Rental vs. REIT Income: Which 1 Is Right for You?

The diluted control (in a REIT) also comes with a diluted risk, which alone might be enough of an incentive to choose it instead of actual property.

Adam Othman

Adam is a value investor who is always on the hunt for fantastic undervalued companies that he can share with Motley Fool readers. He follows Warren Buffett and Charlie Munger's investment advice and has completed the Canadian Securities Course. When he's not investing, Adam can usually be found traveling or skiing.

Published May 13, 2022 3:30 pm EDT

For a lot of investors, choosing between an actual real estate asset that they can turn into a rental income resource and investing in real estate via a REIT is quite easy. It’s made by taking the available capital into account. If an investor has enough capital, they may opt for a rental property, and if they don’t, a REIT it is.

However, even if you have enough capital to buy a rental property (at least a modest one), a REIT might still be a smarter choice.

a person looks out a window into a cityscape — Image source: Getty Images

The case for a rental property

Since the median home prices in Toronto and other major markets are usually at or around $1 million, we can look into more modest markets where the median is quite low, like Thunder Bay. Here you can find a decent property at $350,000 (a bit below the median price). You can also get a monthly rent of about $950.

At this rate, your rental yield (without taking maintenance into account) would be roughly 3.25%. If we go by the 1% rule — i.e., putting 1% of the property price aside for maintenance, which would be around $3,500, the yield will drop significantly (2.25%).

Let’s assume the best-case scenario, and you only have to put a little bit back into the property maintenance, and you are left with about 2.8% (of property price) of the net rental income for a year.

Then there is the property tax and the tax you will have to pay on the rental income. As for price appreciation, the homes in that area have seen a massive increase — from under $150,000 in 2014 to about $350,000 in 2022. That’s a 133% increase in eight years.

The case for REITs

If you decide to put away the same amount in a REIT like Granite REIT (TSX:GRT.UN), the numbers will pan out differently. Currently, the REIT is offering a decent 3.66% yield, so at $350,000, your monthly income would come out to about $1,067. And since there is no cost associated with maintenance, you get to keep all of it.

There are also no property taxes. You may also save quite a bit in taxes if you are holding your REIT in a non-registered account since rental income is taxed at a regular income tax rate.

As for capital appreciation, Granite has seen a price appreciation of about 140% in the last decade, or roughly 14% a year. So, for eight years, that would be about 112%.

This is a little below the mark compared to the rental property, and with stocks, the growth is not as linear or predictable as it is with actual real estate. However, it also means you can see unprecedented growth in the right market conditions.

Foolish takeaway

When you are considering real estate investing in Canada, REITs are always a viable option, even when you have enough capital to buy a rental property. A REIT like Granite (a Dividend Aristocrat) also regularly raises its payouts, which is akin to raising the rent.