REITs vs Rental Properties

[TomK]

I've often thought that I *should* have a rental property or two. Nothing too ambitious, maybe a couple of inexpensive condos to rent out. I've imagined that it would be a good way to diversify my assets and to have a stable income stream. I've run the numbers and while it may be a wash in the early years, it can start to look very attractive down the road. Then of course it is easy to get scared off by the work involved, and the stories of nightmare tenants.

And then I think, hell, I can be landlord of a diversified real estate empire with almost none of the headaches with just a few clicks of the mouse. REITs like O and ARCP, to name just two of very many, give you instant real estate and rental income exposure, managed professionally by a dedicated team, and give you a healthy stream of income immediately.

So why on earth would I tie up a big pile of down payment money, not to mention my time and sanity, in an actual rental property, when I could take the same money and invest in various high-quality REITs?

I wouldn't really know how to begin an actual financial comparison of the two approaches over many years. What do you all think? Are they comparable? What are the less obvious advantages and disadvantages of each?

[hendi_alex]

If you are handy and if you are comfortable with being a hands on landlord, maybe. But unless very competent and motivated, I think that the REIT route is the way to go. One issue with investment property is taxes. Here in S.C. we are taxed about 1/3 as much on a primary residence as we are on an investment property. That difference alone takes about 3-4 months worth of rent to pay. Also, insurance is an issue. It is generally both more expensive and with less coverage than with a homeowners policy. Finally, financing is more expensive. For most investment property financing is done via a five year renewable commercial loan. When rates were in the low 4% range, my previous commercial loan was at around 6.5%.

There is also the issue of local vacancy rates. If there are lots of rental units available, then rentals rates will be under pressure, as will be competition for tenants.

Now a little anecdotal story. My wife and I leased her father's house for about 12 years. The first three tenants were great, giving steady income for about 7-8 years. Then we rented to a high school teacher who taught across the hall from me at the local high school. She was very pleasant and seemed a reliable person. Little did I know that her husband is a non functioning and very nasty alcoholic, nor did I know they she had no skills at maintaining a clean, functional household. Because I knew her so well, I didn't make periodic inspections. Big mistake!

My daughter needed a place to live so I told the teacher friend that the contract would not be renewed. When she moved out, what a surprise! The commode had been leaking in one bathroom, but she didn't bother telling me. Eventually they had stepped totally through the tile floor and still didn't say anything. By the time she had move out, both floors in adjacent bathrooms were totally rotted, plus water damage extended into three other areas. The bathrooms had to be totally stripped and renovated. The kitchen cabinets, tops of doors and any other crack and crevices appeared to have black pepper spread all over and throughout. Those were roach droppings. The house smelled so bad and had so many bugs, that we stripped the entire house of sheetrock, replaced all insulation and built back out. Doing the work ourselves cost about $34K, more than all of the rental income for the previous five years! Moral of the story, always be involved if a landlord, and always make periodic inspections no matter how clean or reliable your tenant appears.

Hopefully this illustrates that not just anyone can be a successful landlord with rental properties. IMO it requires a certain skill set and a certain disposition, if one is to make a reasonable return on investment and if the issues related to the entire process are not to overwhelm and overly stress an individual.

[fiveoh]

Good info Alex. Those are the kinds of things I worry about. I don't think I would have time for it until I retired anyway. For now I will be content to just own REITs.

[ronn38]

My brother is a landlord, has 23 properties/unites of his own, manages 20 for my disabled brother and three we all share. His got a home on the breach in both Florida and Oceanside... and he's a nervous wreck the first week of EVERY month.

I tried my hand at renting a single unit for a few years. That property is gone and the assests in REITs. You can make real money as a landlord (assuming you put enough down to be cash positive month one)- but like any small business there are risks ( vacancies, delinquencies, major repairs, etc) but the stress it can put one you is- I think- unique and much mord accoutered than say opening a plumbing businesses.

Just my two cents...

Ronn

[ChadR]

I've owned a rental in the past. I guess I was lucky, though I did a background/reference check on every renter. Also, I checked on the house at least once a month. You need to be able to do most repairs yourself. I wouldn't do electric or plumbing work, but all else I would do to save money. Sold it shortly after my daughter was born since I didn't want to put time into it anymore and used the proceeds to pay for a prepaid college fund for her. A rental can be more profitable than a REIT because of leverage. Though the extra work and effort might make the REIT a better investment.

If I was single, I would own at least 1 rental. Possibly, I would own either a duplex or fourplex live in one and rent the rest.

[Horace Cugle]

My wife and I owned rental property in the past, mid 70's through the mid 90's. Two condos and two multi-family older homes.

Back then was a good time to own real estate and VERY profitable after taxes and depreciation. If you could buy a property and just come close to the rent paying PITI it was a winner if you could cover the rest.

You really have to know what you're doing when it comes to picking tenants. And you have to really love fixing stuff in the evenings after you already put in a day's work, and you have to love seeing your cash flow dry up as a result of repairs and cap investments. Still it was very profitable if you could live on baloney sandwiches and hang on until tax time.

Eventually all the hassle wore us out and we sold. Don't miss it one bit. Our house was paid off 11 years ago and that's all the real estate I want. Sometimes I don't even want that because I still have to maintain it.

My feeling is the average person or family you might rent to has way less ability to pay the rent than 20 years ago. Of course it would depend on the economic climate in that location, but generally, people don't have it as good as in the past.

---

Alex your experience mirrors mine in many ways.

A landlord must be involved and must run a tight ship or you will be taken to the cleaners. You cannot sit back and expect the money to just flow in like dividends because in most cases, it won't. Or you'll have your property destroyed. You really have to stay on top of it!!

We rented to HUD clients a couple of times and that was good because the rent always came on time. But the next thing you know they'd have 10 people living in a 1 bedroom apartment and there would be trouble on the property. Laws are not exactly landlord friendly either and it takes time to get a no-paying tenant out.

Maybe others see it differently but rental property is not a passive investment. Lots of work and lots of heartburn. But profitable if you can manage your way through it.

[Kerim]

I live in a condo (small townhouse) right now, but we are house shopping. I am not sure if we'll pull the trigger, but we really could use some additional space. If we do, I've been thinking that I'd keep the condo and rent it out. The interest rate and monthly costs are pretty low, and I'm pretty confident that it could be cash-flow positive from month one (even after condo fee and taxes). But the stories you've all posted already are enough to have me thinking twice.

Maybe I'll try to run a spreadsheet comparing the income I could get from renting it to what my returns would be by selling it and putting the money into a REIT or two. Predictions?

[Horace Cugle]

My prediction.......Pain

[EricL]

There is some great discussion about REIT's vs. Rentals in the discussion thread of this article.

http://seekingalpha.com/article/1711932-...ing_notify

[Horace Cugle]

Seriously Kerim, it depends on your situation. In my case I was a young -middle aged guy with a family and job that consumed almost every waking hour. So it was tough to find time to deal with any repairs or God forbid a vacancy. We had 7 units and sometimes it could get a bit overwhelming.

If you can hang on to a valuable asset and get someone else to buy it for you you should, and if you do a good job screening tenants you should be OK. Just remember it's a business and there's a lot of BSers out there.