Rental property: it’s one of the best ways to bring in long-term passive income, many economists argue. You can look forward to high income every single month that you have a tenant. And that can last years, in some cases!
But there are also real estate investment trusts (REIT) that offer passive income as well. While it’s hard to bring in that high monthly income, it comes with a lot less risk. So, let’s do the math and see which is a better option for Motley Fool investors.
Rental property
If you’re going to invest in a rental property, you first need to buy one. And that isn’t easy right now. Interest rates are rising, as are mortgage rates. And that also means insurance, which you would need should you become a landlord.
But that doesn’t mean everywhere is unaffordable. A strong option to consider right now are some of the fringe cities that are close but still outside the limits of major cities. You can pick up a property for far less than you’d pay in a place like Toronto, or even major cities like Kitchener. Instead, you can buy outside the limits and still look forward to rental income.
Depending on where you land, you could be looking at between $1,000 and $2,000 per month in rental income! And that’s certainly nothing to sneeze at. The problem is, you’ll likely need that income to pay for a lot of things. And I don’t just mean your mortgage.
The downside
As mentioned, you’ll have to pay for insurance, but also maintenance of the property, taxes, maybe even condo fees. And that can add up. Furthermore, that money isn’t guaranteed. Tenants have rights and can leave if they give you notice. That could mean you’re paying for a property to sit empty.
So, unless you were able to pay for the property upfront, all these payments can add up, and you’ll actually be losing money for some time before you make it. As of writing, it could cost about $4,300 per month on average to maintain a rental property.
REITs
A REIT certainly will be difficult to invest in and achieve those $1,000 to $2,000 results. But it certainly won’t cost as much as buying a rental property, and you don’t have to make all those payments along with it. That being said, growth isn’t guaranteed, and you’re not in control as you would be with a rental property.
To make $2,000 per month, let’s look at a residential REIT like Killam Apartment REIT (TSX:KPM.UN). Killam has a reasonable 3.7% dividend yield. So, right now, to bring in $2,000 per month, you’d need to invest $650,057! I’m sure you’ll notice you could absolutely buy a property for that amount.
Another issue is that returns aren’t as strong as the appreciation in a property. Shares are down about 20% year to date thanks to the recent fall but have been climbing back in the last week.
So, which is best?
Unless you have a lot of money on hand to buy a rental property, and all the costs that come with it, I would recommend an REIT instead. You won’t be making money on a property for potentially years, and there is no guarantee you’ll have tenants.
Meanwhile, a REIT is safer, but it will certainly be harder to achieve those high numbers. So, you’ll have to be happy knowing you don’t have substantial costs and instead can look forward to stable, albeit smaller, income.
