The pros and cons of investing in REITs versus direct commercial property
Are you better off buying a commercial property asset or putting your money towards real estate investment trusts (REITs)?
On a recent episode of Inside Commercial Property, co-hosts Scott O’Neill and Phil Tarrant acknowledged that the most common approaches to investing in commercial property are through Real Estate Investment Trusts (REITs) and direct ownership of commercial properties.
With many investors unsure as to which option would be more suitable for them, they explored and unpacked the advantages and disadvantages of each investment method.
Liquidity
One significant advantage of investing in REITs is their liquidity. REITs are listed and traded on the stock exchange like shares, allowing investors to buy or sell their shares easily. This level of liquidity provides flexibility, making it convenient for investors to access their funds quickly if needed. On the other hand, direct commercial property ownership lacks this level of liquidity, as selling a property can be a time-consuming process, potentially taking months to find the right buyer and complete the transaction.
According to Mr O’Neill, REITs can be “an easy way to get started into commercial property if you don’t have as much money or expertise.”
“You can invest lower amounts of money and don’t need to be a sophisticated investor.”
Fees and expenses
Investing in REITs may entail various fees and expenses, such as acquisition fees, annual management fees and sales fees. These fees are deducted from the returns generated by the REIT, impacting the overall profitability for investors. Moreover, REITs might enforce the sale of assets every few years, incurring additional costs for investors.
For Mr O’Neill, who is the director of Rethink Investing, the high-fee structure is a negative of REITs.
“They take all these fees off the profit margins. You should be wary of these fees as they diminish your overall returns,” he warned.
In contrast, direct commercial property investors usually encounter lower ongoing management fees. However, investors may face initial acquisition costs, such as buyer’s agent fees or due diligence expenses. Despite these upfront costs, direct property owners may benefit from more control over their investment and the potential to maximise returns.
Leverage
Direct commercial property ownership offers a significant advantage in terms of leverage. Investors can access higher levels of financing, often up to 80 per cent loan-to-value ratio, to fund the purchase of commercial properties. Higher leverage can amplify returns and accelerate wealth creation for investors.
On the other hand, REITs typically maintain lower leverage, usually around 50 per cent loan-to-value ratio. While this conservative approach can provide stability and security, it may limit the potential for higher returns compared to direct property investments.
On this point, Mr O’Neill stressed that the leveraging factor “is the greatest multiplier of profit you can get.”
“As long as you meet your cash flow obligations, there is more upside with direct investing.”
Control over investments
Investing directly in commercial properties gives investors greater control over their assets. Direct owners can make strategic decisions regarding property management, renovations, lease negotiations and rent increases to maximise their returns. They have the autonomy to implement value-add strategies that align with their investment goals.
On the other hand, investing in REITs relinquishes some control over the investment decisions, as professional fund managers manage the portfolio. While this hands-off approach may suit some investors seeking a passive investment, others may prefer the active involvement and decision-making capabilities that come with direct property ownership.
In conclusion, investing in commercial property can be a lucrative opportunity for wealth creation. Whether investors choose REITs or direct property ownership, each option comes with its own set of advantages and disadvantages. REITs offer liquidity, diversification and professional management, but may come with higher fees and limited leverage. Direct property ownership allows for greater control, higher leverage potential and the opportunity for value-add strategies, but lacks the same level of liquidity as REITs.
Ultimately, the decision between REITs and direct commercial property investment should be based on individual preferences, risk tolerance, investment goals and level of expertise.
Whichever path an investor chooses, proper research and due diligence are key to making successful and rewarding commercial property investments.
For more insights, listen to the latest episode of Inside Commercial Property here.