REITs vs. Stocks: A Guide for Real Estate Investors

REITs offer an alternative investment avenue within real estate, allowing individuals to invest in companies that own and manage income-generating properties. In contrast, stocks represent a share of ownership in a company, directly tied to its business operations rather than specifically to real estate assets.

REITs often deliver higher returns than traditional stocks. According to Nareit, they have outperformed the U.S. stock market in annual returns over 56% of the time.

In this article, we will explore the advantages, risk factors, and key distinctions between investing in REITs and stocks, helping you make informed investment decisions.

The Power of REITs

Real estate investment trusts (REITs) are companies that own and manage income-producing real estate properties. By leasing these properties and collecting rent, REITs distribute income and dividends to their investors.

A REIT is an investment vehicle that allows individuals to invest in a diversified portfolio of income-generating real estate assets, such as commercial properties, self-storage facilities, apartment complexes, data centers, office buildings, and healthcare facilities. Publicly traded REITs are bought and sold on major stock exchanges, acting similarly to stocks in terms of liquidity and market volatility. In contrast, non-traded REITs are not subject to the same market fluctuations, offering a more stable income stream but with less liquidity.

Advantages of Investing in Real Estate Investment Trusts

Income potential: Investing in REITs can potentially provide a steady stream of income through dividends. This is because REITs are required to distribute 90% of their taxable income to shareholders as dividend payouts and interest payments.
Capital appreciation: REITs offer the potential for capital appreciation as the value of their underlying assets increases. For publicly traded REITs, shares are exchanged on national securities exchanges daily, meaning their value can fluctuate frequently. When a REIT performs well, investors may be able to sell shares at a higher price, realizing capital gains.
Diversification: Investors can diversify their real estate portfolios by investing in REITs that hold a range of properties across different sectors and, in some cases, across various geographic regions. This can reduce the impact of poor performance or unfavorable market conditions on any single investment.
Low capital requirement: Publicly traded REITs allow investors to gain direct exposure to an asset class that usually requires sizable initial capital, particularly when it comes to commercial properties. Beginner investors can own shares in commercial real estate with a relatively small investment.
Asset management: REITs are managed by portfolio and property managers who handle all the work of finding, financing, and managing properties. This arrangement might be suitable for investors seeking a more hands-off approach to real estate investing.
Liquidity: Publicly traded REITs and Publicly Listed Non-Traded REITs (PLNRs) can be bought and sold on national securities exchanges, providing investors with easy access to their funds when needed. This liquidity distinguishes them from private or non-traded REITs, which may require longer holding periods and are subject to their respective share redemption plans.
Risk and volatility: Private REITs are generally less exposed to the daily price fluctuations of the stock market since they are not publicly traded. Instead, their value is more directly tied to the appraisal and performance of their underlying real estate assets.

However, this does not make private REITs risk-free; they are subject to real estate market cycles, economic downturns, and property-specific risks. Additionally, the lack of daily trading can mean reduced liquidity, potentially making it more challenging for investors to quickly access their funds compared to publicly traded REITs.

Inflation hedge: REITs tend to outperform equity sectors during inflationary periods, primarily because rental income and interest payments also rise with increasing prices. Additionally, many REITs include pricing clauses in lease contracts that allow for adjustments to keep pace with inflation, protecting investors’ purchases in inflationary environments.
Tax advantages: REITs are exempt from corporate income tax as long as they pay at least 90% of their income to shareholders. Additionally, REITs can be held in tax-deferred retirement accounts, such as individual retirement accounts (IRAs) and 401(k) plans. This allows investors to avoid paying taxes until withdrawals are made during retirement.

Risks of REITs

While REITs offer opportunities for income generation and portfolio diversification, they also carry certain risks that investors should consider:

Market Volatility: Publicly traded REITs are subject to stock market fluctuations, which can impact share prices based on market sentiment rather than the underlying value of the real estate assets. This volatility can lead to unpredictable short-term returns.
Interest Rate Sensitivity: REITs can be sensitive to changes in interest rates. When interest rates rise, borrowing costs increase, which can affect a REIT’s profitability and may decrease demand for REIT shares as fixed-income investments become more attractive.
Liquidity Constraints: Non-traded REITs are less liquid than their publicly traded counterparts, often requiring longer holding periods. This lack of liquidity can limit investors’ ability to quickly access their funds if needed.
Leverage and Debt Risks: Many REITs rely on debt financing to acquire and develop properties. Excessive leverage can increase risk, particularly if property values decline or rental income falls, making it difficult to meet debt obligations.
Economic and Sector-Specific Risks: REITs focused on specific sectors, like retail, office, or healthcare, are vulnerable to downturns in those areas. Economic slowdowns, shifts in consumer behavior, or changes in industry regulations can impact a REIT’s profitability.

Understanding these risks can help investors make informed decisions and evaluate if REITs align with their investment goals and risk tolerance.

Stocks: Wealth-Building Through Equity Ownership

A stock is an investment that gives you a unit of ownership in a company. Most shares trade on stock exchanges and can grant shareholders certain privileges, such as a claim on the company’s profits and assets.

Companies issue stocks when they need to raise funds for their operations and expansion without incurring any debt. This can be done in both public and private companies.

As a shareholder with an equity stake in the company, your profit share depends on the business’s success or failure. Companies may pay dividends to shareholders or prefer to reinvest profits for further growth.

There are no guarantees that a company that has historically paid dividends will continue to do so. Companies may cut or eliminate dividends entirely due to financial difficulties or when the economy is experiencing a downturn.

Advantages of Investing in Stocks

Dividend benefits: Some companies pay dividends to their shareholders from profits or earnings generated, usually annually or quarterly. Stock dividends can be a reliable source of passive income, making them appealing for long-term investors seeking consistent returns.
Capital growth: When you buy your shares at one price and sell them at a higher price, you turn a profit, also known as capital gain. Similarly, when a company’s earnings and/or cash flow increase, this is reflected in the share’s market price, leading to an overall increase in value and making the shares you hold more valuable.
Diversification: Stocks provide many options to diversify an investment portfolio with various sectors, industries, and geographic regions. This can reduce portfolio volatility and help you achieve more consistent returns over time.
Liquidity: Publicly traded stocks are considered liquid assets because they can be quickly converted into cash if needed. However, investors may receive a less favorable rate if market conditions are adverse and the share price declines.
Strong regulatory control: The Securities and Exchange Commission (SEC) regulates the stock market and public companies issuing stocks. The SEC is responsible for regulating the securities markets, including stock exchanges and brokerage firms, to ensure that they operate fairly and transparently and to protect the interests of investors. This helps reduce the risks of fraudulent activities.
Flexibility: Shares allow you to invest in equities with a small amount of capital. You can buy shares individually or pool your resources with others through a managed fund, such as a mutual fund or exchange-traded fund (ETF).

There are two main types of stocks: common stock and preferred stock.

Common stock is a type of stock that represents a share of ownership in a company. Holding shares of common stock entitles you to vote on important company decisions and to receive a share of the company’s profits through dividends.
Preferred stock is a type of company share that typically provides fixed dividends and prioritizes payments to holders before common stockholders if dividends are declared. Compared to common shareholders, preferred shareholders have a priority claim on a company’s earnings and assets, particularly in the event of liquidation. However, preferred shareholders typically do not have voting rights, meaning they have less influence over company decisions than common shareholders.

REITs vs. Stocks: A Side-by-Side Comparison

Investors looking to gain dividend-based income and diversify market risk could benefit from investing in REITs and stocks. Here’s a comparative analysis that highlights the key features of these two asset classes.

	REITs	Stocks
Definition	REITs allow individuals to invest in companies that own, operate, and finance income-producing real estate.	Shares are investments that offer ownership in a company; they grant a claim to its earnings and assets.
Income generation	Investors earn income primarily through dividends. REITs are required to distribute at least 90% of their taxable earnings to shareholders.	Many companies pay dividends, but they are not mandatory. Appreciation may also come when the value of the share rises above the purchase price.
Risk factors	REIT returns are subject to real estate market risks, including fluctuations in property values and occupancy rates. Changes in interest rates can also impact REIT performance, particularly for mortgage REITs, which are more sensitive to borrowing costs.	Share value is affected by factors like interest rates, inflation, financial performance, investor sentiment, and other micro- and macro-economic factors.
Return potential	REITs can offer the potential for stable and consistent returns through dividends, with some opportunity for capital appreciation depending on property value trends. However, returns vary based on the type of REIT and underlying assets, so investors should consider specific REIT structures and market conditions.	Stocks, particularly growth stocks, offer higher potential for capital appreciation, though they tend to be more volatile than REITs. While some companies pay dividends based on growth and profitability, non-dividend stocks may still provide substantial long-term capital gains.
Liquidity	Public REITs are highly liquid, whereas private and non-traded REITs are more illiquid in nature.	Highly liquid, as publicly traded stocks can be bought and sold on exchanges with ease.
Tax implications	REITs are required to distribute 90% of their profits to shareholders. Shareholder’s REIT dividends are typically taxed at a higher rate than most stock dividends.	Qualified dividends are often taxed at a lower rate than ordinary income, providing a tax advantage for investors. Capital gains taxes, on the other hand, apply when stocks are sold at a profit, with short-term gains taxed at ordinary income rates and long-term gains typically taxed at lower capital gains rates.
Diversification	Provides exposure to a diversified real estate market portfolio across different property types and geographic locations.	Can provide diversification across different sectors, industries, and geographies, depending on the mix of stocks in a portfolio.
Investment horizon	Generally suitable for medium to long-term investments, REITs appeal to investors seeking income potential and stability while also allowing for potential gains aligned with real estate market cycles.	Well-suited for high-risk-tolerant investors who prioritize capital appreciation. Can be appropriate for both short and long-term investment horizons, depending on strategy.
Market correlation	Public REITs are traded on public exchanges like stocks and can be influenced by economic indicators. However, REITs—especially non-traded REITs—have historically shown a lower correlation to the stock market, which can provide a diversification benefit in investment portfolios.	While some stock sectors can be more stable during economic fluctuations, investors should be aware of potential share price volatility amidst market shifts and conditions.

Selecting the Best Investment for Your Goals

Understanding factors influencing REITs and stocks can help you develop your investment strategy. These are based on your investing goals, time horizon, and risk tolerance.

Before investing in REITs, it’s crucial to evaluate the factors that influence their financial health and performance.

Evaluate REITs based on their diversification across different property types and geographic locations. This can reduce the risks associated with specific sectors and markets.
Occupancy rate is one of the most commonly used metrics to analyze REIT performance. Long-term rental generally provides reliable income and steadier occupancy rates.
Evaluate the qualifications and experience of the management team to gauge their competitiveness in managing the trust.
Review the REIT’s financial statements, mainly focusing on growth in performance metrics like funds from operations (FFO), adjusted funds from operations (AFFO), and net income. These metrics are reliable indicators of a REIT’s ability to generate cash flow and sustain dividend payments.

Before investing in stocks, consider the following factors to make informed decisions.

Quantitative research: Review the company’s financials that you are interested in by examining its annual and quarterly reports. This analysis can give you financial details into a company’s inner workings through key data metrics like revenue, net income, earnings and earnings per share (EPS), price-earnings ratio (P/E), and return on equity (ROE). Analyzing these figures provides valuable insights into a company’s underlying value and overall financial health.
Qualitative research: Evaluate a company’s value based on non-financial factors such as its industry position, stakeholder satisfaction, competitive advantage, and management quality.
Technical research: Analyze stock price movements and trading volume using charts and indicators like moving averages, relative strength index (RSI), and support/resistance levels. Technical analysis can help predict short-term price trends and identify optimal entry or exit points.
Educate yourself: Learn about the different factors that can affect stock prices, including company news, industry performance, investor sentiment, economic factors, and government policy.

Since both securities demonstrate low correlation with each other, many financial advisors suggest compiling a diversified portfolio that mixes stocks, real estate investment trusts, and other assets like bonds to mitigate losses from a single security.

REITs or Stocks? Make Your Choice with 1031 Crowdfunding

Investors may choose to allocate more of their portfolio to real estate investment trusts (REITs) or stocks depending on their financial goals and risk tolerance. REITs could be a stronger focus for those seeking higher dividend returns and potential appreciation over time. Stocks, on the other hand, may appeal to investors comfortable with market volatility and aiming for higher growth potential. Ultimately, a balanced approach that incorporates both REITs and stocks can help diversify a portfolio and achieve long-term financial objectives.

Consult your financial advisor and tax professional to find the right investment option for your financial situation. A balanced approach may also involve a blend of REITs and stocks.

At 1031 Crowdfunding, we offer ready-to-invest REIT offerings that streamline the investment process, enabling you to invest with confidence. Our online marketplace allows you to explore a diverse range of vetted REIT investments and invest based on your financial objectives.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees, and other expenses. This literature must be accompanied by and read in conjunction with a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results, forward-looking statements and projections are not guaranteed to achieve the results described, and your actual returns may vary significantly. Investments in private placements are illiquid in nature, and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice, and you should consult with your tax advisor, as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.

REITs vs. Stocks: A Comprehensive Guide for Real Estate Investors