REIT investing vs. index funds, eREITs, and properties | Point-by-point comparison

Anytime I talk about my passion for real estate and finances, I typically get “Oh yeah, I’m in the same boat. I do REIT investing.” This typically comes from “experts” who’d tell you that REIT stocks should be in every portfolio… YEAH RIGHT! 

Yes, I’m obsessed with real estate (the way my kids are obsessed with llamas) but I wanted to address whether REIT investing really falls in the same boat. 

Advisors, income hungry retirees, investors – both novice and professional, as well as your parents after watching the news will all tell you that REIT stocks have an important place in your investment portfolio. But WHY?!

Investors are so preoccupied with whether or not they can, they didn’t stop to think if they should.

~ Jurassic Park

Seriously!

There are a lot of big words being tossed around to justify that REIT stocks are special. But really, how does REIT investing compare to:

  • Investing in index funds (like S&P 500)
  • Investing in crowdfunded real estate
  • Investing in real estate directly

We’ll dig into the facts, and compare the different types of investments point-by-point, but here’s a quick overview:

REITsS&P 500eREITsOwnership
Double TaxationNoYesNoNo
DiversificationYes and noYesYes and noNot really
EaseEasyEasyEasyNot really
LiquidityHighHighNot reallyNo
PayoutsYes – dividendsDividends availableYesYes – rent
AppreciationGoodGoodGoodVery High

What is a REIT?

A lot of investors really like Real Estate Investment Trusts (REITs). REIT investing involves buying shares in a “trust” that owns and manages a portfolio of either real estate properties or mortgages. 

The “trust” part is important. A trust is a special type of company that has to stay focused on real estate and has to send out most of its profits as dividends otherwise it loses its special trust status. 

REIT investing – why do people fawn over it so much?

Okay. So far we covered that REITs are special trusts. But there must be some other reason people stick them in their investment portfolios. Actually, there are six. And here they are: 

1 – Double Taxation Profits

This is the secret sauce that makes REITs interesting.

One way REIT stocks are different from traditional stocks is the tax benefits given to REITs. Once the IRS approves the REIT status of a company, that firm no longer has to pay corporate taxes on its profit

Normally when you invest in a company you are getting taxed twice. Paying taxes is bad enough, but double taxation is worse than a double slap in the face! 

First, the company pays taxes on corporate profits and then you pay taxes on dividends or capital gains. REITs skip the corporate profit tax and that makes REIT investing very interesting.

REIT-investing-batman-meme

2 – Diversification

Diversification is smart. Once you have a lot of money you want to make sure it doesn’t disappear too easily. If you quit your job to live off your investment income, and told your whole company they’re major suckers for still working, it would certainly be awkward if you no longer had that income. 

Real estate ups and downs are mostly independent of the stock market. So if one goes down, you still have the other. And since REITs are forcefully focused on real estate, you can buy one and voila you have diversified into real estate.

And here’s a diversi-mind-swirl: REITs are large companies that invest in many properties which makes them diversified internally. Double diversification. Great!

3 – Real estate without the headaches of ownership

REIT investing lets you diversify into real estate while also NOT managing the property yourself. That means no tenants calling you, and probably no headaches to go with the broken plumbing. 

Plus, you buy REIT stocks on the stock market, which represents ZERO headaches – at least compared to buying and selling a house. 

4 – They’re liquid

On the topic of selling a house being annoying, REIT stocks are more liquid than buying an actual investment property. REIT investing is easier now that you can trade REIT stocks within seconds (sometimes without paying any commissions) on trading platforms. 

Ever needed some emergency cash? Would you rather sell a stock using an app or sell a whole house?

5 – High Dividend payouts

One requirement of being granted REIT status by the IRS is that the company must pay 90% of its profits as dividends back to investors. So REIT investing offers another great benefit, high dividends! 

Sounds nice but it makes it hard for those companies to invest in themselves, so while dividends are nice for planning your own cashflow, if the company’s not growing – your stockpile isn’t either.

That said, people love dividends! It’s cash in your pocket and it makes the whole equation of how to live off of an investment very simple. A company you buy has a 4% dividend and you have $100,000 invested with them so you can (somewhat) count on getting $4000/yr from them forever.

6 – Great appreciation (in past 20 years)

REIT stocks have done exceptionally well over the last 20 years so that’s a pretty good pitch. 

REIT-stocks-growth-appreciation

Look at the above chart carefully. REIT stocks have outperformed the S&P 500 Index, one of the most diversified groups of stocks in the world, which also includes REITs! 

A little history lesson,

  • During this time, beginning in 1999, the tech market fell apart during the dot com bubble (remember that) 
  • then we had one of the best run-ups in the S&P 500 ever. 
  • There was a hiccup in 2009 (the great recession), after which S&P 500 went up five-fold! 
S-and-P-500-growth-chart

Back to our history lesson…

Remember what really caused the great recession – Real Estate. So the fact that REITs beat the S&P 500 is pretty impressive. So much going against REIT stocks in that 20 year period and so much going well for S&P 500 and REITs still performed better. 

So it’s decided… REITs are king of the stock market… (Or not?)

Impressive, but you can always find a time span where some sector outperformed another. For example, if you look at the past 10 years the S&P 500 has obliterated REITs.

S-and-P-500-vs-REIT-stocks-chart

Seriously though, are REITs really different from any other stocks? 

No, they are not! REITs aren’t “real estate investments!” They are normal stocks focused in the real estate sector. 

If I decided to buy PizzaPizza stock or even buy some S&P 500 (which contains PizzaPizza stock), is that the same as opening a restaurant? Of course not. 

Same for investing in a software company, can I start calling myself the next Steve Jobs? Absolutely not! 

REIT investing is just like investing in any other stock market industry. Yes, it is a different industry and REIT stocks have specialized benefits. But so does the Technology Industry and so does the healthcare industry.

How does the S&P 500 compare to a REIT stock?

So if REIT investing outperformed the S&P 500 over 20 years, but S&P 500 outperformed REIT investing in 10 years, it’s fair to ask: 

Do the S&P 500 and other index funds have the same advantages as some REIT index?

1 – Double taxation Profits 

No. This fascinating feature is only unique to REITs

2 – Diversification

Oh hell yeah! S&P 500 is 3% real estate and REIT stocks are 100% real estate

3 – No headaches 

Investing in the S&P 500 is super easy. 

4 – Liquidity 

Both REITs and S&P 500 indexes are freely traded on the stock market, so they’re easy to buy and sell. 

5 – High Dividend payouts

S&P 500 gives almost 2% dividend yield, which is plenty high. (Assuming a higher dividend-yielding sector gives better results is just guessing.) 

6 – Appreciation

Well, we just saw that S&P 500 outperformed REIT stocks over the past 10 years, (but not the past 20 years.) So let’s just say they both do well. 

Bottom line: REIT investing vs. S&P 500

People should have money in real estate to be diversified in something uncorrelated to the rest of the economy. REITs are stocks and they will tank when your stocks tank.

During peak fear from COVID, we’ve seen it ourselves, no one is safe. No stock or basket of stocks is immune to stock market fluctuations. So if your REIT investments are just going to move around like any other stock, why bother going out of your way to buy them? You don’t. 

REIT-stocks-over-covid

If you want to have 10% of your net worth in REIT investing. Why not also pass 10% to utilities? And 10% to tech? Trying to pick a winning sector is stock picking and fraught with issues, plus you’ll likely end up with an odd version of the S&P 500 at the end and you could have skipped the effort.

Bottom Line: My pick is the S&P 500. 

What about eREITs or crowdfunded real estate?

eREITs (aka crowd-funded real estate) are just another form of REIT investing but with one important weird benefit. It’s a product that is offered by some of the new fintech companies of the world that pool funds via crowdfunding from regular individuals and then invests those funds in new real estate developments or existing real estate management projects like a REIT would do.

You can start with just $500, or $1,000 but the weird benefit is that you can’t easily exit out of the funds. Unlike REIT investing, eREITs are not stocks in publicly traded companies traded on a stock exchange. It’s a private investment traded on private exchange markets. 

So this is basically an illiquid investment. 

Isn’t that bad? No. Not having enough liquid investments is bad because you need cash sometimes. But there is a downside to liquid investments. When people freak out they do crazy things. Remember that market plot above. COVID came and everything tanked. If people can’t sell investments during a downturn, they are way more stable. 

So crowdfunded real estate is less liquid, but it’s more stable and gives you something nice to hang onto during a downturn. It’s a balance that’s important and that’s the whole freaking reason you should have investments in real estate!

Special note on crowdfunded real estate investing,
At the moment, I’m really liking the AcreTrader and the FundRise eREITs.
I’ve also dedicated a whole article to a deep-dive on crowdfunded real estate, as well as a review of the most popular eREITs.

eREIT vs. REIT investing

Again, let’s look at the benefits of REIT stocks and compare them to eREITs. 

1 – Double taxation free profits 

Oh yeah, you technically own the real estate so there are no corporate taxes.

2 – Diversification

Yes and no. It’s still 100% real estate, but you’re invested into multiple properties just like with REIT stocks. Plus you should be diversifying your portfolio anyway! 

3 – No headaches?

Click-of-a-button easy!

REIT-stocks-investing-meme

4 – Liquidity

No, but that’s better!

5 – High Dividend Payouts

It functions as an owned property with rental payouts (minus a fee). 

6 – Appreciation

You own the property and they can grow quickly!

Bottom line: REIT stocks vs. crowdfunded real estate

So great, we solved it. REITs are just like any other stock index and crowdfunded real estate is a real estate investment in spirit without the hassle. 

Bottom line: Crowdfunded real estate (or eREITs) are the way to go and I’d super-recommend them. But you can go 1 step better. 

Direct Real Estate ownership

Okay. So far we’ve covered all the workarounds to investing in real estate without actually talking about… investing in real estate. 

And why? Cause it’s a headache?

It doesn’t have to be! 

I’ve already documented and shared my entire rental property experiment in different types of rental properties so you can learn from my lessons and avoid my mistakes. And you know what I learned? Any way you cut it, rental houses are pretty sweet. And that’s because you can get crazy mortgages and use them to pay little tax.

Let’s break it down. You can buy a REIT or an eREIT to give a real estate company an insane loan to invest in some property. OR… you can get an insane loan from the bank (aka a mortgage) to buy a second home to rent out. Great rates. Huge values. Amazing monthly payout. 

That’s impossible to match. 

But what about the headache of owning real estate?

You won’t be the first person to buy or sell a home. You won’t be the first person to manage a property. You won’t be the first person to talk to tenants. It’s all been done before, and there are tons of people reaping the rewards of real estate. 

Oftentimes, you can buy your rental home “turnkey” meaning it’s freshly reno’d to rent out and ideally already has tenants. 

You also don’t have to manage the property yourself, but there are tons of new tools and apps that make it easy. 

And if it still feels like it will be a headache, you can always take a course to set yourself up on the right foot. 

Direct real estate ownership vs REIT investing?

1 – Double taxation free profits

Oh yeah, plus I can jig the mortgage around to make a “tiny” profit each year (although eventually it would catch up in the form of huge capital gains… Oh well, I’ll figure it out then.)

2 – Diversification

Not really… houses are expensive! Maybe you’ll own 10 someday so the ups and the downs will even out though. 

3 – No headaches?

I’ll admit, owning a house can be a headache. You can lessen it with my suggestions above, but it’s still no button-click-investing. 

You can buy some Tylenol with all the rental income that’ll be coming in. 

4 – Liquidity

No, but that’s better (in moderation)!

5 – High Dividend Payouts

Rental income is the most amazing payout ever!

6 – Appreciation

My most leveraged house has been growing over 50%/yr for 4-years. That’s insane!

Bottom line: REIT investing vs. REAL real estate 

Okay. So I don’t even think I need to bother writing the bottom line, because you already know how much I love my rentals. 

When you make a direct investment into real estate you get to DECIDE what works for you. You decide:

  • The type of property to invest in
    • Commercial real estate
    • Residential real estate
    • Storage facilities
    • A quadplex or a basement tenant, etc. 
  • Type of market you’ll invest in

When you invest directly, you are much more in control. Yes, it’s also a double-edged sword because you have to make the decisions, but don’t pass the buck to some company. It’s worth it if you commit to taking it on. 

The other truth about real estate

The benefits of investing directly in real estate are more than just freedom. It’s an investment unicorn! 

But during this pandemic, businesses went bankrupt, people lost jobs, stock market fell, even REITs fell. 

Property prices? They went up. 

My real estate portfolio grew by $100,000 in 2020 while doing nothing at all. 

median-home-price-over-covid

Sure demand for housing went down a little. But supply for housing went down A LOT!  So prices soared for the few houses that were still on the market. 

Surprised? Don’t be! 

That’s the point of investing in real estate AND in the stock market. If one goes down, you can still hold on to the other. 

And it doesn’t end there! 

Look at the Interest rate history of the last 62 years… 

interest-rate-over-time-chart


Notice a trend? Even if I don’t invest in any more properties (impossible), even if I don’t raise rents ever again (even more impossible), my cash flow will still grow because interest rates have been coming down since 1980, making borrowing cheaper and cheaper!

Am I in some sort of money-generating vortex? This can’t be right! 

So to wrap up: 

TL;DR – REIT investing vs. Index funds, crowdfunded real estate, and direct real estate:

  • REITs are stocks invested in the real estate sector, but they perform like any other stock and don’t shield you from stock market ups and downs like real estate in general. 
  • REIT stocks have some special benefits, but I own none, and would prefer more S&P 500 investments for myself than REITs.
  • Crowdfunded Real Estate is a good real estate investment that provides better real estate specific benefits than REITs. I 100% recommend these to people if you don’t want to take on the real headache of rental property ownership. (Read my eREIT reviews here.) 
  • The best real estate benefits, however, are had by owning real estate directly. I think everyone should own at least 1 rental property.


Mr. FYFE's Top Tips to get into Financial Shape

#1 - The news is bad for you. It takes up too much time, makes you dumb, and stresses you out. You should spend that time on other things. Limit yourself to JUST 1 newsletter per day. I recommend MorningBrew which I review here.

#2 - Take a course about real estate investing. Real estate is an AMAZING vehicle to build wealth quickly and build income long term. I tested a few to find SparkRental's course to be king.
Sept 2020 Update: I temporarily have a MEGA discount ($500 off) for my readers who take the course. #WorthIt. (Buy button appears near the end of the video which you can fast forward/skip if you want.


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