What are REITs and how do they compare to a buy-to-let investment?

Thinking about investing in property? Buying shares in a Real Estate Investment Trust (REIT) can be an appealing alternative to buying your own property to rent out. Whereas one strategy involves becoming a landlord, the other is a more liquid and flexible form of investing. 

The truth is – there are pros and cons to each strategy, and many differences between them. Even more importantly, many choose to buy-to-let and invest in REITs – they’re not mutually exclusive. Let’s take a closer look.

What are REITs?

A Real Estate Investment Trust – or REIT – is a company that owns and manages income-producing real estate. The company itself is listed on the stock exchange (not all companies are listed, but many of the largest ones are), and investors can buy shares in it, just like they’d buy shares in any other company. Because these shares can be traded publicly they’re classed as highly liquid assets, making them popular among investors who know their way around public equities.

Every investor who purchases shares in a REIT earns a share of the income that REIT produces. This is attractive as they get a consistent income without having to get involved in the management of the company or its properties. Plus, like with any other stock investment, their shares can go up in value over time. 

The REITs market has been active in the UK since 2007 – and it doesn’t look like it’s going anywhere any time soon; March 2023 figures showed the market value of outstanding UK REIT shares to be £58 billion.

The different types of REIT

There are lots of different variations of REITs. These can be distinguished by which type of real estate the REIT invests in. For example, a REIT might specialise in investing in residential, industrial, commercial or office real estate – or even in healthcare properties, like hospitals and nursing homes. 

Another distinguishing factor can be where the REIT invests – some might focus on properties in the United States, Europe or Asia, for example. There are also REITs that invest specifically in mortgage loans secured by residential or commercial properties.

As an investor, these various REIT categories give you the chance to invest in trends that you believe will affect the market – without the challenges and constraints of acquiring a physical asset. For example, you might believe that real estate in a specific country or region is about to experience strong growth. But, of course, investing directly in property in another country may be completely out of reach due to the complexity of navigating a foreign legal system, language and even financial requirements. In this case, investing in REIT shares in this country allows you to take advantage of the opportunity without actually having to get directly involved with buying an asset.

Investing in REITs vs investing directly in a buy-to-let 

As with anything in the world of investing, there are upsides and downsides to buying shares in REITs, just as there are for buying your own buy-to-let property. Read on for the pros and cons of both strategies:

Investing in REITs – the pros

• A passive income: When you invest in a REIT, you get a consistent income without actually having to do anything from a property management point of view. The REIT takes care of everything. You also get the peace of mind of knowing REITs are managed by experienced professionals who have a track record of success in the real estate industry. This might appeal to those who like the idea of investing in property but don’t feel confident in actually managing rentals.
• A steady income: REITs are required to pass on 90% of their profits to their shareholders. This means shareholders get to enjoy a regular distribution of dividends from their REIT investments, with these dividends often being much higher than the average stock on the S&P 500. 
• Liquidity: You can buy and sell shares in REITs as rapidly as you can for any other company on the stock exchange. This means a REIT share is a highly liquid asset – easier and quicker to sell than a physical buy-to-let property. In a nutshell: you could get cash for your REIT within a few minutes, whereas it could take you many months (or longer) to sell a property.
• Diversification: Investing in a REIT means you’re instantly diversifying, as each REIT owns many properties, not just one. Investing multiple properties lowers the overall risk you take as an investor – compared with if you were to invest in one single buy-to-let property. Of course, many traditional landlords diversify successfully, but it can take years to get to this point.
• Financially more accessible: If you can’t secure a buy-to-let mortgage for any reason, REITs can be a great way to invest in property by using the cash you do have available. While £10,000 could be allocated to REITs shares straight away, this is unlikely to be enough for a buy-to-let mortgage deposit, for example. 

Investing in REITs – the cons

• A hands-off investment: When you invest in a REIT, you don’t get any say over which properties the company invests in. It’s a fully hands-off investment which means you relinquish control to the REIT – you can’t physically see or touch the properties you’re investing in, making the whole endeavour feel far less tangible. This lack of decision-making and involvement may appeal to many, but might not suit those who prefer a hands-on approach. 
• Potential for slow share growth: Because REITs are required to pass on 90% of their profits to their shareholders, they tend to grow more slowly on a whole than companies that are able to invest more of their profits back into themselves. Which means the REITs share prices don’t usually grow as fast as, say, those for a Silicon Valley tech company.
• No tax deductions: You can’t deduct any expenses from the money you earn from REITs when it comes to paying tax. (You need to pay income tax on your REITs earnings). With a buy-to-let property, on the other hand, there are deductible expenses you can claim, lowering the amount of tax you pay on your rental income. 

Being a landlord – the pros 

• Leverage: When you take out a buy-to-let mortgage, you can leverage a much higher level of debt financing than with a REIT. 

Say you pay a £30,000 deposit on a £120,000 rental property. In this case, you pay the deposit and over time get the returns on the full £120k (financed through the mortgage). The good thing here is that you can manage the repayment over a longer time horizon, whilst benefiting from the property’s rental income into your cash flow.

With a REIT, your investment will most likely be limited to the £30k cash, without the additional £90k leverage that you could get with a mortgage.

• Hedging against stock market volatility: The real estate market doesn’t directly correlate with the stock exchange – so it doesn’t react to any volatility within it. In the 2007 recession, for example, when the stock market dropped by 30% in terms of market value, direct rental property ownership carried on delivering above market returns.
• More control over your investment/s: When directly buying rental property, you get the chance to seek out the most lucrative opportunities. You can search for properties with potential for strong capital growth, as well as high rental yields. Plus, as your asset grows in value over time, you can refinance it and use the money you make to invest in further assets. It’s a much more hands-on approach where, with the right strategy, you can really drive your investments forward. 
• Potentially higher returns: It’s difficult to say exactly which strategy will return higher yields – REITs or buy-to-let. According to data from Savills, the average annual total return on investment (TRI) for REITs in the UK was 7.2% between 2010 and 2020. The average annual TRI for residential property in the UK over the same period was 6.4%. However, this is a broad view – and some place the annual yields for REITs at more around the 2-3% mark. 

Investing directly in a rental property could provide a lot more scope for higher returns. For example, turning a property into an HMO or holiday let means it could deliver significantly higher yields than the average. Likewise, seeking out properties in areas of promising growth can also deliver high returns. With REITs, you have less control over your investment; there are less avenues to explore in terms of seeking out higher returns. 

Being a landlord – the cons

• It requires time and effort: From finding and screening tenants to taking care of property maintenance and managing rental income and expenses – being a landlord requires time and effort. Hiring a property management company can significantly reduce the workload, of course. But this is always going to be a much more hands-on approach than investing in REITs. 
• It requires more intimate knowledge of the market and of compliance requirements: There’s a lot to get your head around as a landlord – especially regarding legislation and regulations (which can change frequently). Plus, if you want to build a portfolio as a buy-to-let landlord, you’ll need to be able to really get the inside track about your target market to seek out the best opportunities. With REITs, you might leave this to the company you’re investing in.
• Financing: The old adage rings true here – you need money to make money. Buying a rental property requires a significant investment upfront – you’ll probably need at least a 25-40% deposit. If you don’t have access to this kind of cash, you simply won’t be able to get on the buy-to-let ladder just yet.

Which investment strategy is right for me?

Deciding whether to invest in REITs or your own buy-to-let property does not have a final “right or wrong” answer. Ultimately, it does depend on your own very unique set of circumstances. 

If you like the idea of owning a tangible asset that you have full control over, and you feel equipped to stay on top of the property management side of things, being a landlord could be for you. You’ll need to be ok with the fact that your asset is relatively illiquid, compared to shares – you can’t buy and sell a property as rapidly as you can trade on the stock exchange. But you might find that doesn’t matter as you’re treating this as a long-term investment. It can be exciting looking for lucrative buy-to-let opportunities and building up a portfolio, but this does require a level of knowledge and a willingness to get stuck in. Still, it can be incredibly rewarding. 

REITs, on the other hand, can be a great, more hands-off way to invest in property with less exposure. Perhaps you like the idea of directly investing in a buy-to-let but you don’t access to the funds right now. Or perhaps you strongly believe in the potential of a current trend in property, but you don’t feel like taking the plunge by buying a property outright, and you would like to test your insights first. In both cases, investing in REITs could be a good way to reap the rewards of property investment without directly buying property. 

If you have the budget and knowledge – investing in both REITs and your own buy-to-let/s can be a smart move. This is the ultimate in diversification, and helps to lower the risks you take as an investor. 

Of course, our recommendation is always to seek advice from a financial advisor who specialises in this field before making any big decisions. 

Some quick tips for investing in REITs

• Do your research: Before you invest in any REIT, it’s crucial to do your research and understand the risks involved. Always speak to a financial advisor before making any big decisions. 
• Consider your goals: Are you looking to generate income, build wealth, or both? Once you know your goals, you can choose the REIT that is most likely to help you achieve them.
• Consider your risk tolerance: How much risk are you comfortable taking? Some REITs are more risky than others, so it’s important to choose one that’s appropriate for your risk tolerance.

That’s a wrap. We hope this guide has been useful! As always, please consider that our content is for educational purposes only and it is not financial advice.

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