Six reasons why REITs are safer than rentals

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Recently, we shared “8 Reasons Why REITs Are More Profitable Than Rentals.” In short, research shows that REITs earn 2% to 4% higher annual returns than private real estate. There are eight reasons for this:

1. REITs love it big economies of scale.
2. He can grow outside.
3. They can develop their own yours properties.
4. They can get more profit by monetizing their platform.
5. They enjoy it stronger to negotiate with their employers.
6. They benefit from off-market deals to a great extent.
7. They are very talented.
8. They avoid disastrous consequences.

But high returns also mean high risk, right? That’s why many rental property investors stay away from REITs. They see themselves as riskier than rentals because they trade in the form of stocks, and these come with significant volatility. But I don’t agree.

I think so REITs are a much safer investment than rental properties. Here are six reasons why.

Concentration vs. Diversification

Rental properties are a big ticket investment. Therefore, many investors end up having one or more owners.

As a result, you are focused on a limited number of properties, tenants, and markets. If you face bad luck, you may face a great loss because you are not separate.

A tenant abandoning your home, a leaky pipe, an insurance company defaulting, a large property tax increase, poor local market conditions, a tenant suing: These things happen, and that hence the diversity key to reduce risks.

REITs, on the other hand, you have hundreds, if not thousands, of buildings, which are results in the middle big diversity by property, tenant, and market. In addition, there are 1,000 REITs worldwide that invest in 20+ different real estate sectors and 20+ countries, allowing investors to building very diverse portfolios that can stand the test of time.

Private vs. Public

Rental properties are private investments, making them relatively illegal, less transparent, and subject to inconsistent regulations, which can increase the risk of fraud. Finding reliable information is often very difficult, investor protection is limited, and many people may try to take advantage of market volatility.

REITs, on the other hand, they are public, liquid, transparent, SEC regulated, and scrutinized by many analysts, encouraging short sellers and lawyers who I’m looking for the smallest of all company tracking issue.

The risk of buying private property and overpaying for it, because you they lacked something the key information, is very large, and selling it in the future will also be very complicated and expensive, given its illegal nature.

High Leverage vs. Low Leverage

Most property investors rent the will usually use ~80% leverage when buying properties. This means that a 10% drop in property value can result in a 50% loss in equity value.

This explains why so many real estate investors filed for bankruptcy during the great financial crisis. As property prices fall, a lot of investors ended up with negative equity in their properties and handed the keys back to their lenders—a complete write-off.

In comparison, REITs are more stable because they they have learned their lesson from that experience. They usually use only 30% to 50% of the energydepending on the type of building. This leads to a lower risk in the event of a downturn.

Personal Liability versus Limited Liability

A big a risk that most rental property investors do not appreciatein my opinion, it is an obligation.

You might think i LLC and/or insurance will protect you from everything, but that easily it’s not fair. The bank will probably still need personal credit when you take out a loan, and your employers or contractors can get it still sue you personally if they believe you are responsible for the problems that arise.

For example, let’s assume that some mold it grows in your bathroom, and your employer eventually becomes infected as a result. Even if it’s not your fault, the employer may sue you personally, leading to many headaches, sleepless nights, and big legal bills at least.

With REITs, your debt is protected because you own a minority of the shares of a publicly listed company. You are not actually to sign in any of the debts personally, but you still enjoy the benefit of them. Employers again I won’t sue you directly, and you can’t lose more than your fair share in the worst case scenario.

Public Risk vs. Protected from Operation

Real estate investing is a people businessagain it comes with a risk to society. Many people like to take advantage of property owners, and this can lead to emotional or even physical pain.

I know people who have been threatened by their employers. Although rare, there are also cases of tenants beating or killing landlords. They are a number of cases of tenants refusing to pay rent, deliberately damaging the property, and/or to growl and refusing to go out.

All this is possible literally waste your life and cause such stress that your mental and physical health takes a hit. You might think that you they can avoid this by simply selecting and hiring only the best employers, but people will lie and change over time. If you own a property long enough, you will probably have to deal with such problems.

In my mind, i The potential benefits of investing in rentals are there almost never it is worth running this risk.

I can a lot rather get a slightly lower return and be completely protected from operations, with a professional handling everything on my behalf. You mayof course, hire a property managerbut that will come at a higher cost because you won’t enjoy the same scale as REITs.

In comparison, REITs can handle management in a a more cost-effective method due to their economies of scale, and completely protects you from these operational risks.

No Quote vs. Daily Quote

Finally, consider that REITs are more volatile than rentalsthink again. The reason why think that real estate prices are more stable than REIT stock prices is something because you are comparing the rental property value to the equity value of REITs, which are apples and oranges.

Instead, you should be to compare your tense situation yours equal amount of volatility in share prices of REITs. If you do that, you will quickly realize that REITs are very stable in most cases.

As noted, if you which they use 80% loan, then you only have 20% equity in the property. This means that a A 10% lower property value can cause your equity value to drop by 50%. A 20% drop will lead to total extinction.

Now ask yourself: If you own a private, illegal, concentrated property with one tenant, high capex, and public risk, how likely is it that your property will face such problems? The answer is that it is very high.

A leaking roof that causes water damage can easily reduce the value of your property by 5% to 10%, ie that’s yours the equity value will decrease by 25% to 50%. A tenant who stops paying rent, refuses to move out, and trashes your place? That’s a 10% to 50%+ drop in equity.

Even if you don’t face problems, your position is illiquid, and the information is invisible. Therefore, its value is highly uncertain. So, if you take the offer every day (like the stock market), you can often get offers 10% to 20% below your appraised value, resulting in a large fluctuation in your equity value.

Just you are not actually to get the average of the day again there is Ignoring this offer does not mean that your equity is completely stable.

Now compare that to REITs. What you see being sold is the value of the equity, and while it is it changes, in most cases, it is not to the same extent.

And, that makes sense REITs will have less volatility, as long as they are large, diversified, public, and liquid companies regulated by the SECand there enough information about them and input from countless expert analysts. Corner then it’s much easier for the market to determine the right price, and it won’t have to fluctuate too much.

A learn by Brad Case, CFA, PhD found that REITs are 17% less volatile than private real estate when on the right adjustments are made to compare apples to apples.

Final thoughts

Rental properties are a concentrated, private, illiquid, highly profitable investment with credit issues and public risk.

Meanwhile, diversified, public, liquid REITs are moderately invested that you enjoy limited liability and professional management.

It is night and day in terms of risks. Renting is much more risky than REIT investing, and anyone who argues against this is simply uninformedin my opinion

This is clearly seen in the levels of people who are in need of money.

There are many real estate investors applying with bankruptcy every year, however only a this is a minority REIT bankruptcies have occurred over the past few decades.

A Note About BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BiggerPockets.