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Investing in Real Estate

Investing in Real Estate

Real Estate Investing

Buying and owning real estate is both a satisfying and lucrative investment strategy. Monthly rent, equity, passive income, and tax breaks are some of the benefits of real estate investing. There are endless ways of investing in real estate, from securing a home mortgage to building rental properties. Unlike bond and stock investors, real estate investors can use leverage to acquire property by paying a portion of the property cost upfront and paying the balance plus interest over time.

Typically, a conventional mortgage requires the applicant to make a 20% to 25% down payment. However, in some cases, a borrower only needs a down payment of 5% to buy an entire property. Upon acquiring a mortgage, you control the property from the moment you sign the papers. Therefore, you can even take out a second mortgage and secure it with the same property.

If done right, real estate investing can be lucrative or even flashy. It can bring an additional income stream and help you to diversify your investment portfolio. If you have ever had a landlord, you would probably not want to be one. The unending phone calls from tenants can be draining. The good news is that the best real estate investments do not involve dealing with tenants directly. Here are some of the best real estate investment methods.

1.      REITs – Real Estate Investment Trusts

Concept image of Business Acronym REIT as Real Estate Investment Trust. 3d illustration

When it comes to investing in real estate, there are a number of different options available. Two of the most popular choices are REITs and 1031 Exchanges. So, what exactly is the difference between these two options?

REITs, or Real Estate Investment Trusts, are a type of investment that allows investors to pool their money together to buy and manage income-producing properties. One of the main benefits of investing in REITs is that they offer the potential for high returns. In addition, REITs are often less risky than other types of real estate investments, such as direct ownership of property.

1031 Exchanges, on the other hand, refer to a specific type of tax-deferred exchange that allows investors to trade one investment property for another without incurring any capital gains taxes. 1031 Exchanges can be an attractive option for investors who are looking to diversify their portfolio or upgrade to a better property. However, it should be noted that 1031 Exchanges come with a number of complicated rules and regulations that must be followed in order to qualify for the tax deferral.

So, which option is right for you? The answer depends on your individual investment goals and objectives.

REITs are a great way of investing in real estate without holding physical property. They are a great investment option for investors seeking real estate portfolio exposure without a conventional real estate transaction. A REIT is created when a trust or a corporation uses investors’ funds to acquire properties. Often compared to mutual funds, real estate investment trusts are companies that own commercial real estate like retail spaces, office buildings, hotels, and apartment buildings. REITs are a viable retirement investment because they pay high dividends. Investors who don’t need regular income can re-invest the dividends to expand their investments.

REITs are a great investment, but they are also varied and complex. Like stocks, some REITs are bought and sold on major exchanges, but some are not publicly traded. The type of REIT you invest in will be a big factor in determining the investment risk involved. Usually, non-traded REITs aren’t easy to sell and can be hard to value. Especially if you are a new investor, you should stick to publicly traded REITs that you can easily sell through a brokerage firm.

In order to maintain the REIT status, an organization must pay out 90% of its profits as dividends. By doing this, a REIT does not have to pay corporate income tax. Regular organizations are taxed on their profits and can then decide whether to distribute their after-tax profits to investors as dividends.

Like stocks, REITs are an excellent investment for investors who prefer regular income. Because they are exchange-traded trusts, REITs are highly liquid. An investor does not need a title transfer or the help of a real estate agent to cash out their investment.

If you are considering investing in REITs, you should differentiate between equity REITs and mortgage REITs. Equity REITs own buildings, while mortgage REITs offer to finance real estate and focus on mortgage-backed securities.

Pros

·       Pays dividends to investors

·       A long-term cash-producing lease

Cons

·       The leverage associated with conventional rental real estate doesn’t apply

 

2.      Investing in Rental Properties

Right Facing Red For Rent Real Estate Sign in Front of Beautiful House.

You should consider purchasing rental properties if you intend to make a significant commitment to investing in real estate. Rentals have the possibility of appreciation over time and offer a steady cash flow. However, rentals are a labor-intensive method of investing in real estate. There are two main ways of investing in rental property: long-term rentals and short-term rentals.

Long-term rentals are designed to be rented for an extended period, usually at least a year. They provide a steady income source, but this will depend on the reliability of the tenants. You can invest in single-family homes or a multifamily property that you rent to others.

Short-term rentals often cater to rotating occupants, whose stay could be as little as one night. A good example is Airbnb. You can invest in a property solely meant for short-term rentals, and you can list your entire home or apartment when you are not in.

Investing in rental properties provides a great potential for profits. However, it also requires a lot of effort from the investor, especially if they’re also the property manager. For example, the investor must pay for ongoing maintenance of the property, find and vet potential renters, and take care of repairs and other issues that could arise. You can hire a property management company to reduce some of these headaches. When investing in rental property, the low-interest rates and resources available to primary residence investors are not available. Therefore, it is often more expensive to invest in rental properties.

Pros

·       Rental incomes maximize capital through leverage

·       Provide a regular stream of income

·       Rental property has the potential to appreciate

Cons

·       Potential vacancies could lead to reduced rental income

·       Tenants can cause property damage

·       Managing tenants can be hectic

 

3.      Crowdfunding Real Estate Platforms

Crowdfunding Concept. People Inserting coins into piggybank

If you don’t intend to take a more hands-on approach to real estate investing, you should consider crowdfunding real estate investment programs like Fundrise. These online real estate platforms allow wealthy investors to invest in a specific real estate development project instead of holding large, generic investment properties. Real estate crowdfunding platforms fund development projects using other people’s money (pooling funds from different individual investors). You have to commit to the investment for an extended period, usually a minimum of five years. You can still access your money before this period depending on the platform’s discretion. However, you might face an early withdrawal penalty.

Many online real estate investment platforms charge fees. You should consider all the applicable fees, including additional property management fees, because these could diminish your returns. Many online platforms have minimum investment requirements. Therefore, you may not qualify to invest in some platforms. The minimum investment often ranges between $500 and $25,000 or higher. Some platforms only accept accredited investors, meaning that an investor must have a net worth of $1 million without including the primary residence. An accredited investor should have a yearly income of $200,000 or a combined income of $300,000 together with the spouse.

Pros

·       You can invest in a single project or several projects

·       Geographical diversification

Cons

·       Investors incur a management fee

·       The investment tends to be illiquid, with a lock-up period

 

4.      Flipping Properties

paint brushes against a wall after property has been decorated ready for selling

You don’t have to own rental properties to be a real estate investor. Buying and flipping real estate property is a common investment strategy. However, like investing in rental properties, this investment strategy takes a lot of work. It means buying and upgrading properties before reselling them. You must know how to identify the best neighborhoods that allow you to sell at a premium.

House flipping involves construction and renovations. Therefore, you must be willing to incur out-of-pocket costs and take on a higher risk. Home flipping is not as easy as it might sound. You will have to obtain the relevant permits for major renovations. Sometimes, the remodeling costs will be higher than you expect, especially if you have to outsource some work or hire contractors.

You should look for homes that do not need major renovations to minimize the effort needed in flipping properties. The neighborhood matters a lot. Sometimes, the neighborhood you expect to be trendy in the future might never catch on, leaving you with a hard-to-sell home.

House flipping is the wild side of real estate investing. Real estate flippers differ from buy-and-rent landlords, the same way day trading is distinct from buy-and-hold investors. Usually, house flippers buy undervalued properties, which they sell within six months (usually at a profit.)

If a flipper is unable to offload a home within a short period, they might find themselves in trouble. Some flippers do not hold enough money for long-term mortgage payments. Most flippers make money by buying property, renovating it, and selling at a profit. Others buy a property and rent it out as they wait for prices to rise.

Pros

·       Flipping properties can provide quick returns

·       This investment ties up capital for a short period

Cons

·       Hot markets might cool unexpectedly

·       An investor must have a deep market knowledge

 

5.      Real Estate Investment Groups

If you would like to own real estate minus the headaches of running it, real estate investment groups, commonly abbreviated as REIGs, are a great option. REIGs are more like mutual funds that invest in rental properties. Typically, a company builds or buys apartment condos or blocks. Then, the company allows investors to buy the units, thus joining the group. You can own one or several self-contained units. However, the company that operates the investment group manages all the units, advertises vacancies, interviews tenants, and handles maintenance in exchange for a percentage of the monthly rent.

The units put together a portion of the rent to cater to unexpected vacancies. Therefore, an investor will still receive income even if their unit is empty. There should be enough money to cover the costs, provided that the vacancy rate doesn’t persist.

Pros

·       Provides both income and appreciation

·       Less involving than owning rentals

Cons

·       Investors incur fees similar to those associated with mutual funds

·       Vacancy risks

·       A risk of subjection to unscrupulous property managers

How Real Estate Compares to Other Types of Investments

Every type of investment has its advantages and disadvantages. Below is a look at how real estate compares to other types of investments.

        I.            Real Estate vs. Mutual Fund

It is easier to invest in a mutual fund than in real estate. However, real estate provides investors with a hedge against economic downturns that could cause other investments to deteriorate in value.

      II.            Real Estate vs. Bonds

Bonds are one of the safest forms of investments because investors will never lose money by investing in them. Real estate investments have a higher potential for making profits, unlike bonds. However, investing in real estate has a higher likelihood of losing money.

    III.            Real Estate vs. Stocks

The value of stocks can rise and fall quickly. Real estate is less volatile than the stock market. However, real estate is less liquid than stocks. You can easily sell particular stocks and access money faster than you would in real estate.

    IV.            Real Estate vs. CDs

Like investing in bonds, investing in CDs (certificates of deposit)is a safe investment option whereby you can never lose money. However, the potential gains from investing in CDs are lower than the potential returns of real estate investments.

Why You Should Invest in Real Estate

Investing in real estate is lucrative; it could help you realize major profits despite its potential pitfalls. To get the most out of your investment, you should research properties and neighborhoods. Here are some of the most important reasons to invest in real estate.

·       Great Returns

Real estate increases in value over time, meaning that you can sell it at a significant profit. However, the returns are not guaranteed. You must invest in the right property to realize good returns.

·       A Steady Cash Flow

Real estate investments are a great way to increase your monthly income. Whether you invest in commercial or residential real estate, you can always rent out the space to tenants. You will then receive monthly payments in the form of rent. However, you should be careful when choosing tenants. Ensure that you understand the tenant’s payment history. By doing this, there will be little risk that the tenant will stop paying rent at some point.

·       Portfolio Diversification

Adding real estate into your investment portfolio brings diversification. This means that you will have an upper edge during times of economic turmoil. Even when stocks are suffering because of an economic downturn, your investment might still be increasing in value.

·       Tax Benefits

Real estate investments come with tax advantages. For example, you can deduct certain expenses associated with owning property. The expenses include management fees, mortgage interest, property taxes, insurance, and the costs of ongoing maintenance.

·       Passive Income

Owning real estate gives you passive income, meaning that you don’t have to work to earn this money. For example, if you rent out single or multiple living spaces, the rent you receive every month is an example of passive income.

Other benefits include long-term security, the ability to leverage funds, a chance to build capital, and fulfillment & control.

Challenges that Real Estate Investors Face

Despite the many benefits of real estate investing, it also comes with potential risks and challenges.

a)      Starting Capital

A real estate investor needs a significant amount of capital to get started. Residential and commercial properties are not cheap. Sometimes, you have to apply for a mortgage loan to acquire these properties. Investing in CDs, stocks, and mutual funds requires less starting capital.

b)      Liquidity

Unlike stocks, real estate is not liquid. Once you invest in real estate property, you may have to sell the property to realize profits. Other investments like bonds and stocks are far more liquid. You can easily sell stocks to get some money.

c)       Location

Location really matters when investing in real estate. If your property is not located on an estate where its value is appreciating, its price is not likely to increase resulting in a bad investment. When investing in real estate, you should do thorough research on the property’s neighborhood.

d)      Time

The profits from a real estate investment do not come fast. You might charge rent to residential and commercial tenants; however, this income will mainly cover the costs of maintaining the property and your monthly mortgage payment. You can only realize big profits when you sell the property for more than you bought it. After acquiring a property, you must wait for several years for it to appreciate in value.

Should You Invest in Real Estate?

Many experts agree that real estate should be part of a well-diversified investment portfolio. Real estate does not closely correlate to bonds and stocks. Real estate also provides income from rent in addition to the potential for capital gains. However, the risks and costs of real estate investing can run high. Therefore, REITs are the best choice for people with limited income or who are not seeking to invest in a primary residence.

If you decide to start flipping properties or investing in rental properties, you should ensure that you are aware of the potential risks. You should also have a plan for how to earn back on your investment. Real estate is often illiquid in the short term. You must be willing to make a big financial commitment.

Final Thoughts

If you intend to invest in real estate, you should review the various types of real estate investments. Ultimately, the right way to invest in real estate depends on your risk tolerance and long-term investment goals. Remember, you are not limited to one investment type. You can choose several real estate investment strategies for the best returns. Now that you understand the ups and downs of real estate investing, you can proceed to invest in your first property. Provided you do the necessary research; real estate can bring you big returns.