental laws, and providing any necessary repairs or improvements. In essence, being a landlord is sort of like being self employed. In return, the tenant pays rent to occupy the space.
Many people choose to invest in rental properties because they provide a steady source of income and the potential for appreciation over time. This kind of investment provides a lot of flexibility both financially and lifestyle-wise. Additionally, rental properties can be a good way to diversify one’s investment portfolio.
Related Reading: What is Tenant Insurance?
What is a REIT?
A REIT, or real estate investment trust, is a type of investment that offers shareholders the opportunity to invest in a portfolio of income-producing real estate assets. REITs can be publicly traded on major stock exchanges, or they can be private funds, and are required to distribute at least 90% of their taxable income to shareholders as dividends. A key feature of REITs is that they do not pay corporate income taxes on the earnings generated by their real estate assets, as long as they distribute most of those earnings to shareholders in the form of dividends.
Generally, REITs are structured as corporations or trusts. They offer investors a way to diversify their portfolios and earn income from real estate assets without the hassle of direct ownership. In other words, owning a share of a REIT is like owning a rental property or a portion of the real estate market indirectly.
There are several different types of REITs, including equity REITs, mortgage REITs, and hybrid REITs. Equity REITs invest in properties and collect rent from those properties. Mortgage REITs invest in mortgages and other real estate loans. Hybrid REITs combine aspects of both equity and mortgage REITs.
Investing in REITs vs rental property
While there are various ways to get involved in the real estate market, REITs and rental property are often considered the most by the standard investor. Both investments have their pros and cons, and the best option for any given investor will depend on their individual goals and circumstances. Let’s take a closer look at the two options to see how they compare. From there, you can determine what’s best for you in the rental vs REIT comparison.
|Potential for higher returns||Increased financial risk|
|Tax breaks||Management responsibilities|
|Control over the property||Maintenance and repair costs|
Pros of Rental Property
Rental properties are often owned by one person or a few people. For this reason, there is greater risk, but also greater reward. Although, real estate is a relatively safe investment because people will always require a place to live. Stable rental income and a property that will appreciate over time are great rewards compared to the risk.
Owning rental property comes with some tax breaks. For example, you can deduct expenses like repairs and maintenance against your rental income. If you choose to incorporate your rental property, there may be some additional tax benefits too.
Finally, as a landlord, you’ll have complete control over your property. You’ll be able to choose your tenants, set rent prices, and decide how to maintain the property. You can also set your own schedule and enjoy the freedom of being your own boss.
Related Reading: Best Monthly Dividend Stocks in Canada for 2022
Cons of Rental Property
One of the biggest risks is the increased chance of vacancy. If you are relying on rental income to cover your mortgage payments, a prolonged vacancy can put you in a difficult financial position. In addition, not every tenant is ideal. Some will create a mess in your property or cause other headaches. Furthermore, you may have to deal with things like eviction or hassling people for rent.
As a landlord you will be responsible for all management and maintenance tasks. This includes finding and screening tenants, handling repairs and abiding by local rental laws. If you don’t do your job as a landlord, you can run into legal issues and the law tends to favour tenants.
Lastly, you will be responsible for all costs associated with maintaining the property, from paying the property taxes to major repairs. Even with steady rental income, it’s important to have an emergency fund available to cover these costs because sometimes they arise unexpectedly.
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|Low initial investment||Limited control|
Pros of REITs
One of the main advantages of investing in a REIT is it offers diversification. By pooling the money of many investors, REITs are able to spread their funds across a wide range of investment properties. This diversification can help to protect investors from losses if one or more of the underlying properties experiences problems.
Another advantage of REITs is they offer a relatively low initial investment. Unlike other types of real estate investment, REITs can be purchased for a small sum of money. This low cost makes them an attractive option for many investors. You can invest more money if you’d like to, there’s a lot of flexibility.
Finally, REITs offer liquidity, which is the ability to easily convert an asset into cash. This liquidity is provided by the fact that REIT shares can be bought and sold on major stock exchanges. You can also purchase REITs privately, but this is a less common practice and does not provide the same degree of liquidity.
Cons of REITs
One of the biggest drawbacks is that REITs tend to have lower returns compared to other investments. REITs are generally purchased for their high dividend yields, not for the opportunity to earn a capital gain. Unfortunately, REITs do not appreciate the same way real property does. As a result, investors in REITs may miss out on the upside potential of the market.
Additionally, REITs offer limited control compared to other investments. While shareholders do have a say in how the company is run, they do not have direct control over individual properties or day to day decision making.
Finally, REITs charge management fees, which can eat into returns.
Related Reading: Best Canadian REITs for 2022
REITs vs Rentals: Choosing what is best for you
If you want to get involved in the real estate market, both rental property and REITs are good options. However, not every investor has the luxury to invest in both simultaneously. Ultimately, you have to choose the best option based on your preferences and financial circumstances.
REITs offer the opportunity to invest in a diversified portfolio of properties without the hassle of being a landlord. However, they also come with higher fees and offer less control than if you were to directly own real property.
On the other hand, rentals give you more control over your investment but can be time-consuming and expensive to manage. There is a greater potential for reward, but you have to put in a lot more work and you’re the only one who’s on the hook.
If you’re looking for stability and income, a REIT may be a good choice. If you’re looking for appreciation potential and are willing to put in the work, a rental property may be the better option. Good luck on your real estate investing journey!