Most people know, or at least have the sense, that investing in real estate is usually a good idea. That’s not to say that all properties have the potential to be profitable or that every real estate investment decision is going to turn out well, but generally speaking, people who invest in real estate consistently and wisely fare better than their counterparts.
The problem is, purchasing properties and managing those properties on an individual basis can be stressful, time consuming, and challenging, even for experts. One alternative that can give you exposure to the real estate market is investment in the form of real estate investment trusts (REITs); another is fractional real estate shares, which are somewhat similar.
But are these investment options really worth it? And how do they stack up to actual property investment?
An Introduction to REITs and Fractional Real Estate Shares
Let’s start with some definitions.
Real estate investment trusts (REITs) function like companies that buy, manage, and sell real estate on behalf of investors. Investors can purchase, hold, and sell shares of REITs the same way they might purchase, hold, and sell shares of stock.
Investors are entitled to dividends, or distributions of profit, according to the organization’s structure, and generally hope to see their shares increase in value over time. Management decisions are made by a central governing body within the organization and these organizations are subject to strict rules set by regulatory bodies, much like stocks.
Fractional real estate shares are a similar way to invest in real estate indirectly, but they function on a smaller scale and are slightly less accessible than REITs. In this arrangement, you’ll combine your funds with the funds of other investors and purchase real estate together, pooling your assets and distributing ownership of the property into fractional shares accordingly.
For example, you might buy 10 percent of a property in exchange for 10 percent ownership of it and entitlement to 10 percent of the profits. These deals and organizations vary wildly, and are highly customizable, so management decisions can be made in a variety of conceivable ways.
Downsides of Owning Physical Properties in Full
Owning physical properties in full is the default strategy for many real estate investors, but there are some downsides associated with it.
- Capital demands. If you’re going to invest in a property by yourself, you’ll need the capital to do it. Even if you’re taking out a loan, you’ll still need capital for the down payment, and you’ll need the financial standing to qualify for a loan. This is difficult to do if you have limited income, if you have limited savings, or if most of your capital is already tied up in other ventures.
- Risk. Similarly, investing by yourself means you’re taking on a disproportionate amount of risk. If a property fails to become profitable and you only own 10 percent of it, you’ll only suffer 10 percent of the damage compared to someone with 100 percent ownership of a similarly failing property.
- Allocation and diversification issues. Investing in a single property means allocating significant assets to a single unit (in many cases). Investing through REITs and fractional real estate shares means it’s much easier to diversify your portfolio; if you have enough money to invest in a single property, you can instead distribute your money across several properties, getting exposure to different cities, different types of properties, and even different management styles.
- Management responsibilities. Owning a property by yourself means you’ll be responsible for maintaining and keeping up with it. If you intend to rent the property, this can saddle you with a host of landlord responsibilities. With the help of a property management company, you can delegate most of these responsibilities, but it’s still something you’ll have to consider.
Downsides of REITs and Fractional Real Estate Shares
It may seem like REITs and fractional real estate shares are advantageous over individual property ownership, and in some ways they are, but they also come with some downsides:
- Lack of transparency. While you can read about investor directives and management responsibility distribution, there’s still an inherent lack of transparency when you’re working with partners or an external organization. Compared to owning and running your own property, this can make certain decisions much harder.
- Lack of control. You’ll also forfeit control by allowing another organization to take control of your investment decisions and management approach. For some investors, this is totally acceptable, but others prefer a hands-on approach.
- Fees and upkeep costs. In many cases, you’ll be responsible for paying fees or upkeep costs that compromise the profitability of your investments in these areas. Owning properties individually may present some extra headaches, but they also come with greater upside in many cases.
- Logistical challenges. Forming an investment group you trust is extremely challenging, and researching which REITs to invest in can be tedious and overwhelming. It may not be as complex as navigating a first-time home purchase, but it’s not exactly easy, either.
Which Approach Is Most Profitable?
What about overall profitability?
For many investors, this is the most important consideration. Unfortunately, because of the many directions that each investment can potentially go, it’s impossible to make a concise determination of which real estate investing approach is most profitable.
Because of lower fees, more control, and greater variability, investing in individual properties can be argued to have more potential upside. However, because risk is also higher with this approach, there’s also a bigger potential downside. REITs and fractional shares sometimes provide a more consistent, reliable return, if slightly lower – though this isn’t always the case.
The Bottom Line
Investing in individual properties, investing in REITs, and investing in fractional real estate shares are all viable strategies that can help you get exposure to the real estate market and make your money go further. However, it’s a mistake to say that any one of these strategies is strictly superior to the others; there are strengths and weaknesses to each approach that you must consider before adding any of them to your portfolio. Consider your risk tolerance, current holdings, and investment style carefully before moving forward.
If you’re feeling overwhelmed by all the variables and factors you need to consider in your real estate decisions, or if you just need some extra help getting your rental properties up and running, Green Residential can help you. We have property managers, real estate agents, and advisors who can lend you the knowledge and wisdom necessary to help you build your real estate portfolio properly. Reach out for your free consultation today!