#23 Real estate or REITs: Which is the better investment?

In the world of real estate investment, there are several ways to profit from the real estate market. Two of the most popular options are direct investment in real estate and participation in real estate investment trusts, or REITs for short. Both approaches have advantages and disadvantages.

Direct real estate investments

Direct real estate investment refers to the direct purchase of real estate. This can involve residential, office or investment properties for own or third-party use. Some of the advantages of real estate as an asset class are tax incentives, the general increase in the value of real estate in the past and a certain degree of protection against inflation.

Advantages of direct investments:

• Tax incentives: direct real estate investments offer various tax advantages, including the deduction of mortgage interest and the cost of maintaining them.
• Leverage effect: Anyone who buys a property usually takes out a loan from a bank. Borrowing capital creates a leverage effect, which makes it possible to make higher investments and therefore potentially achieve higher returns. However, as an investor, you also take on more risk by taking on debt.
• Value appreciation: Property prices have been rising steadily since the turn of the millennium, as the Swiss real estate market has been characterized by high prices and stable value growth for many years. Available land is limited and the demand for living space is very high, especially near urban centers. As an asset class, real estate is therefore experiencing a general increase in value.
• Inflation protection: Experience shows that tangible assets such as real estate offer investors a certain degree of inflation protection. If inflation is high and interest rates are low, real estate prices also tend to rise. At the same time, the real value of the mortgage debt falls due to inflation.

Disadvantages of direct investments:

However, investing directly in real estate also has disadvantages.

• Poor diversification: One disadvantage of investing directly in real estate is poor diversification. Direct investments in one or a handful of properties lead to a high concentration of risk. Individual real estate markets tend to develop in cycles. If there is a sharp correction in real estate valuations in Switzerland, it is likely that the Swiss economy will also correct at the same time - with corresponding consequences for the labor market. Two problems then come together at the same time.
• Obligation to make additional contributions: When buying real estate directly, the obligation to make additional contributions must also be taken into account: If the valuation of the property falls below a certain value, the mortgage bank demands partial or full repayment of the mortgage. As a mortgage debtor, you are personally and fully liable for this.
• Labor-intensive: The time and labor-intensive nature of real estate as an investment property should not be underestimated. The management of real estate alone requires a lot of time and commitment. From maintenance and letting to solving tenant problems, holding properties directly involves a considerable amount of work.
• Low liquidity: Compared to other asset classes such as shares or bonds, real estate investments are also less liquid and tie up a lot of capital. Selling a property can take a long time and lead to additional costs.

Real estate investment trusts (REITs)

REITs (Real Estate Investment Trusts) are an alternative way to invest in real estate. REITs are special investment instruments that allow investors to invest in real estate without directly buying physical properties. They function as corporations or trusts that invest in various types of real estate and generate regular income from rental income and property sales. Real estate funds are also used in Switzerland.

Although REITs are susceptible to fluctuations, as they are particularly sensitive to interest rate rises, real estate tends to correlate positively with inflation in the long term and therefore offers a certain degree of protection against inflation. With REITs, you as an investor benefit from almost all the advantages of direct real estate ownership from an investment perspective, but without the disadvantages. REITs are generally liquid, well diversified, have leverage like equities with no obligation to make additional contributions and do not involve any work. They are therefore very suitable as a portfolio addition, as they have a relatively low correlation to the bond and equity markets. For REITs, it is also stipulated in most countries that at least 90 percent of profits are paid out directly to shareholders, which makes them attractive as dividend-bearing securities. At True Wealth, we therefore also use REITs and real estate ETFs in our investment portfolios.

Personal preferences

The decision between direct real estate investments and REITs ultimately depends on individual goals, risk tolerances and circumstances. It's important to weigh up the options carefully and be aware that both have their own advantages and disadvantages.

Do you invest in real estate? If so, directly in individual properties or through REITs? I would be interested to know. Please send me an e-mail.