Real estate is one of the foremost, tried, and tested investment vehicles that have generated wealth for investors for an extended period. There are different ways to invest in real estate with varying levels of risk and profitability.
Investing in real estate can help diversify your portfolio, provide you with steady cash flow, and help you build long-term wealth through appreciation in asset values.
Types of Real Estate Investments
You can invest your money in real estate through various mediums, depending on your personality and financial goals.
Real Estate Investment Trusts (REITs)
REITs are stocks of companies that purchase and invest in real estate properties (Equity REITs) or provide mortgage financing for real estate investors (Mortgage REITs). REITs work like stocks, except you are purchasing the shares of a company that invests solely (or primarily) in the real estate industry.
REITs pay a large portion of their profit as a dividend to investors (90% in many cases). However, the dividends might not be eligible for low tax rates compared to dividends from regular stock. It is a healthy option for investors who want consistent returns and want to avoid the tedious work involved in purchasing and managing their properties.
Real Estate Investment Groups
REIGs are a less formalized version of REITs. They work like mutual funds where individual and professional investors pull funds together and invest in real estate properties. A group of professionals who charge a percentage of profit as management fees manage them.
REIGs also provide an excellent platform to earn returns from real estate investing without active participation. The management fees can eat into your profits, and poor management choices can hurt your investment.
For more on REITs, read- How to Invest in REITs: A Step-by-Step Guide
Real Estate Flipping
With real estate flipping, an investor purchases an undervalued property makes some repairs to put it into a good shape and sell it off for profit. Real estate flipping is similar to income investors who buy stocks at low prices and sell at higher prices to make a profit. The only difference is, with real estate, you will need to spend money to put the property into good shape before you can sell to make a reasonable profit.
Real Estate Flipping requires a lot more knowledge and experience than REITs and REIGs. First, you need to identify good properties (with potentials to make a profit after cost of purchase and repairs) and make an accurate estimate of all the repairs required to put the property in good shape. It is very easy to make a loss with real estate flipping. However, when done right, it has huge potentials for profit.
To read more on Real Estate Flipping, read- How to Flip a House
Real Estate Trading
The only difference between real estate trading and real estate flipping is that the former does not necessarily include repairs and renovations. Flipping is all about finding undervalued properties, making repairs and renovations, and selling for a profit. However, a real estate trader may purchase a property in perfect condition with the prospect of appreciation in the price over a specified period.
Similarly, flippers tend to be more short-termist (they try to sell within three to four months) in their approach compared to traders.
To read more on Real Estate Trading – How to Invest in Real Estate: 3 Basic Steps and What to Expect
The alternative to flipping and trading is purchasing a property and leasing/renting it out for regular cash flows. Owning and renting out properties requires more active participation (unless you employ property managers, which reduces your returns). Becoming a property owner is fun for some who have the skills and personality, while it is a no-no for others. However, you can still take advantage of the benefits of becoming a property owner (without the stress) by employing property managers. Owing properties also provide many tax benefits.
To read more – Earning a Living with Rental Properties
Types of Real Estate Properties
These are residential houses, townhouses, apartments, and vacation homes.
These are office buildings and skyscrapers.
Industrial properties are warehouses, storage units, or car washes.
Retail Properties are shopping malls, strip malls, and other retail storefronts.
Pros of Real Estate Investing
There are many reasons why you should include real estate in your portfolio. Some of them are:
- Leverage: The ability to use leverage is one of the most exciting things about real estate investing. You can purchase a property with mortgage financing, rent out the property, make repayments (and earn a profit) from the rent (and build equity value). Most mortgages will only request for 20% down payment on the purchase price of the property.
- Value Appreciation: Generally speaking, properties tend to appreciate. Of course, there are times when the market is unfavorable. However, for the average investor who knows how to identify the sound and potentially rewarding properties, there is an enormous prospect for profit.
- Consistent Income: When you buy REITs or rent out properties, you can earn a steady income on your investments.
- Tax Benefits: Income from rent is not taxable as a self-employment income, among other tax benefits.
- Inflation-Proof: The growth in the value of properties in the real estate market tend to exceed the growth in the inflation rate. Investing in real estate is a good hedge against inflation.
- Passive Income: Income from real estate is mostly passive income. It does not require your active participation (except you want to be the landlord) before you earn a profit.
Cons of Real Estate Investing
Despite the endless list of advantages, there are also some downsides to real estate investing.
- Capital: Investing in real estate requires a reasonable capital outlay. Unlike stocks where you can buy little chunks and commit little capital, real estate needs more capital outlay. As they say, “you need money to make more money.”
- Risks: Buying the right properties at the right time is essential in real estate investing. When you buy the wrong properties or the right ones at the wrong time, it can spell disaster. The actual cost of repairing and renovating a property for flipping can exceed the estimate by far and make the whole process a loss.
- Complications: When you decide to own and rent, it will require more commitments. Dealing with people is never easy, and there is every possibility that some problems may arise with your renters. Some renters will default. Some will leave the house in bad condition. Many situations will develop that require appearances at the court. If you manage the properties, these will require time and effort. Even if you hire property managers, you will still have to deal with certain issues.
- Limitations to tax benefits: Some of the tax benefits don’t apply across the board. After exceeding certain income levels, you cannot enjoy some of the tax benefits that come with real estate investing.
- Have clear financial goals: Everything begins and ends with your financial goals. This is always the starting point.
- Ensure you get an accurate estimate of the cost of repairs and renovation when you engage in real estate flipping.
- If you don’t have a penchant for dealing with people or DIY skills for repairs and maintenance, you should hire a property manager.
- Do not purchase properties for emotional reasons. Ensure you have a good basis for your financial projections and expectations.
- Don’t make assumptions when it comes to taxes. Know what taxes you qualify for and which ones you don’t.
- Use leverage, but don’t over-leverage.
You can find other tips for real estate investing here.
Investing in real estate is a good way to diversify your investments, earn a consistent income, or profit from appreciation in the price of properties.