Real estate investing has numerous benefits. Carefully selected properties can provide considerable returns, regular cash flow, diversification and various tax benefits. But like any investment, real estate investing has its risks.
You might also think it takes a house-sized pile of money to get started. As we’ll outline below, it doesn’t.
Let’s look at some of the reasons why you might want to invest in real estate. Then we’ll show you your options and what to consider as you get started.
People invest in real estate for all sorts of reasons, but many find it appealing for these reasons.
1. Diversification: Real estate helps investors build a well-diversified portfolio. If you diversify within real estate itself, there are several ways to gain exposure to the market.
2. Tangible, appreciable assets: Real estate is a popular tangible asset among investors because it consistently increases in value over time and outperforms many other investments.
3. Flexibility: Real estate is a flexible investment that offers not only many ways to invest your money but also flexibility in what you can do with your property. You can:
- Sell it
- Rent it out
- Rezone it for different purposes
- Subdivide it into multiple residential units
Real estate investing pros and cons
Like any investment, real estate has its upsides and drawbacks.
- Additional and steady source of cash flow
- Unique tax benefits
- Leverage borrowed money to make money through appreciation
- Upfront cash, and potentially lots of it
- Unruly tenants or issues with your property
- Long-term investment with poor liquidity
- Carrying costs
There are five main ways to invest in real estate, each with its benefits and drawbacks.
1. Invest in a real estate investment trust (REIT)
A REIT is a company that owns or operates income-producing commercial real estate, such as office buildings, apartment complexes and shopping malls. They allow investors to earn income produced from commercial real estate without having to actually go out and buy commercial real estate.
Since many of these trade on the market like stocks, this keeps the buy-in cost similar to buying stocks.
Investors can benefit from long-term capital appreciation, and REITs are required to distribute at least 90% of their taxable income to shareholders to maintain their status as a REIT.
- Consider if you want exposure to commercial real estate, potentially high dividend yields and good liquidity but don’t want to own and manage physical properties yourself.
- Look elsewhere if you want the greater tax efficiency of owning and managing property.
- How to: Many REITs are publicly traded on stock exchanges and can be purchased or sold similarly to stocks or ETFs. These are known as publicly traded REITs. Others are registered with the SEC but aren’t publicly traded. These are known as public nontraded REITs and can be purchased through brokers like Fundrise or DiversyFund that participate in public nontraded offerings.
2. Real estate investing platforms
Fundrise and Diversyfund are only two examples of the many different real estate investing platforms out there. Real estate investing platforms are generally crowdfunding platforms that allow investors to pool their money together to fund real estate projects. These can include REITs, multifamily units and individual commercial properties.
Real estate investing platforms have taken off in recent years as they have made real estate investing much more accessible to the public. Many offer low investment minimums and simple fee structures and the ability to easily invest in real estate projects throughout the country. Note that some platforms are only available to accredited investors. But nonaccredited investors still have several options.
- Consider if you want geographic diversification, low investment minimums and the ability to passively invest in real estate.
- Look elsewhere if you want greater control over your investments and don’t want to pay fees.
- How to: Decide on a platform after comparing fees, required minimum investments and investment options. Then, fund your account and invest.
3. Rental properties
Rental properties allow you to build equity while earning an additional income. While the majority of rent payments will likely go toward property expenses, any amount left over is profit. This is a passive income source that requires relatively little effort.
Owning a rental property also positions you to benefit from property value appreciation and various tax benefits. While rental income is taxable, expenses you incur on your rental property can be deducted from your rental income. These expenses may include mortgage interest, property tax, depreciation and repairs.
- Consider if you want to own physical real estate and use borrowed money to potentially obtain a high return on your investment.
- Look elsewhere if you want more liquidity in your real estate investment or want to avoid the headache of property management and the possibility of a difficult tenant.
- How to: Secure a down payment, calculate how much house you can afford and get preapproved to jump on a good deal at a moment’s notice. You’ll also want to find the right location — low property taxes, decent schools and plenty of amenities.
4. Rent out a room
If you’re not ready to commit to buying a full-fledged rental property, you might consider renting part of your home. There are a few ways to do this. You could rent out a room through a site like Airbnb, though this would likely be on a short-term basis and wouldn’t necessarily provide a steady source of income as tenants move in and out. You could also offer a finished basement as a rental unit, which would provide more separation and make it easier to secure a long-term tenant. If you have a detached guest house, even better.
- Consider if you want to dip your toe into real estate investing and have a spare room or living space but don’t want to commit to buying a separate property.
- Look elsewhere if you’re not comfortable sharing your space with a stranger or you don’t want to give up the freedom to use your space as you please.
- How to: If you go the Airbnb route, create an account and set up your listing. But before you do, check your city’s zoning laws. There might be conditions to renting out a room.
5. Flip a property
Investors who flip houses have no intention of holding onto them. Flippers buy properties, fix them up and quickly resell them for a profit. Since it takes time to renovate, list and sell a property, “quickly” can mean anywhere from a few months to a year. But an ideal flip is a property in a good location that has the potential to increase in value after renovations.
While flipping houses has the potential to deliver fast, strong returns, there are plenty of unique risks. Namely, the property turns out to be less easily repairable than you thought and you end up dumping more money into it than you had planned. Or the market shifts and you’re stuck paying for a property you had no intention of holding on to.
- Consider if you understand the local market and want to make a quick profit.
- Look elsewhere if you don’t have the capital for unexpected expenses or you want to be more passive with your real estate investing.
- How to: Research your local market, set a budget and get funding for your flip. Hiring a realtor with flipping experience can help provide the market knowledge you need to find a suitable flip.
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Real estate investing is a great way to diversify your investments and potentially create extra income. Invest in real estate passively through REITs or crowdfunding platforms — or invest actively by owning physical properties.
But investing in real estate has unique risks you should clearly understand before you jump in. Spend some time researching the different ways to invest in real estate and see which approach is best for you.