Investing in real estate can be a lucrative way to diversify your investment portfolio. But it’s riskier than stocks and bonds, and there’s no one-size-fits-all approach. The best way to invest in real estate comes down to your risk tolerance, budget and overall experience.
The many ways to invest in real estate vary by liquidity, investment minimum and time commitment. The best real estate investment for your portfolio hinges on your budget and stomach for risk.
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Real estate investment trusts are a way to invest in real estate without purchasing physical property. Instead, you invest in a company that purchases and operates income properties. And you can do it through a brokerage account with an online trading platform.
REITs are a practical option for stock market investors seeking portfolio diversification. These trusts are bought and sold on major exchanges — similar to stocks. And like stocks, REITs pay dividends.
The perk of investing in REITs is that they’re highly liquid, which means you can buy and sell them quickly — typically in a day. They also offer access to commercial real estate an investor might otherwise have difficulty accessing, including office buildings, apartment complexes, malls and hotels.
The major downside to investing in REITs? They’re complex and lack leverage. With so many types of REITs, some are riskier than others. Beginners will want to stick with publicly-traded REITs.
Another option for investors who don’t want to purchase property of their own is to buy into real estate mutual funds. These mutual funds pool the assets of multiple investors between REITs and real estate operating companies. And you can invest through an account with an online broker.
Like REITs, real estate mutual funds are also fairly liquid. But unlike REITs, mutual fund profits remain in the fund unless you sell. Mutuals funds also provide access to a broad sweep of assets with fewer transaction costs.
That said, when you buy into a real estate mutual fund, you have little say in the companies your money is invested in.
If you need some extra cash and have an extra room, you can rent it out through services like Airbnb, FlipKey and OneFineStay. Most allow you to set your own prices and offer tools to help you determine prices competitive in your area. You can also decide when and for how long guests can stay. Think of it as turning your home into a mini hotel you run.
But it’s not as easy as it sounds. Make yourself aware of the laws and regulations regarding these types of rentals in your town, city or state. Also, ask the service provider about any available insurance or liability policy available in case your guests damage the property. Make sure you understand the terms.
And be aware of the tax implications. Rental income on these types of properties is generally taxable unless you meet these two guidelines.
- Rent the property for no more than 14 days during the year
- Use the vacation house yourself 14 days or more during the year or at least 10% of the total days you rent it to others.
But even if you follow the 14-day rule, you should report the income on your tax return just to prove you did.
Online lending platforms take a page out of the crowdfunding playbook to connect investors with real estate developers. To invest, you’ll need to select a platform and open an account with the required minimum deposit.
Through these platforms, you can help finance a real estate project through debt or equity. In return for your investment, you receive monthly or quarterly distributions.
Popular platforms include Fundrise, Cardone Capital and PeerStreet. Minimum investments range from $500 to $25,000 and platform fees are typically around 1%. Different platforms offer access to different types of real estate, and some are open only to accredited investors with a net worth of at least $1 million.
When entering into a real estate limited partnership (RELP), investors help finance a real estate project managed by a real estate development firm or property manager — the general partner of the RELP.
RELPs aren’t publicly traded and are less liquid than REITs and mutual funds. To invest, you’ll need to partner with a real estate development firm accepting investors.
When accepted, investors become limited partners with part property ownership. As a limited partner, you have little management control over the project, but you take on less risk than the general partner overseeing the development of the property.
These short-term real estate investments typically involve the purchase of undeveloped land with the intention of developing the land and selling it for a profit. RELPs don’t often offer cash distributions — the investment payoff comes when the property is sold at a profit. Once the property is sold, the RELP is dissolved.
Real estate investment groups (REIGs) allow investors to purchase one or more units of real estate across a set of buildings — typically apartment complexes. To invest, you’ll need to research REIGs in the area you’re interested in and find out what’s available for purchase.
This option is well suited to investors that want to own and rent their own property but don’t want the hassle of maintaining it. Instead, the investment group manages the units, including property maintenance, interviewing tenants and filling vacancies.
When you invest in property through an REIG, your name is on the lease, but a portion of your owed rent is deducted to cover maintenance costs. You’ll also need to be wary of vacancy risks — although your REIG may ask investors to contribute a portion of the rent to safeguard against empty units.
Those seeking consistent income and full control over the real estate investment experience may want to consider purchasing rental property. This investment option involves buying a piece of real estate and renting it to tenants. Rental properties provide rental income, many expenses are tax-deductible and most properties appreciate in value over time.
But being a landlord is no easy feat. You’re responsible for paying the mortgage and property taxes, as well as the maintenance and upkeep of the property. You also run the risk of vacancies and irresponsible tenants who can damage your property or neglect to keep up with rent.
Also known as real estate trading, house flipping involves purchasing a property for a short period of time — typically less than six months — and reselling it for a profit. Many investors get started by searching the real estate market for undervalued properties within a price range.
Some property flippers do not invest time or funds into improving the property before reselling it. Others renovate the property before putting it back on the market.
This investment strategy offers the opportunity for sizable short-term returns. But it also carries significant risk. If the market turns and you’re unable to offload a property, you run the risk of continued losses in the form of ongoing mortgage payments.
House flipping is considerably more complex than home renovation shows would have you believe. Turning a profit flipping properties requires a solid understanding of the real estate market and renovation experience.
Pros and cons of investing in real estate
As with any investment strategy, investing in real estate offers unique benefits and drawbacks.
- Leverage. Unlike stocks, real estate investments offer the power of leverage, which means you don’t need to cover the total cost of the investment up front. Depending on where you live, you can hold property by paying as little as 5% of its total value — but higher leverage generally means higher risk.
- Low volatility. Traditionally, the real estate market is less volatile than the stock market. This means you’re more likely to receive a consistent return on investment.
- Diversification. Adding real estate to your investment portfolio helps lower portfolio volatility while protecting against inflation.
- Tax benefits. Investors have access to a number of deductible expenses, including mortgage interest, property taxes, property improvements and operational expenses.
- Passive income. Whether it’s dividends from a REIT or monthly rent from a tenant, real estate investments can earn you passive income.
- Illiquidity. Unlike stocks and bonds that you can swap in seconds, real estate is fairly illiquid, meaning it can take months to offload.
- Expensive. Real estate investing requires a higher cost of entry than stocks. A down payment on a property can run in the thousands, while mortgage payments, property taxes and maintenance costs can eat into your bottom line.
- Time-consuming. You can monitor your stocks from a computer or device with ease. But property investments often require in-person visits — especially for those managing rentals or flipping houses.
You have a variety of ways to invest in real estate, with options that vary by liquidity and skill level. And while property investments are historically less volatile than stocks and bonds, the cost of entry is higher — and takes work, depending on the option you choose.
If you prefer a strategy that requires less capital, learn about other investment options that can complement your portfolio and goals.