When looking for investment options, there are many choices for where to put your money. Stocks, bonds, exchange-traded funds, mutual funds, and real estate are all good investments no matter what level of experience you have; forex or cryptocurrency may be too volatile for beginning investors. Which option you choose will depend on how involved you want to be in your investment, how much money you have to start investing, and how much risk you are comfortable taking on.
Buying and owning real estate is an investment strategy that can be both satisfying and lucrative. Unlike stock and bond investors, prospective real estate owners can use leverage to buy a property by paying a portion of the total cost upfront, then paying off the balance, plus interest, over time.
What makes a good real estate investment? A good investment has a high chance of success, or return on your investment. If your investment involves a high level of risk, that risk should be balanced out by a high possible reward. Even if you choose investments with a high probability of success, though, that isn't a guarantee. You shouldn't put money into real estate—or any other investment—if you cannot afford to lose that money.
Though a traditional mortgage generally requires a 20% to 25% down payment, in some cases, a 5% down payment is all it takes to purchase an entire property. This ability to control the asset the moment papers are signed emboldens both real estate flippers and landlords, who can, in turn, take out second mortgages on their homes in order to make down payments on additional properties. Here are five key ways investors can make money on real estate.
Key Takeaways
- Aspiring real estate owners can buy a property by using leverage, paying a portion of its total cost upfront, and paying off the balance over time.
- One of the primary ways in which investors can make money in real estate is to become the landlord of a rental property.
- People who are flippers, buying up undervalued real estate, fixing it up, and selling it, can also earn income.
- Real estate investment groups are a more hands-off way to make money in real estate.
- Real estate investment trusts (REITs) are basically dividend-paying stocks.
1. Rental Properties
Owning rental properties can be a great opportunity for individuals who have do-it-yourself (DIY) renovation skills and the patience to manage tenants. Properties can be local, or there may be good out-of-state opportunities. This investing strategy does require substantial capital to finance upfront maintenance costs and to cover periods when the property is empty or when tenants do not pay their rent.
Pros
Provides regular income and properties can appreciate
Maximizes capital through leverage
Many tax-deductible associated expenses
Cons
Managing tenants can be tedious
Potentially damage property from tenants
Reduced income from potential vacancies
According toU.S. Census Bureau data, the sales prices of new homes (a rough indicator for real estate values)consistently increased in value from the 1960s to 2007, before dipping during the financial crisis. Subsequently, sales prices resumed their ascent, even surpassing pre-crisis levels. The long-term effects of the coronavirus pandemic on real estate values remain to be seen.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
2. Real Estate Investment Groups (REIGs)
Real estate investment groups (REIGs) are ideal for people who want to own rental real estate without the hassles of running it. Investing in REIGs requires a capital cushion and access to financing.
REIGs are like small mutual funds that invest in rental properties. In a typical real estate investment group, a company buys or builds a set of apartment blocks or condos,then allows investors to purchase them through the company, thereby joining the group.
A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all of the units, handling maintenance, advertising vacancies, and interviewing tenants. In exchange for conducting these management tasks, the company takes a percentage of the monthly rent.
A standard real estate investment group lease is in the investor’s name, and all of the units pool a portion of the rent to guard against vacancies. To this end, you'll receive some income even if your unit is empty. As long as the vacancy rate for the pooled units doesn’t spike too high, there should be enough to cover costs.
Pros
More hands-off than owning rentals
Provides income and appreciation
Cons
Vacancy risks
Fees similar to those associated with mutual funds
Susceptible to unscrupulous managers
3. House Flipping
House flipping is for people with significant experience in real estate valuation, marketing, and renovation. House flipping requires capital and the ability to do, or oversee, repairs as needed.
This is the proverbial "wild side" of real estate investing. Just as day trading is different from buy-and-hold investing, real estate flippers are distinct from buy-and-rent landlords. Case in point—real estate flippers often look to profitably sell the undervalued properties they buy in less than six months.
Pure property flippers often don't invest in improving properties. Therefore, the investment must already have the intrinsic value needed to turn a profit without any alterations, or they'll eliminate the property from contention.
Flippers who are unable to swiftly unload a property may find themselves in trouble because they typically don’t keep enough uncommitted cash on hand to pay the mortgage on a property over the long term. This can lead to continued, snowballing losses.
There is another kind of flipper who makes money by buying reasonably priced properties and adding value by renovating them. This can be a longer-term investment, and investors may only be able to take on one or two properties at a time.
Pros
Ties up capital for a shorter time period
Can offer significant returns
Cons
Requires a deeper market knowledge
Hot markets cooling unexpectedly
4. Real Estate Investment Trusts (REITs)
A real estate investment trust (REIT) is best for investors who want portfolio exposure to real estate without a traditional real estate transaction.
A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, like any other stock.
A corporation must payout 90% of its taxable profits in the form of dividends in order to maintain its REIT status. By doing this, REITs avoid paying corporate income tax, whereas a regular company would be taxed on its profits and then have to decide whether or not to distribute its after-tax profits as dividends.
Like regular dividend-paying stocks, REITs are a solid investment for stock market investors who desire regular income. In comparison to the aforementioned types of real estate investment, REITs afford investors entry into nonresidential investments, such as malls or office buildings, that are generally not feasible for individual investors to purchase directly.
More importantly, REITs are highly liquidbecause they are exchange-traded trusts. In other words, you won’t need a real estate agent and a title transfer to help you cash out your investment. In practice, REITs are a more formalized version of a real estate investment group.
Finally, when looking at REITs, investors should distinguish between equity REITs that own buildings and mortgage REITs that provide financing for real estate and may also invest in mortgage-backed securities (MBS). Both offer exposure to real estate, but the nature of the exposure is different. An equity REIT is more traditional in that it represents ownership in real estate, whereas the mortgage REITs focus on the income from real estate mortgage financing.
Pros
Essentially dividend-paying stocks
Core holdings tend to be long-term, cash-producing assets
Cons
Leverage associated with traditional rental real estate does not apply
5. Online Real Estate Platforms
Real estate investing platforms are for those who want to join others in investing in a bigger commercial or residential deal. The investment is made via online real estate platforms, which are also known as real estate crowdfunding. This still requires investing capital, although less than what's required to purchase properties outright.
The best real estate crowdfunding platforms can pool resources of investors looking for investment opportunities with other investors looking for financial backing for new or current real estate projects. Thereby giving you the opportunity of diversifying your investments with not much money.
Pros
Can invest in single projects or portfolio of projects
Geographic diversification
Cons
Tend to be illiquid with lockup periods
Management fees
Why Should I Add Real Estate to My Portfolio?
Real estate is a distinct asset class that many experts agree should be a part of a well-diversified portfolio. This is because real estate does not usually closely correlate with stocks, bonds, or commodities. Real estate investments can also produce income from rents or mortgage payments in addition to the potential for capital gains.
What Is Direct vs. Indirect Real Estate Investing?
Direct real estate investments involve actually owning and managing properties. Indirect real estate involves investing in pooled vehicles that own and manage properties, such as REITs or real estate crowdfunding.
Is Real Estate Crowdfunding Risky?
Compared to other forms of real estate investing, crowdfunding can be somewhat riskier. This is often because crowdfunding for real estate is relatively new. Moreover, some of the projects available may appear on crowdfunding sites because they were unable to source financing from more traditional means. Finally, many real estate crowdfunding platforms require investors' money to be locked up for a period of several years, making it somewhat illiquid. Still, the top platforms boast annualized returns of between 2% and 20%, according to Investopedia research.
The Bottom Line
Whether real estate investors use their properties to generate rental income or to bide their time until the perfect selling opportunity arises, it's possible to build out a robust investment program by paying a relatively small part of a property's total value upfront. And as with any investment, there is profit and riskwith real estate investing and markets can go up as well as down.
