Building Wealth Through Real Estate: Rental Properties vs. REITs
“Real estate is the best investment in the world, because it is the only thing they’re not making anymore.” – Will Rogers
When it comes to building wealth, real estate is one of the most powerful tools at your disposal. But should you dive into owning rental properties or invest in Real Estate Investment Trusts (REITs)?
I've gone back and forth on that very question more times than I can count. So now I do both. One is not necessarily better or worse than the other. Each method has its unique set of benefits and challenges.
In this article, we’ll break down the key differences between rental properties and REITs, so you can make a well-informed decision on how to use real estate to grow your wealth. Whether you're a seasoned investor or just starting out, understanding these two options is crucial to your financial success.
What Are Rental Properties and How Do They Build Wealth?
I stumbled into real estate investing when my step-mother was looking to sell her rental property. I was fortunate enough that it was the perfect sized home for my daughter and I in an ideal location. She gave me a great deal where it was a win-win for both of us.
I knew it wouldn't be my forever home and I was able to pay it off in about 5 years of living there and turn it into a rental property. That "accidental" home ownership experience taught me more than any book could!
Rental properties come in so many flavors—I started with that single-family home that served as my main residence, later bought a fourplex, and eventually will be focused on buying distressed properties for long term rentals. Each property type has its own personality and demands.
The wealth-building power comes from multiple sources. My first rental brought in $3,200 monthly, but the real magic happens when the property value steadily climbs over the years. That's when your money is working double-time for you!
Tax benefits? They're seriously amazing. I was shocked when I was doing my taxes that first year and TurboTax showed me how depreciation deductions essentially made a chunk of my rental income tax-free. Plus, I got to write off mortgage interest, repairs, and even my mileage driving to check on the property.
Don't let anyone fool you—being a landlord takes work. I tried managing everything myself at first and got midnight toilet calls that made me question my life choices. Eventually, I hired a property manager who takes 8% but saves my sanity. Even with a property manager it isn't entirely passive. You still need to keep up with managing your managers.
My costliest mistake? Not fully knowing the market I was buying in. The fourplex was just outside the active area so I was hit hard with vacancies. Always, always verify the market and work with top tier real estate professionals!
REITs: How I Became a Real Estate Investor Without Being a Landlord
I wish someone had told me about REITs when I was stressing over how to raise a ton of money to buy a property! Real Estate Investment Trusts are basically companies that own or finance income-producing real estate across different sectors. They're required to distribute 90% of their taxable income to shareholders—which is why I love them for their steady dividends.
After learning more about developing a well rounded investment portfolio, I started exploring REITs and discovered they come in different flavors. Equity REITs own actual properties (like the shopping center near my house), while mortgage REITs deal with real estate loans and mortgage-backed securities. I've stuck mostly with mortgage REITs because they're easier to understand, ya know?
The best part? I get exposure to massive real estate portfolios without dealing with tenants or toilets. My REIT investments let me own tiny slices of apartment complexes, medical facilities, and shopping centers I could never afford on my own.
The dividend checks are pretty sweet too. Most of my REITs pay quarterly dividends with yields around 4-6%—way better than my savings account! During market downturns, those steady payments helped me sleep at night.
Getting started was super simple. I bought my first REIT through my Roth IRA account just like buying any stock. Later, I added a REIT ETF to get broader exposure. Just watch out for those non-traded REITs—learned that lesson when a buddy got stuck in an illiquid investment for years.
Rental Properties vs REITs: What I Learned After Trying Both
I've gone both routes with real estate investing, and let me tell you—the differences are bigger than I expected! When I bought my first rental property, the down payment nearly cleaned out my savings. We're talking $40,000 just to get started on a modest single-family home. Compare that to my first REIT purchase: $2,000 that I invested through my Roth IRA account while sitting in my pajamas.
Financing options create another huge gap. With my rental, I leveraged a mortgage to control a $200,000 asset with that $40k down payment. With REITs, what you invest is what you invest—no bank is giving you 5x leverage on REIT shares! But then again, when I needed cash quickly, I sold my REIT shares in minutes. My rental property? It would take almost three months to sell if I needed out.
Time commitment isn't even close. My rental property became like a part-time job some months. I still remember getting a call about a leaking underground pipe while on vacation—talk about a mood killer! My REITs have never once called me with problems. They just quietly deposit dividends while I go about my life.
The returns have surprised me too. My rental property has appreciated about 4% annually, plus I've been collecting rent that yields roughly 6% after expenses. Not bad! My REITs have delivered more consistent 12-15% annual dividend yields, but without the equity buildup that comes from tenants paying down my mortgage.
The tax situation might be the biggest difference of all. With my rental, I've written off depreciation, mortgage interest, repairs, and insurance. Those deductions have sheltered a big chunk of my rental income. My REIT dividends? They show up on my 1099 and would get taxed as ordinary income if they weren't in my Roth IRA. No deductions, no breaks.
For someone starting out, the choice really comes down to whether you want to be actively involved. Do you mind midnight maintenance calls? Are you ready to deal with tenant issues? Or would you rather just collect dividends without the drama?
Pros and Cons of Rental Properties
I jumped into rental property investing 5 years ago, and what a ride it's been! The biggest win? Watching my tenants build my wealth. Every month, they pay down my mortgage and increase my equity. It's like having someone else fund your retirement account!
The appreciation has been a game-changer for my net worth. My first rental property in a fairly established neighborhood has grown 150% in value over 5 years. That kind of growth is hard to match anywhere else! Plus, being able to make decisions about renovations, rental rates, and property improvements puts me in the driver's seat of my investment.
But let's get real about the downsides. That first property? The $40,000 down payment plus closing costs and initial repairs meant I needed almost $55,000 liquid cash to get started. It took me a while to pull that off.
And nobody warns you about the 2 a.m. phone calls! I hired a property manager—which cut into my profits but saved my sanity. I simply didn't have the capacity to deal with everything from burst pipes to tenants locking themselves out during snowstorms.
The scariest moment was right after I purchased my fourplex it went to 100% vacancy in 3 months. In addition to that there was a downturn in the market and the property sat vacant for 12 months. Covering the mortgage, insurance, and taxes with zero rental income was a painful reminder that real estate isn't always the passive income dream some make it out to be.
Pros:
- Building equity through mortgage payments
- Potential for significant property appreciation
- Control over the investment and direct involvement
Cons:
- High upfront costs and down payments
- Property management headaches and maintenance costs
- Market risk: property value fluctuations and vacancies
Pros and Cons of REITs
I was skeptical about REITs until I tried them—now they're a core part of my portfolio. The entry point completely blew me away. While my friends were saving forever for rental property down payments, I started with just $1,000 in a REIT ETF. That accessibility let me dip my toes in real estate investing years before I could've afforded a physical property.
The diversification has saved my portfolio more than once. When the office real estate market tanked, my residential and healthcare REITs kept chugging along. Other folks who owned office buildings weren't so lucky. Through my REITs, I own tiny pieces of hundreds of properties across multiple states—something I could never achieve on my own.
Those dividend checks feel like magic money. Most of my REITs pay quarterly, and seeing that consistent 4-6% yield hit my account without any work on my part is pretty sweet.
The downside? I sometimes feel like a passenger instead of a pilot. When a REIT manager decides to sell properties I like or buy ones I don't, I have zero say in the matter. That lack of control can be frustrating when you disagree with their strategy.
Market swings can be brutal too. During the 2022 interest rate hikes, my REIT values dropped nearly 30%, even though the underlying properties were still generating income. And while those dividends kept coming, they're taxed at my ordinary income rate—unlike the tax advantages I get with my rental property.
The biggest lesson? REITs are fantastic for hands-off investing, but don't expect the same wealth-building power as direct ownership. They're different tools for different jobs in your financial toolbox.
Pros:
- Low initial investment and liquidity
- Diversification: Exposure to a range of properties and markets
- Passive income through regular dividends
Cons:
- Limited control over individual properties or investments
- Market volatility and potential for low dividend yields in downturns
- Less tax advantages compared to owning physical property
Finding Your Real Estate Sweet Spot: What I Tell My Friends About Rentals vs. REITs
I've helped dozens of friends figure out their real estate investing path, and here's what I've learned: this isn't a one-size-fits-all decision. My risk-averse buddy nearly had a panic attack thinking about a tenant not paying rent, while my hands-on mentor thrives on finding fixer-upper properties. You've got to be honest about what matches your personality.
Time horizon matters big time. In my experience, rental properties typically need at least 5-7 years to weather market cycles and offset those hefty closing costs. REITs are much more forgiving for shorter timelines.
The active vs. passive question is huge. I learned this lesson when I bought my first rental during a crazy time at work. Between getting units occupied and maintenance issues, I was stretched way too thin. Now I ask friends: "Do you actually have 5-10 hours a month to manage a property?" For my current active lifestyle REITs were clearly the better fit.
Starting capital makes a big difference too. When I began investing, I only had about $5,000 to work with. REITs let me start immediately, while saving for a rental down payment would've delayed me years. That early start with REITs actually helped me save enough for my first rental property later on.
For retirement planning, I've found the ideal approach is often a mix. My rental properties provide growing equity and inflation protection, while my REITs deliver more predictable income for monthly expenses. They complement each other perfectly.
My best advice? Start with REITs if you're new to real estate investing, have limited capital, or want to test the waters. Graduate to rental properties when you have more capital, time, and local market knowledge. Many of my most successful friends use both strategies rather than picking just one.
Both rental properties and REITs are solid options for building wealth through real estate, but they cater to different needs and lifestyles. If you’re looking for hands-on control, rental properties might be your best bet.
However, if you prefer a more passive, diversified approach with lower upfront costs, REITs offer an excellent alternative.
Whatever you choose, the key is starting now. Real estate has consistently proven to be one of the best wealth-building vehicles, and by understanding these two methods, you’ll be well on your way to building a profitable portfolio.