I recently shared an article in which I discussed all the reasons why I quit buying rental properties to buy real estate investment trusts, or REITs, instead.
To make it short, I think that REITs (VNQ) are better in most cases because of three main reasons:
Reason #1: REITs generate higher returns on average.
Reason #2: REITs are also a lot safer investments.
Reason #3: REITs allow you to optimize your career and lifestyle.
I would encourage you to read the whole article by clicking here.
Most people who read the article appeared to agree with my reasoning. There are over 100 comments, many of which came from investors who have invested in both: rentals and REITs.
But a minority of readers disagree. They are convinced that they can earn higher returns by investing in rental properties.
I think the disagreement stems from a simple misunderstanding.
They missed the part where I say “in most cases.”
I think that REITs are better investments “in most cases” because studies have shown that they generate higher returns on average with less risk and much lower effort. You also retain your geographic freedom and limited liability.
But that does not mean REITs are better investments “in all cases.” That is not what I said, because I recognize that private real estate investments can vastly outperform REITs in some particular cases and this is why I invest in both.
In today’s follow-up article, I want to discuss some of the exceptional cases when I would favor private real estate over REITs.
1) International Real Estate
Today, there are REITs in over 30 markets in the world.
This is great, but it is not enough.
The world is vast and lots of markets are not covered by REITs, and some other markets are only covered by low-quality REITs that are mismanaged.
For this reason, you will often have to buy private real estate if you want to invest in a particular foreign market.
To give you an example: I am very bullish on the future of Estonia and expect the real estate prices in their capital city, Tallinn, to rise significantly over the coming decade. It is becoming the “Luxembourg of Northern Europe,” pulling lots of entrepreneurs and wealthy individuals from other EU countries thanks to their business-friendly policies. But they don’t have any REITs. They only have a few listed real estate investment firms and they all present some issues.
For this reason, I ended up buying a property there and I don’t regret it. I bought it in late 2021, and the value of my equity has more or less doubled.
2) Ability to Add Value
If you are buying private real estate, you need to add value to it if you want to have a chance to keep up with REITs.
REITs are always creating value by improving their assets or even developing them from the ground up. You cannot expect to beat them if you are simply buying stabilized assets and paying full price.
But the reality is that most people can’t expect to add much value. It requires skills and effort and this is why I think that this is an exceptional case.
My latest purchase was the property in Tallinn, Estonia so let’s use this example again.
I bought a luxury condo in a brand-new building. The condo was very attractive, but some improvements could make it even more desirable and increase its value.
One improvement that I made is that I removed the bathtub, increased the size of the bathroom, and added a sauna to it.
A lot of the wealthiest buyers in Tallinn come from Finland and Sweden, and they often expect to have saunas in a luxury condo. It cost me ~$5,000, but it could make or break a deal and realistically add ~$50,000 of value to the property.
3) Your Own Home
Real estate can also provide non-financial returns, but REITs can’t.
Buying your own home will allow you to have full control over your own residence. No landlord can kick you out and you can customize it to your own desires.
That has value.
You cannot move inside your REITs. That just isn’t possible.
It may be more rewarding to invest in REITs and use the returns to pay your rent, but life isn’t just about financial returns.
4) Specialty Property Sectors
Today, REITs invest in most property sectors. This includes even specialty sectors like cell towers (AMT), data centers (DLR), net lease properties (O), warehouses (PLD), and timberland (WY).
But there are some niches that are still poorly covered by REITs.
To give you an example: if you want to invest in Farmland, there are today only two farmland REITs and both present some issues.
Gladstone Land (LAND) is most invested in permanent crops, it is externally managed, and priced at a high valuation.
Farmland Partners (FPI) is potentially undervalued, but it also has a brokerage and asset management business, and therefore, it isn’t a pure-play farmland investment.
Therefore, REITs may not be a good option here and it may be preferable to invest in private farmland.
I think that farmland crowdfunding is probably the best option here as it will allow you to invest in private properties with the added benefits of professional management, diversification, and limited liability.
There are a few platforms today, and my favorite is FarmTogether.
5) Synergies With Your Career
Real estate takes a lot of time, and this is one of the main reasons why I think that it isn’t worth it for most people.
I think that you would be much better off focusing on your main career and investing in REITs instead.
But the exception is if there are some clear synergies with your career. Let’s say you are a real estate broker and you get to see new deals before they hit the market. This may be a clear competitive advantage.
Or perhaps you are a carpenter and often come across properties for sale that are discounted because they require a lot of work that scares off potential buyers. You could buy these properties and work on them in your free time to increase their value.
You get the point. If you have a competitive advantage, go for it. It can be very rewarding. But if you are just an average Joe who works in a non-real estate-related field, I just don’t see the point of putting in a lot of time and effort when you could simply invest in REITs. You won’t have a competitive advantage anyway.
It does not have to be just one or the other.
I invest in both, REITs and private real estate.
My point is simply that REITs are better investments in most cases and therefore, I think that most investors should favor REITs.
My real estate allocation is about 80% REITs / 20% private real estate. It is not that I wouldn’t have the skills as I come from a private equity real estate background. I just think that undervalued REIT investments offer much better risk-and-hassle adjusted returns to investors.