There is no doubt that being a landlord and owning real estate can be a great way to build a high net worth.
Homes typically appreciate in value over time, and in many locations, the opportunity to raise rents consistently means steady cash flow increases. There’s also the pride that comes with owning a physical asset, and the ability to improve that asset’s value with sweat equity.
That said, being a landlord isn’t for everyone — especially if you’re interested in generating passive income.
For some, passive income is best achieved through Canadian dividend stocks and Real Estate Investment Trusts (REITs). REITs are a quick and easy way to invest in a diversified portfolio of properties, without what can sometimes feel like a landlord’s round-the-clock worries. That said, REITs will not let you leverage your money to the same degree that investing in physical houses will. Here are the pros and cons of investing in real estate via the stock market versus actual real estate.
Pros and cons of being a landlord
Being a landlord can be worthwhile for many reasons, including the fact that:
- There’s a physical nature to your investment.
- Mortgage payments make it easier to stick to a long-term investment plan. Plus, if you compare mortgage rates, you can secure a lower monthly payment than if you didn’t.
- You can earn rental income and build equity over time.
But the drawbacks of landlording are worth considering as well:
- Leveraged investments can result in an “underwater mortgage” where you owe more on your property than it’s worth on the market.
- Dealing with fixes and tenants can be demanding on both your time and sanity.
- Extra costs, like maintenance, can eat away at what looked like great margins on paper.
How REITs work
When you invest in a REIT, you effectively toss your money into a big pool of cash alongside that of other people. Then, investment professionals take your money and purchase various properties. They handle the collecting of rent and maintaining the properties. As they get paid, the REIT management team passes the cash flow back to you, similar to how a shareholder receives dividends.
Technically, the payments that REITs send out each month (or quarter) are not 100% dividends, but they’re close enough that most investors refer to them that way. In many cases, as the properties go up in value, there is an element of capital gains mixed into these payments as well.
There are almost as many types of REITs as there are colours of the rainbow. There are REITs that specialize in shopping malls, others in warehouses, and several that purchase and rent out commercial properties. There are also REITs that deal in residential properties, such as the Canadian Apartment Properties REIT (CAPREIT).
REITs versus owning real estate as a landlord
There’s no inherently right or wrong way to invest in real estate. If you’re comfortable with the idea of being hands-on with your investment, then purchasing real estate might be an excellent fit. And many people have gotten wealthy by being landlords.
On the other hand, the diversified nature of a REIT, combined with hands-off dividend income make it a better fit for someone who is less inclined to respond to the hands-on demands of being a landlord.
If you thrive on improving physical properties while putting in sweat equity, and you’re confident that housing demand in your area will be strong over the long term, then being a landlord is probably going to be quite rewarding to you.
If you prefer a more passive income stream to gently pour into your brokerage account each month, then a REIT might be worth considering.