Real estate investment trusts, or REITs, allow small investors to take stakes in big commercial undertakings like shopping malls, office buildings and apartment complexes. Investors buy shares in REITs, which trade like regular stocks. There are no mortgage hassles; it's easy entry, easy exit. REITs take your money and promise ownership benefits without the drawbacks. However, there is one very notable exception -- you don't actually own property.
Buying rental property or investing in a REIT can hinge on the expected length of the investment. REITs offer advantages for short-term planners. There are no financial commitments beyond the initial share purchase and you can sell shares in publicly listed REITs in at most, a few days. Property ownership is a longer term proposition in part because the initial financial commitment is high. Selling a property also takes longer than disposing of a REIT stake.
No matter what the terms of your financing, buying a property usually involves a downpayment and commitment to servicing a substantial debt. Property purchasers incur closing costs that can include commissions to realtors, taxes, insurance, inspections, appraisals and fees to prepare deeds for registration. None of this occurs with REITs, although there may be a broker's fee. The minimum investment in an exchange-traded REIT is the price of one share.
Property owners realize income from rent and value through real estate appreciation. Dividends and share price represent income and value to REIT investors. Rental ownership goes sour when units stand vacant --and property value declines, or both. Maintenance costs and property tax reduce return. REITs pay 90 percent of taxable income to shareholders as dividends. A REIT turns sour when no there is no taxable income -- and no dividend is paid. When the share price falls, so does the value of your investment.
Rents and REIT dividend payments are income and, therefore, are subject to tax. A rental property is a small business, which means costs like a mortgage, maintenance or building improvements can reduce the amount of income subject to tax. Sales of property or stake in a REIT are both taxed as capital gains. The tax you pay on the profit from the sale of a rental property depends on how long you owned the property and depreciation of the property. If you're looking to flip a rental property quickly, you're likely to pay a high tax rate on your gain. Furthermore, if you own stake in a REIT, you can receive capital-gains distributions subject to the 25 percent maximum tax rate as well; this can occur when the REIT sells a piece of depreciable property and distributes the profit to its shareholders.
REITs are easier to manage than rental property. Purchasing shares also buys REIT expertise to manage your money. Many countries have followed the United States's lead in establishing REITs, which allows investment in better-performing markets abroad. Rental properties require personal management, or hiring a manager; however, ownership offers greater latitude. Personal use of a vacation rental unit, for example, can qualify it for secondary-residence tax breaks. Improvements increase value. Another consideration is that property is readily accepted collateral -- perhaps, for your next investment loan.
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