If you’re considering buying real estate for investment purposes, you might not like ownership responsibilities, including tenant issues, maintenance, market fluctuations, and taxes.
One solution might be indirect real estate investment, which can expose you to the real estate market without the challenges of “tenants, toilets, and taxes.” However, indirect real estate has its challenges.
Knowing the pros and cons of this investment type can help determine if it’s effective for your financial situation.
The Pros: Potential Income Without Ownership Stresses
One main benefit of indirect real estate investments is the potential for passive income. Investments in Delaware Statutory Trusts (DSTs), Real Estate Investment Trusts (REITs) or real estate funds can help generate returns without hands-on involvement.
Other positives include:
- Lower capital requirements. You might not need as much upfront capital to invest in a DST or REIT as you would for a direct real estate investment. Furthermore, you could have easier access to high-quality, institutional-grade properties that you might otherwise not be able to afford.
- Possible tax advantages. You could defer capital gains taxes and depreciation recapture if you exchange direct-owned investment real estate into a DST through a 1031 exchange. Such a tax-advantaged strategy could potentially help you grow wealth over time.
- Diversification and risk mitigation. Owning a single rental property in a specific market exposes you to concentrated risk. However, indirect real estate investments through a DST or REIT provide you with diversification across asset types and geographic locations. This can help mitigate risks associated with local economic downturns or demand.
- Professional management. As a REIT or DST investor, you could benefit from the skills of a professional asset manager who conducts due diligence, market analysis, and operational oversight to support investment performance. You aren’t responsible for investment and management decisions.
- Estate planning. Indirect real estate ownership could help facilitate wealth transfer. DSTs involve fractional ownership, while REITs are stocks. Both can be passed on to heirs, according to estate plans.
The Cons: No Control
Indirect real estate investments mean you don’t have to worry about hands-on decisions or management regarding the properties involved. It also means you have no control over what happens to those properties. You can’t decide on acquisitions, dispositions, capital improvements, financing, or other aspects.
Here are a few other disadvantages tied to indirect investing:
- Volatility Risk. REIT prices can fluctuate in the short term, influenced by interest rates, market conditions, economic factors, and property-specific issues.
- Tax implications. Tax benefits vary by investment type. While REIT dividends are generally taxable, certain indirect investments, such as DSTs, may allow tax deferral through a 1031 exchange.
- Management fees. Indirect real estate investments often have management fees, especially when investments are made through DSTs or real estate funds. Those expenses can reduce your return on investment.
- Liquidity risk. While it’s possible to sell shares of your REIT quickly, it’s more difficult to sell shares in a private real estate fund, or DST can be more complicated. There are few secondary markets for funds or DSTs, meaning your capital could be tied up for years.
- Sponsor risk. The success of your investment trust or fund depends on the sponsors’ expertise, financial stability, and strategy. A poor strategy or bad management decisions could reduce your returns.
Another Way to Invest in Real Estate
Indirect real estate investment can offer a viable strategy to receive many potential benefits but aren’t interested in the stress of active ownership. When used correctly, indirect investment can provide regular passive cash flow, diversification, and hands-off ownership. However, there are disadvantages to such a strategy as well. Talk with knowledgeable professionals before embarking on an indirect real estate investment plan.
If you’re considering exchanging active investment real estate into a DST through a 1031 exchange, contact the professionals at Realized 1031. The staff can offer tailored investment strategies and advice that align with your goals.
To schedule a no-obligation consultation, visit realized1031.com.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
