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4 Differences Between Investing in REITs and Physical Properties

If you are reading this, you may wonder, ‘How can I be the next Li Ka Shing or Donald Trump when I’m just a wage earner?’ Or, perhaps, you may have accumulated some savings, and you are contemplating, ‘Should I start investing in a small apartment for rental income or build a portfolio of real estate investment trusts (REITs) that generate high dividend yields?’

In this article, I will share four key differences between investing in the two. From this, I believe it would help you to decide which of the two you should go for.

Loan Eligibility

This varies between banks and the country of your residence. In general, you should maintain a good credit score at all times so that you can qualify to get a loan to buy properties. If you are currently eligible for a mortgage, perhaps, you should invest in physical properties. However, if you are not eligible for mortgages, then, your best alternative is to invest in REITs.

Growth

How fast are you able to grow your investment portfolio? Well, it depends on your financial status which impacts the maximum amount of mortgage that you can qualify for. If you intend to borrow more, then, you need to grow your income. Thus, the ability to grow your portfolio of physical properties is dependent on your ability to grow your income.

However, this is not the case for REITs. They usually have stronger financial positions compared to any individual on the street. Hence, they are more efficient and more capable of raising funds from banks and new investors to finance their acquisition of new properties, thus, growing their portfolios. As such, the portfolio growth in REITs is dependent on their financial positions, not yours as individual investors.

Capital

If you are planning to buy a small apartment, you may need to prepare a sum of capital which includes its down payment, renovation costs, legal fees and stamp duties. Let’s assume that 10% down payment is required. The legal fees and stamp duties work out to be 5% of the property price. Thus, if the small apartment costs $300,000, you may need to prepare a minimum of $45,000 in upfront capital to consider the purchase. In fact, you need to prepare more as you may need to do some minor renovation and service your mortgage.

What about REITs? You can start investing in REITs with just a few hundred dollars. Of course, that is not advisable as the transaction costs are relatively high. It is best to invest a minimum of $3,000 to make the investment more meaningful and worthwhile. Thus, if you do not have much capital to start with, you may consider REITs as an investment option.

Liquidity

Selling a physical property could be a major decision for you. You may have to advertise and negotiate to find the right buyer who offers a good price for your property. The whole process could take months or even years before the sale of your property is concluded.

It is different for REITs as you can buy and sell REITs like any stock listed on the stock exchange with just a few clicks of the button. There is usually always a ready buyer and a ready seller who is willing to buy your units in REITs. Here, there are no advertisements, negotiations and real property gain tax to be incurred from the disposal of your REITs. Thus, REITs are more liquid as the process of buying and selling the units are easier and convenient than physical properties.

The Foolish Takeaway

Should I go with a small apartment or build a REIT portfolio? The answer lies in your current financial status, loan eligibility, and your investment objectives. It is prudent to make sure what your intended results of investing are first before investing your hard-earned money.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.