Happy Friday! I just landed in Paris and am off to a weekend of investor meetings and a little site-seeing. I will share more about my trip next week.

This week, I want to answer one of the most commonly asked question I get when talking about real estate investing…

Is homeownership a substitute for investing in REITs?

This question has come up multiple times over the years and seems to be a favorite of late. I will probably be asked about it in Paris as well.

I have answered it many times (C’est la vie!). But as much as I feel like a broken record answering it, I believe it is the right question to ask in order to unpack the power of a REIT. 

Fundamentals First

To start out, I want to take a step back for new readers. For those wondering, a real estate investment trust (REIT), is a business structure that makes money by owning or financing property. First legally created in the U.S. through the Real Estate Investment Trust Act of 1960, REITs do not pay any corporate income tax.

To qualify as a REIT in the eyes of the IRS, a company must meet specific criteria. The most widely known provision is that a REIT must pay shareholders a common dividend equal to at least 90% of its otherwise taxable income.

The dividend that REIT investors receive out of earnings, therefore, has not been reduced by taxes at the corporate level – making REITs tax-efficient conduits for real estate income.

The original legislative intent was that REITs would be an inclusive approach. They would allow all Americans to enjoy the benefits of investing in high-quality commercial real estate without having to be ultra-wealthy. 

Now going back to the original question, I want to share two major reasons why home ownership is not a substitute for investing in REITs.

1. A House is a Consumption Good, Not an Investment

First, a home is a consumption good, not an investment. A house does not produce current income if left to sit on its own after purchase. A house requires regular mortgage interest, real estate tax, insurance payments, and maintenance costs.

Maintenance costs are often overlooked when it comes to homeownership because they’re much harder to quantify.

No matter how grandiose the property may have been when first purchased, humans produce waste and it has to go somewhere. A house that is lived in will experience plumbing issues over time with age. It is unavoidable. And this may be the least of the problems discovered over the years.

Even if you purchase a home in order to turn it into a rental property, you add potential tenant fees into your overall maintenance costs.

In contrast, REITs represent an investment in commercial real estate, which generates continuing income flow from rents. These rents that come in are then issued to you as the shareholder, tax-free, in the form of dividends.

As I often say, unlike homeowners, REIT owners avoid the three T’s: Toilets, Taxes, and Tenants. The REIT management teams take care of all of the above.

And in the end, a home is ultimately a good that is consumed over time if left to its own devices… whereas a REIT is a much more straightforward investment that actively grows your ROI over the long run.

2. A REIT is a Liquid Investment, A House is Not

Next, a REIT is a liquid investment, a house is not. If I needed cash on hand for an emergency, or for unplanned monthly expenses due to an upcoming recession… I would choose a REIT over a house any day.

Just type into Google “how long does it take to sell a house?” And you will see everything from 18 days to a number of months. For a REIT, the payout is almost instantaneous. Sell your shares and reap the previous dividends you received in addition to any profit you might have on the current share price.

So moral of the story is, if you need cash in hand and quick, a house is not something you want to have to turn to. Compared to a REIT, a house is an illiquid asset.

Never Put all Your Eggs in One Basket

Lastly, if those two reasons aren’t clear enough, a piece of investing advice that is handed out across all asset classes is always: diversify. It is never advisable to place all your eggs in one basket.

The fact that one REIT can be diversified across a range of real estate properties in a variety of geographic locations, is a bonus advantage that a house can never live up to. A house is highly concentrated in one area and one location. This is why homeownership will never be a substitute for REIT investing.

REITs win every time. I’ve learned the hard way, so you don’t have to.

If you’ve had the same question, I hope this can help you make a more informed choice for your investments. And if this makes you more excited about REITs, we have an entire portfolio dedicated to this asset class in the Intelligent Income Investor. Check it out, here.

Happy SWAN (sleep well at night) investing,

Brad Thomas
Editor, Intelligent Income Daily