Knowing your options is the key to making money with real estate investments. Where real estate is concerned, there are two main categories: direct investing and indirect investing. You can use these real estate investing strategies to your advantage if you understand their differences. We created this guide to help you compare direct vs. indirect investments so you can make the right decision for your real estate portfolio.
What Is a Direct Real Estate Investment?
A direct investment approach means the money you invest in a property gives you a stake in that property’s ownership. You might own the entire property and rent it out for a monthly income, or you could own a portion of the property with other investors, such as a large retail space or apartment complex that provides a higher cash flow. If you sell the property, you can realize all or a portion of the capital gains, depending on your stake. With direct investing, a property’s performance matters to your bottom line.
Advantages of Direct Real Estate Investing
Direct real estate investing has several advantages.
Control Over Investments
When you invest in a specific property through direct investing, you have more control over how your money is spent. A single-family rental property, for example, might benefit from upgrades that improve its appearance, which you can approve if it makes sense. Once improvements are complete, you can rent the property for a higher price, improving your cash flow. In addition, you’ll have more control over who can use the space and the terms of your rental agreement.
Tax Benefits
Direct real estate investing may offer tax benefits that help you limit your tax liability. You can write off expenses for repairs and maintenance, property taxes, property insurance, mortgage interest, and property management costs on property for which you own a stake. There are ways to defer capital gains taxes when you sell property as well, such as a 1031 exchange.
Capital Increases
When you own a direct stake in a property, your potential to accumulate capital in your investment is much better than if you don’t directly own property. This is because you can make changes and improvements that directly affect a building’s value. As you increase a property’s value, you gain equity in that property.
Diversification Opportunities
With direct investing, you can diversify your real estate holdings to incorporate a wide range of assets. It can pay to have direct ownership in residential, commercial, and industrial sectors, as this can help limit your losses if any specific real estate market experiences a downturn.
Disadvantages of Direct Real Estate Investing
Of course, there are some downsides to direct real estate investing.
High Upfront Costs
To complete a direct investing deal, you’ll often need to make a down payment and pay closing costs and fees associated with buying a property. When it’s all added up, the upfront cost of buying real estate can be a hurdle to overcome. You may need to seek alternative funding sources from banks if you can’t obtain a traditional loan.
Financing Hurdles
In addition to a down payment and other fees, most investors need to secure financing for a direct investment. This is another obstacle that can be difficult to navigate, especially for new investors who don’t have substantial leverage. You’ll need to meet all the requirements to obtain a loan.
Long-Term Investment
Direct investing can tie your money up for years. Whether you’re investing in single-family homes, multifamily properties, or strip malls, your money will likely need to remain in the property for years to come before you see profit or gains from ownership.
What Is an Indirect Real Estate Investment?
An indirect real estate investment is one where you don’t own a stake in a specific property. Instead, you’re buying shares of a company that manages a real estate portfolio. You might make an indirect real estate investment through a fund or by purchasing stock in a company. Indirect real estate investments are usually made through real estate investment trusts (REITs) and exchange-traded funds (ETFs). The REIT and ETF managers make decisions on which properties the portfolio contains.
Advantages of an Indirect Real Estate Investment
If you believe indirect real estate investing is for you, consider the below advantages.
Less Involvement
You don’t have to be as involved with indirect real estate investing as you do with direct investing. Indirect investing only requires you to put your money in a fund or purchase stock. You don’t have to be involved in the day-to-day operations of a property.
Less Capital
Indirect investing doesn’t require a large down payment. You’ll have to pay brokerage fees and any other costs associated with purchasing a REIT or ETF, but these costs can be less than a down payment on a property.
Good Diversification
Taking the indirect real estate investment approach helps diversify your portfolio. Because many real estate funds have assets in various types and classes, you can own real estate investments in multiple categories without having to learn how to invest in each one.
Disadvantages of an Indirect Real Estate Investment
You must also be aware of the disadvantages of indirect real estate investing.
High Taxes
One downside to indirect real estate investing is that you can’t use tax write-offs for owning property. You’ll also have to pay taxes on any capital gains you earn on your investment. Income taxes will be due on dividend payouts you receive from a real estate fund or stock.
Less Control
You don’t have much control over the holdings in a real estate fund, as it’s up to the manager to buy and sell real estate to meet the needs of all investors. Having stock in a company also doesn’t offer much control over how the company operates.
Less Transparent
Getting direct information about the real estate in a fund can be difficult. This can include tenant information and the condition of the property. Essentially, you have no idea what kind of real estate you own.
How To Choose the Right Real Estate Investment for You
Choosing the right investment strategy is easy when you work with a trusted partner. The team at Titan Funding can help you decide how to maximize your real estate investments through direct and indirect investing. Give us a call to learn more about how we can help you.
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