When it comes to stock alternatives, some investors seem to have been led to believe that investing in Real Estate Investment Trusts are somehow preferable to direct, private real estate investments. Whether through sole ownership, or private placement offerings that pool investor capital and bank financing to leverage larger developments such as those offered by institutions like National Realty Investment Advisors (NRIA), Realty Mogul, MX Luxe Capital and Grand Cardone, to name a few, real estate ownership is preferable to REIT investments in many ways.
There are several reasons why more direct real estate investment, whether through pooled investment or single investor purchases, can be far preferable to REITS, as explained below. We explore four of them here.
First a note on misinformation: be diligent in conducting your research. There is a lot of misinformation published out there about the superiority of REITs, such as one recent article that NRIA provided us as an example of propaganda, that we won’t link to for fear of lending it more credence that suggest that “REITs generated 3.7% to 6% higher annual total returns.”
Fancy chart, right? Clicking through to the source citation shows that it’s from a company touting European REITs. To be clear, the subject of this article is what we believe to be the relative superior performance of United States real estate investing to the U.S. REIT markets. We have no opinion about the viability of foreign real estate or REITs and will leave that for another day. We would also suggest that research supporting any conclusion about U.S. real estate, REITs or even stocks, should rely largely on U.S. companies for their research.
Why are we so confident in our opinion that direct real estate investments are superior to real estate investment trusts? What follows is a concise explanation as to four primary reasons why private real estate investing is preferable to REITS.
Reason #1: Location, Location, Location
According to research provided by NRIA, average listed sales prices for single family homes in South Florida’s top 4 counties gained exponential traction year over year in the past few year.
When it comes to real estate, location is everything. You are already diversifying by adding direct real estate investment to your investing portfolio. Most REITs further diversify this real estate investment by offering fractional interest in all of their diversified holdings. And real estate is not as liquid as stock.
This could mean that you will also be investing in the next big thing (but from 10 months ago because it’s still in the REIT’s portfolio). Direct real estate investing allows you to pick your target markets based on readily available research that you can find on your own.
According to research gleaned from Catalus Capital and NRIA, when including Miami-Dade, increases property investment returns for many individual investors have netted over 40% return in the past 16 months, before taking into account leveraged returns when taking into account the rock bottom pricing of lender financing. NRIA also provided research suggesting home sales of over $3 Million, had increased for the past 6 consecutive months.
Why the focus on Miami at the moment? Because everyone is moving there and corporations are migrating there for tax and political reasons. The point? With a REIT you don’t have that kind of independent judgment. REITs, by definition are designed to be broadly allocated into markets around the country through process that some cynical stock analysts have called “diworsification.”
But you don’t need to look to glitzy regions like Florida for evidence of real estate growth. New Jersey has boasted record performance in recent history as well.
Reason #2: You Can’t Move Into a REIT
This is perhaps the number one reason to invest in real estate on your own. And frankly, it probably doesn’t apply to most pooled real estate investments either, like those offered through the kinds of private placement offerings that funds like those that we imagine Realty Mogul, NRIA or MX Luxe Capital might offer. But when you purchase your own home, whether as a primary residence or an investment property, if you lose your job, or if your other investments go south, you can always move into your investment.
That’s why we typically advise avoiding investing in properties that you would never want to visit. You need not invest in your dream home either however. In fact, research provide by a Home Loan Funding veterans and NRIA suggest that lower income property can sometimes yield much higher returns in considering rent to debt ratios and other cost of carry figures.
But you should purchase property you like and could live in. This is because real estate, unlike stocks, bonds and even REITs can be your safety net if you can live there. And, applying Warren Buffet’s stock picking principle to real estate, the first rule is invest in what you know and understand. If you don’t like the neighborhood, you likely don’t understand it. Invest in what you know and in a potential home.
Reason #3: DiWorisification
We covered a little of this above, but the short of it is that making great returns means being courageous. We’re talking about the foolish kind of courage that has you betting your life savings on penny stocks. We mean, a calculated risk that assigns a portion of your investible savings into an investment you believe in. With REIT’s, in most cases, you are allocating the real estate portion of your portfolio across the board. And there will likely be management fees for the benefit of spreading out this risk. When you bet on every horse the race, guess what happens?
We’re not suggesting that you should not portion some of your would-be index or mutual fund investment portfolio into REITs. You probably should. But if we are talking about actual real estate investing, then you should make a targeted decision that puts you in the driver’s seat. By over diversifying you are diworsifiying, meaning the return on your best real estate investments will be dragged down by the other 75% of your investments in the REIT that are less than stellar performers.
There are perhaps exceptions, like something we read recently about AvalonBay Communities (AVB) that supposedly creates value for shareholders by actually building its own properties. We don’t have an opinion on whether that structure approximates direct ownership or private placement opportunity offered by funds like NRIA.
Reason #4: Peace of Mind
Ahh, the solid ground of real estate equity. Terra Firma. We’re land lubbers by nature. Let’s face it, there is something reassuring about investing in something that you can grab with your bare hands while the ethereal nature of stocks and shares in REITs resembles earth only insofar as we can imagine their values slipping through our fingers like sand. Is the security provided by investing in the literal earth real or imagined? Who cares? According to NRIA, real estate investing provides equity growth opportunity that can later be leveraged to expand into stock purchases as well, much like margin accounts, but secured by real property rather than a stock portfolio that can be called if the market turns.
Banks require certain loan to value ratios, but primarily loan on borrower ability to pay, not equity. This means that the bank won’t call your loan or accelerate if the value falls. Also according to the NRIA, when property values fall, often times rent values are inversely correlated, allowing property owners to weather the storm by renting their property out. All things being equal, there is real comfort in knowing you own something tangible. Rental values may rise and fall. You may lose a tenant. But real estate, provided you’re not over leveraged, won’t ever vanish into thin air the way that a stock can vanish into nothing.
Key Takeaways
You often hear investors say that REITS, as investments are more outperform traditional real estate investments. While anecdotal evidence might support this claim on a case by case analysis, it’s generally not true.
In fact, the opposite is the case. Imagine purchasing a $400,000 property with just 20% down, or $80,000 invested. Your bank loan is 3.5% and your rental income is $5,000 per month or $60,000 per annum. What happens if that real estate appreciates just 5% in year 1? Your $400,000 investment is now worth 400,000 x 1.05 = $420,000. You made $20,000 in appreciation alone. But wait, you didn’t invest $400,000. You only put down $80,000. So you just made $20,000 on an $80,000 investment. That’s 25% in year 1 and your mortgage payments were more than covered by the rent. Now that’s an investment!
Some of the major players in the private equity space that focus on real estate investments include:
- Kuzari Group
- Catalus Capital
- NRIA – National Realty Investment Advisors
- Gemini Investors
- Tyree and D’Angelo Partners
- Oroco Capital
- Pillsman Partners
Special thanks to SVN Florida, NRIA and XPera Group for the information they helped provide.
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