Your Options for Investing in Real Estate
The old saying, “Don’t put all your eggs in one basket” holds true when it comes to investing your money for the future. By diversifying your portfolio, you may reduce your risk of loss as you spread your money throughout several different asset classes, including stocks, bonds and other investments. Real estate is another asset class you can use to diversify your holdings.
Of course, it’s important to do your research to learn which available options best fit your needs, and how to finance your real estate investments.
Six ways to invest in real estate
Although other options may be available, the following are six common real estate investing options to consider.
Your primary residence: Although not technically an investment property, your home may still qualify as an investment. When putting your financial portfolio together, your home will be considered an asset, one that could be liquidated if necessary. You can also use the equity you have in your home to secure cash through vehicles including home equity loans and home equity lines of credit. Additionally, if you sell your home in the future, the home value may have appreciated, meaning you would receive a return on your initial purchase. Of course, this is never guaranteed, and as we saw with the housing crash and Great Recession of 2007 through 2009, your home could lose value over time. As with any investment, there is risk involved.
Rental property/Airbnb properties: These properties could be secondary residences you purchase, or they could be located at your primary residence — for instance, as a basement apartment. As rentals, these properties offer two sources of income: The first is the rental fee you receive each week, month or other term you agree to with the renter. The second is the proceeds you will receive if and when you sell the property. This could be an option with a good return if you are able to keep the property rented on a regular basis. Keep in mind that you will have to be educated on local zoning laws if you plan to be a landlord. You should also be aware that some cities have stricter rules than others when it comes to Airbnb and other similar rental services.
Commercial property: There are many types of properties deemed commercial, including shopping centers, multifamily residences, coffee shops, hotels, office buildings and warehouses. And there is more than just one way to invest in commercial properties. You may opt to purchase the entire property and then rent or lease it to the business owner(s), or you may join in with other investors to fund the project.
Because of this, your risk and return on a commercial property investment could vary greatly. For instance, if you buy the property outright, you are liable for repaying the loan on the property. If you have reliable tenants, you may be able to repay the loan as agreed. However, if you find it hard to attract reliable tenants, you alone are responsible for coming up with the funds to repay the loan. If you invest in the property with a group, this risk is shared by the other investors. Likewise, your potential return may be diminished, given that any rental income or sale proceeds will be divided among all the investors.
Land investing: Purchasing land can offer a varying level of risk and return. For instance, buying some acreage in an area close to a burgeoning business district could provide a big return if sold to a developer looking to build residences near that growing commercial center. However, it could take years for such an investment to pay off. You also may buy land for the purpose of building a dream home from scratch, or even maintaining a campground. Financing a land investment may be more complicated — and more expensive — than it is for other real estate investments.
Flipping homes: This real estate investing option requires a lot of education and, possibly, upfront cash. In most cases, houses purchased for the sole purpose of flipping are in need of renovations to not only improve the home’s existing condition, but to also elevate its value. After all, you want to make a good profit if you choose to flip.
One thing you should be aware of is that not all communities are ready for such renovations. For one, in their efforts to build a home that will sell for a good profit, investors may overprice a home for its market. As a result, it can take much longer to flip the home, and sometimes this will be at a loss rather than a gain. There is also a great deal involved in starting and financing a home-flipping business, so make sure you understand how the process works.
REITs: REITs, or real estate investment trusts, are companies that own and typically operate income-producing real estate or related assets. These are not properties developed to sell off, but rather to become a part of the company’s own investment portfolio. Individuals are able to invest in these REITs, which can provide them with investment opportunities they otherwise may not be able to afford.
Some REITs are publicly traded on the stock exchange, meaning individuals can purchase shares of them like other stocks. Other REITs are not publicly traded, but may still be open to individual investments. As with stocks, REITs may offer higher dividend yields. Also, as with stocks, they can come with a fair amount of risk.
Pros of real estate investing
One key benefit of investing in real estate is the potential for a financial return. And, with many real estate investments, the risk of loss is minimal, meaning this could be a solid addition to your portfolio. Depending on the type of real estate investment, you could enjoy short-term gains in the form of rental income as well as the long-term benefit of seeing a profit once the property sells.
With rental properties, you also may enjoy such tax benefits as mortgage interest deductions, a real estate depreciation deduction and a deduction of all reasonable and necessary repairs. Be sure to discuss all possible tax benefits of owning a rental property with your financial advisor to ensure you maximize any and all deductions.
Cons of real estate investing
When investing in real estate, there may be some disadvantages you haven’t considered beforehand. For instance, with rental properties, you will be taking on the role of landlord. As such, you’ll be faced with renter complaints, and you’ll have to address (and pay for) maintenance issues at all hours. You will also have to monitor the property or building to ensure renters are complying with rental guidelines.
In the alternative, you could hire a management company to handle these issues, but the costs involved will cut into your rental income.
Also, investing in real estate ties up your money in a relatively illiquid asset. You don’t have the same flexibility to move whenever you want, as you generally do in a rental situation. In addition, when it comes to REITS, you may be faced with high brokerage fees on publicly products and high sales commissions and upfront offering fees on the non publicly traded REITs. It may be wise to talk to a financial adviser before investing in any kind of REIT.
And, as always, there is no guarantee your real estate purchase will appreciate in value, and you may even experience a significant decrease in value, as homeowners did during the housing crash and Great Recession of 2007-09.
How do I finance investment properties?
When it comes to financing your primary or rental properties, a conventional mortgage is one of the most common options available. However, if you are financing something other than your primary residence, expect to pay a higher interest rate and larger down payment. You also may be required to have a minimum amount of cash reserves on hand.
FHA and VA loans also may be an option for multifamily properties if you plan to live onsite in one of the units, and the property has a required number of units. Home equity lines of credit and home equity loans also might be possible financing options, but you risk losing your primary residence should you default on those loans.
Other financing options include loans from private lenders or investors, but these, too, could be risky. These loans may include high interest rates, high down payments and high origination fees. And, if you are borrowing from family or friends, that could lead to potential problems down the road if you don’t repay the loan as agreed.
Is real estate investing right for me?
You should conduct a full review of your current finances and your financial goals to determine if real estate investing is right for you. Understand that qualifying for an investment property generally entails stricter guidelines from the lender, meaning you need a solid credit history and score. If you think you might have a hard time qualifying, it may be better to wait until you build up a good credit report, as well as the needed down payment and any required cash reserves.
The bottom line
Investing in real estate could provide a solid return on your money, but it’s not always the best option, and it comes with risk. Before making any decisions, the best step is to fully evaluate your current financial picture, determine what your financial goals are and see what is required to build a bridge between the two. If you find yourself on solid financial footing, then real estate investing could be a good move for you. However, make sure you review all real estate investing options and consult with your financial advisor to determine which one may be the best fit for your needs.