Real estate investors like the hands-on nature of their preferred vehicle. Unlike stocks and bonds, real estate is something you can see and touch. You can put your own muscle into improving your investment, and that's the fundamental difference between real estate and the stock market. Buying a thousand shares of Microsoft? They're not going to let you into the boardroom in Redmond so you can start tinkering with the company. But, if you're buying a half dozen houses for rental or for flipping, you can load up your truck and spend your weekends painting, fixing drywall and tinkering with the plumbing. You can have a direct and material role in improving your investment.
If you're a serious real estate investor though, the fundamental question in today's market is whether to be a hands-on real estate investor, complete with pickup truck and toolbox, or an abstract investor, putting money into REITs (real estate investment trusts) and ETFs (exchange-traded funds). In the latter instance, not only will you never hold a paintbrush or climb a ladder, you may not ever even see the property in your portfolio.
Besides the inherent advantages that investing at such an abstract level offers those who are less handy, there is a financial advantage as well, since investing in REITs and ETFs allows for a more flexible investment model. Rather than tying oneself to a mortgage with a fixed monthly payment and the burden of improvement and maintenance costs, the abstract model allows investors to put money in at their own pace. While investment advisors may recommend setting aside a fixed amount every month towards your real estate investment, the advantage is that it's not mandatory, and there's generally a much lower barrier to entry.
Real estate investment on the rise
Under the current economic and tax climate, investment in real estate is more advantageous than it has been ever since before the Great Recession. High net worth investors in particular will see several positive benefits under new federal tax laws. A big change, especially for those investing in commercial real estate, lets owners count improvement costs as a direct expense in the year of installation, rather than having to amortize those expenses over time. Older rules for amortizing improvements may have discouraged some commercial property owners from undertaking investments in commercial properties which required significant upgrades. This represents a big win for this class of investors, who can now take the complete write-off immediately and in full.
High net worth investors may be getting a big break, but ordinary real estate investors will get a break as well under the new law. What many investors don't realize is that the new tax law, while hitting homeowners with limitations on mortgage interest and property tax deductions, does not apply those same restrictions to income property, and all owners of investment property can get a federal tax deduction of as much as 20 percent of their net rental income. The benefit also accrues to investors in REITs, who will also be allowed to deduct up to 20 percent of their REIT dividends. This law, "Deduction for qualified business income of pass-thru entities," allows owners of any pass-through entity such as an S-corporation to deduct up to 20 percent of business income on personal tax returns, so that it is taxed at the lower personal rate.
A new surge in REITs and ETFs
This year will be very bullish on REITs and real estate ETFs. The real estate market has always been cyclical, with some analysts noting that real estate investments follow a predictable 18-year cycle which occurs in four phases: recovery, expansion, oversupply, and recession. Most areas of the United States are in a current sweet spot of expansion, and REITs are still generally undervalued in relation to the stock market, meaning that REITs are likely to outperform the market over the next few years.
The simplicity of REIT investment as well as the potential long-term benefits, and the benefits of the new tax climate that classifies REITs as pass-through investments, are causing at least a small boom in this type of investment, with some analysts expecting a breakout year for REITs and double-digit gains.
The housing crash of 2007 did make some investors overly cautious, although the surge today differs from that time in several ways. The Great Recession occurred in part due to rampant speculation and loose credit, coupled with a tendency of the market to create complex financial instruments and collateralized debt obligations (CDOs), which tended to overly obscure the risk. REITs and ETFs on the other hand, are much more transparent.
Like any set of options, the choice between physical real estate or a REIT/ETF option isn't the same for everyone, and while this year, the advantages for REIT investing are greater than ever, old-fashioned real estate investment will always have the pull and the satisfaction one always feels when walking into an older home, and making it look new with your own two hands.
