Why REITS Are Better Income Investments Than Rental Properties
Here’s Why Rental Properties Make for Lousy Income Investments
The other day, I stumbled across a story about a young couple losing their shirt on a rental property they’d purchased as an income investment.
The duo bought the two-bedroom condo “for the capital gains.” They also liked the idea of earning passive income from rental properties. And with the tenants paying the mortgage each month, they thought they had stumbled on a sure path to building wealth.
Then COVID-19 happened.
The tenant, a young woman working for the local health authority, quit paying rent in April after getting laid off. She’s back to work now, but decided to stop back payments anyway. Because the government banned evictions, tenants know landlords have no recourse.
But the couple still has bills to pay. The monthly mortgage payment tops $1,400 a month. Insurance, condo fees, and property taxes add $800.00 a month.
Despite a hot housing market, the couple can’t unload their rental property on account of the tenant situation. And given the bureaucratic backlog, they expect it will take two years before they can kick the freeloading tenant out.
Not the easy income investment they were hoping for, that’s for sure.
So, why bring this up?
For me, anyway, the story highlights the sad reality of amateur landlording. And things look like they will only get worse as the COVID-19 pandemic drags on.
Rents have plunged nationwide, according to online rental platform Zumper.
The pandemic has hit the country’s most expensive markets, like Boston, New York, and San Francisco, especially hard, with prices falling as much as 15% in some places year-over-year.
COVID-19 has also virtually shut-down Airbnb rentals, resulting in thousands of former vacation properties flooding the rental market. This could lower rents further. (Source: “Zumper National Rent Report: August 2020,” Zumper, July 30, 2020.)
All of which assumes landlords can collect rent at all. With millions of Americans now unemployed, many tenants can’t pay. And with the government putting bans on evictions, millions more simply won’t pay.
Any landlords that take reasonable actions against deadbeat renters get cast as social pariahs, portrayed in the media as ruthless bloodsuckers stamping on the necks of the downtrodden. At the same time, owners are expected to maintain a spotless residence…mowed lawns, painted walls, trimmed hedges. And all paid for, of course, at the landlord’s expense.
Credit has also tightened, which is surprising given the recent plunge in interest rates. Banks have tightened lending standards, demanding higher downpayments and better credit scores. They have also made it more difficult for amateur landlords to roll over loans, especially those underwater on troubled rental properties.
Why REITs Are Much Better Income Investments
In contrast, compare that to my experience owning real estate investment trusts, or REITs, as an income investment.
Each month, these partnerships deposit their “rent checks” into my brokerage account. Over the years, this income stream has grown into hundreds of dollars of regular, passive income. And I can use this money to pay my bills or buy even more units to grow my interests further.
A professional management team handles all of the day-to-day operations of the business. That means I don’t have to screen tenants, maintain properties, or inspect damages. The whole process works on auto-pilot and units can be bought and sold with the click of the mouse.
But the best part? The big, upfront yields.
Most rental properties represent huge cash sinks, at least at the beginning. Unless you’re willing to put up a huge downpayment, few rental properties earn enough rent to pay all of their expenses.
REITs, on the other hand, generate immediate income. Because they represent huge operations, executives can spread their overhead costs across thousands of units. That allows them to pay upfront yield upwards of 7%, 12%, and even 15%.
What could be better than that?
For investors looking to get started in the REIT game, you can find some of my favorite income investment ideas in the IncomeInvestors.com archive. And I plan to highlight more examples in upcoming columns.
You just don’t want to end up in the same position as that young couple.