Real estate stocks vs REITs: Key differences and where to invest - CNBC TV18 (2024)

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Real estate stocks vs REITs: Key differences and where to invest - CNBC TV18? ›

While direct investments in realty stocks often expose investors to higher risks from market volatility and leverage, REITs can provide more predictable and steady income through dividends, making them a safer and more reliable investment option compared to direct realty stocks.

Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.

REITs are traded on stock exchanges, making them more liquid and easier to buy and sell compared to direct real estate investments, which are typically less liquid and involve higher transaction costs.

REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, and to have no more than 50% of its shares held by 5 or fewer individuals during the last half of the taxable year. This typically results in a higher and more stable yield compared to the average stock.

When investing only in REITs, individuals incur more risk than when they are part of a diversified portfolio. REITs can be sensitive to interest rates and may not be as tax-friendly as other investments.

The potential downsides, or CONS, of a REIT investment include the fact that they are taxed as income, the variation in the fee structures of different managers, and market volatility due to interest rate movements or trends in the real estate market.

Interest Rates. During periods of economic growth, REIT prices tend to rise along with interest rates. The reason is that a growing economy increases the value of REITs because the value of their underlying real estate assets increases.

Over a 15-year period, according to Cohen & Steers, actively managed REIT investors realized an annualized 10.6% return. Of the other active strategies, opportunistic real estate funds placed second, at 9.8%. Core and value-added funds had average annualized returns of 6.5% and 5.6%, respectively, over 15 years.

Commercial real estate has historically performed well relative to other investment options. Average 20-year returns in the commercial real estate sector slightly outperform the S&P 500 Index. With these enhanced returns comes greater stability.

Real estate investment trusts, or REITs, are known for their dividends. The average dividend yield for equity REITs was around 4% in mid-2024 -- more than double the dividend yield of the average dividend stock (The S&P 500's dividend yield was less than 1.5%).

What I wish I knew before investing in REITs? ›

A lot of REIT investors will select their investments based on the dividend yield and think that a higher yield will likely lead to higher total returns. But in reality, it is often the opposite. More often than not, the lowest-yielding REITs have actually outperformed the highest-yielding REITs over the long run.

REITs Outperform Stocks During Recessions

The stock market is extremely volatile during recessions. Publicly traded stocks rely heavily on the performance of the companies that are being traded in order to succeed. During a recession, those companies struggle, and their stock value drops.

REITs have been wealth-creating machines over the years. Realty Income, Equity Lifestyle, and Prologis have all outperformed the S&P 500 over the long term. These well-built REITs should continue enriching their investors in the future. They have the potential to turn long-term, consistent investors into millionaires.

Perhaps the biggest advantage of buying REIT shares rather than rental properties is simplicity. REIT investing allows for sharing in value appreciation and rental income without being involved in the hassle of actually buying, managing and selling property. Diversification is another benefit.

Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.

“I recommend REITs within a managed portfolio,” Devine said, noting that most investors should limit their REIT exposure to between 2 percent and 5 percent of their overall portfolio. Here again, a financial professional can help you determine what percentage of your portfolio you should allocate toward REITs, if any.

These properties are often rented out, producing income. REITs distribute at least 90% of their income to their investors in the form of dividends. REITs are an easy way to invest in real estate without having to own property yourself.

REITs are interest-rate-sensitive, which means they tend to outperform the broad market when interest rates fall and underperform when interest rates rise. During the trailing one-year period, the Morningstar US Real Estate Index returned 28%, while the Morningstar US Market Index returned 27.17%.

As mentioned above, stocks generally perform better than real estate, with the S&P 500 providing an 8% return over the last 30 years compared with a 5.4% return in the housing market. Still, real estate investors could see additional rental income and tax benefits, which push their earnings higher.

As a whole, REITs have consistently and repeatedly outperformed stocks and brought in better returns.