Should You Own a Rental Property or REIT?

Introduction

The UK real estate market has long been a popular choice for investors that are seeking stable returns as an alternative form of investing to stocks. With that in mind, the question is: should I invest in a rental property or REITs (Real Estate Investment Trust) in order to improve my long term financial growth prospects?

In this article I will write a detailed breakdown, provide real world example comparisons, and an overview over the long term based on projections to help you make a more informed decision on whether a rental property or REIT is a better investment for your long term goals. Feel free to add your own input below in the comments!

Overview: Rental Property vs REITs

A quick overview of rental properties or REIT investments for the long term.

Rental Properties

Rental properties are the more common type of property holding. Ownership of rental properties essentially means buying a residential or commercial property with the aim of earning rent and getting returns through appreciation overtime. The landlord is required to professionally nurture tenants, maintain the property in a good state, and feel other UK obligations such as EPC (Energy Performance Certificate) rating.

Example: Buying a two bedroom flat in Manchester for £200,000 with a mortgage (25% deposit) would involve an initial investment of £50,000. With an annual rental income of £12,000, expected costs include mortgage interest, property taxes, maintenance, and insurance.

REITs

REITs are companies that own, operate, or finance income-generating real estate. Investors can buy shares of REITs (or mREITS, BDCs but that’s a topic for another day) on stock exchanges, making them a liquid and hands-off alternative to owning property directly. You also forego the need to seek clients to occupy your housing as you would with a Rental property, thereby mitigating periods of absence and therefore not being paid.

Example: Investing £10,000 in British Land (LSE: BLND), which has a historical dividend yield of 4.5%, provides annual dividends of £450 with minimal management effort.

Financial Breakdown: Costs and Returns of Rental Properties or REITs

1. Initial and Ongoing Costs

Key Notes:

• For landlords, compliance with UK rental regulations (e.g., EPC upgrades) could add £5,000-£10,000 in additional costs.
• REITs have no property-specific costs but may charge a management fee of 0.5%-1% of your investment annually and don’t forget if you choose a US REIT, you will need to pay 15% on dividends.

2. Expected Returns

Example Calculation:

A quick comparison between rental property or REITs.

• Rental Property: Let’s take a £200,000 flat with a gross yield of 6%, annual costs (£5,000) reduce net returns to £7,000 or 3.5%.
• REIT: A £10,000 investment in British Land with a 4.5% dividend yield provides £450/year, plus potential capital gains of 3%-5% annually.

Detailed Comparison: Risks and Rewards

Liquidity and Accessibility

Diversification

Management Effort

Long-Term Market Trends in the UK

1. Property Market Dynamics:
   • Rental yields remain attractive in cities like Manchester (5%-6%) and Birmingham (4%-5%). London offers lower yields (2%-3%) due to high property prices.
   • Capital appreciation in UK properties has averaged 3%-5% over the last decade, but regional differences are significant.
2. REIT Market Trends:
   • REITs focusing on logistics (e.g., Segro) and green buildings have seen higher growth due to demand for sustainable infrastructure.
   • Dividend payouts have remained stable, with average yields of 4%-6% across major UK REITs.
3. Economic Factors:
   • Rising interest rates increase borrowing costs for landlords but minimally impact REIT investors.
   • Government policies favoring urban regeneration could benefit both sectors but may impose additional compliance costs for landlords.

Recommendations

For Investors with Limited Capital and Time

Investing in REITs is an accessible, low-risk option for those seeking consistent income and diversification. For instance, a £10,000 investment in Segro (focused on industrial properties) could yield £500/year in dividends with potential for stock price appreciation.

For Investors Seeking Higher Control and Long-Term Gains

Rental properties may offer superior returns for investors willing to manage tenants and navigate regulations. For instance, if you own a £200,000 property in Birmingham, that could provide a net annual return of £7,000 after expenses (excluding additional long-term appreciation to the property value).

Conclusion

Choosing between a rental property or REIT depends on your risk tolerance, financial goals, and level of commitment you are prepared to make. Although rental properties require more active management and significantly more capital, they offer greater control and potentially higher returns. REITs, on the other hand, provide an easier, more diversified way to invest in real estate.

Final Takeaway: For most UK investors, I believe REITs offer a more balanced, low-effort investment strategy with more consistent returns and no need to worry about tenants. However, for those with the time and expertise, rental properties can deliver higher rewards over the long term and you own tangible brick and mortar.

External Resources

• UK Government Guide on REITs
• Comprehensive Landlord Guide to UK Regulations
• British Land Investor Insights

Check our our article about the options out there for lowering your income tax legally

Disclaimer: Remember, that this article does not constitute financial advice. Please seek a professional when managing your finances.