Real estate remains a popular asset class for individuals seeking portfolio diversification within a self-directed IRA. However, real estate exposure can take different forms. Some account holders choose direct real estate investments, such as rental properties or commercial real estate, while others prefer REITs, also known as real estate investment trusts.
Understanding the differences between direct property ownership and REITs can help you better understand the available investment opportunities within a self-directed IRA.
What Is Direct Real Estate in a Self-Directed IRA?
Direct real estate investments involve purchasing and holding physical real estate assets within a self-directed IRA. These assets may include:
- Residential rental properties
- Commercial property
- Office buildings
- Multifamily housing
- Vacant land
- Income-producing real estate
- Other property types permitted by IRS regulations
With direct property ownership, the IRA owns the investment property rather than the individual account holder.
Direct real estate can provide exposure to rental income, property appreciation, and other potential tax advantages available within qualified retirement accounts. However, direct ownership also comes with ongoing responsibilities related to property management, maintenance, property taxes, closing costs, and other operational considerations.
What Are REITs?
REITs, or real estate investment trusts, are companies that own, operate, or finance income-generating real estate across a variety of property sectors.
Depending on the REIT, holdings may include:
- Apartment communities
- Commercial real estate
- Office buildings
- Industrial facilities
- Healthcare facilities
- Hotels
- Retail centers
- Data centers
Many publicly traded REITs are bought and sold on stock exchanges, similar to stocks and ETFs. REIT shares allow account holders to gain exposure to the real estate sector without directly owning or managing physical properties.
REITs may also be available through mutual funds or ETFs that focus on real estate assets.
How Do Direct Real Estate and REITs Differ?
The primary difference is ownership structure.
With direct real estate investments:
- The IRA owns a specific property.
- The account holder selects the property.
- Income and expenses flow through the IRA.
- The investment is generally more hands-on.
- Active management may be required.
With REITs:
- The IRA owns shares of a real estate investment trust.
- The REIT owns and manages the underlying properties.
- Exposure is spread across multiple properties or property sectors.
- The approach is generally more hands-off.
- Professional management handles day-to-day operations.
Both approaches provide access to the real estate market, but they do so in very different ways.
How Does Liquidity Compare?
Liquidity refers to how easily an asset can be bought or sold.
Direct real estate investments are generally considered illiquid. Selling an investment property can take time and often involves:
- Market conditions
- Property values
- Closing costs
- Buyer demand
- Financing considerations
By comparison, publicly traded REIT shares can often be bought and sold through a brokerage account during market hours, providing greater liquidity.
For some account holders, liquidity can be an important consideration when evaluating different asset classes.
How Does Diversification Differ Between the Two?
Portfolio diversification is often one reason individuals explore real estate exposure within a self-directed IRA.
Direct ownership typically provides exposure to a specific property or small group of properties. Performance may be tied to:
- Local market trends
- Property values
- Rental demand
- Interest rates
- Regional economic conditions
REITs may provide broader diversification because a single REIT can own multiple real estate assets across different geographic areas and property types.
Depending on the REIT structure, exposure may include:
- Commercial real estate
- Residential properties
- Healthcare facilities
- Industrial properties
- Mixed-use developments
This broader exposure may help reduce concentration within a single property sector.
What Are the Management Requirements?
One of the biggest differences between direct real estate and REITs is the level of involvement required.
Direct ownership may involve:
- Property management
- Tenant coordination
- Property maintenance
- Repairs and improvements
- Insurance oversight
- Recordkeeping
These responsibilities can make direct ownership more time-consuming than owning REIT shares.
REITs are generally managed by professional teams that oversee acquisitions, operations, leasing, and property maintenance. This makes REITs a more hands-off option for those seeking exposure to the real estate sector.
How Can Market Conditions Affect Each Option?
Like any asset class, both direct real estate and REITs may be influenced by changing market conditions.
Factors that can impact both include:
- Interest rates
- Market volatility
- Economic downturns
- Property values
- Rental demand
- Capital markets activity
However, the effects may differ.
Direct real estate may be more closely tied to local market conditions and property-specific factors.
REIT shares may respond more quickly to broader market trends because many publicly traded REITs trade daily on stock exchanges.
What About Income and Potential Appreciation?
Both direct real estate and REITs are often associated with income-generating opportunities.
Direct ownership may generate:
- Rental income
- Potential property appreciation
- Cash flow from tenants
REITs may generate:
- Dividend distributions
- Exposure to multiple income-producing properties
- Participation in broader real estate market performance
Results vary based on market conditions, property types, and the specific real estate assets involved.
Which Real Estate Approach Is Right for Your IRA?
There is no one-size-fits-all answer.
Direct real estate investments and REITs each offer different characteristics related to liquidity, diversification, management responsibilities, and exposure to the real estate market. Some real estate investors prefer the control associated with direct property ownership, while others appreciate the convenience and broader exposure offered by REITs.
Understanding the distinctions between these approaches can help account holders evaluate the real estate investment opportunities available through a self-directed IRA.
Explore Real Estate Opportunities with Mainstar Trust
Mainstar Trust provides custody services for a wide range of alternative assets, including direct real estate investments and REITs held within self-directed IRAs.
If you're interested in expanding your retirement account beyond traditional assets, our team can help you understand the account setup process and available asset types.
Contact Mainstar Trust today to learn more about opening a self-directed IRA and accessing alternative asset opportunities for your retirement account.