Feb 24, 2023
How to Invest in Real Estate
Does investing in real estate feel like it’s only for Mr. Monopoly? Believe it or not, you don’t need a top hat and bags of cash to get into real estate investing. There are actually several options, ranging from low to moderate to high levels of effort, for investors interested in adding this sector to their portfolio. As with any type of investment, there are advantages and there are risks.
On the highest-effort end of the spectrum, you can invest in residential or commercial real estate property to lease out or sell for a profit later. The benefits can include tax advantages, a steady stream of passive income, and the potential for long-term security and high returns. On the other hand, realizing returns may take a while, maintaining rental property takes time and money, and you run the risk of declining market value and occupancy demand.
Many investors go for the much lower-effort and lower-barrier option of purchasing shares in a Real Estate Investment Trust (REIT), which can help you diversify your portfolio by gaining exposure to the real estate industry without having to buy any rental property. Other options for real estate investing include using an online real estate platform, renting out a spare room, or house flipping. Depending on the amount of time and money you want to put in, you may find a real estate investing strategy that works for you.
In this article, we’ll cover:
1. Purchase a REIT (Real Estate Investment Trust)
Effort required: Low
A REIT, short for Real Estate Investment Trust, is a company that owns, operates, or finances income-producing real estate. Types of residential or commercial real estate may include a wide array of properties such as:
- Office buildings
- Shopping malls
- Hotels, resorts
- Self-storage facilities
You can also invest in mortgages on those properties. The company earns money from renting or leasing the rental property it owns or, in the case of mortgage REITs, from interest on mortgages and mortgage-backed securities. REITs work similarly to mutual funds by pooling the capital of many investors. When you buy shares in a REIT, you can then earn dividends from the shares you own without having to purchase, manage, or finance property yourself. Most REITs are registered with the Securities and Exchange Commission and publicly traded, which can allow more people to get exposure to the real estate sector. If you’re looking for the easiest way to diversify your portfolio with real estate investment, a REIT or an exchange-traded fund (ETF) that includes REITs may be worth exploring.
|Pros of REITs||Cons of REITs|
|Portfolio diversification||Sensitive to interest rates|
|Typically accessible through national exchanges||Must pay ordinary income tax on dividends|
|Generally pay healthy dividends||May have high up-front/annual fees and commissions|
|Build a passive income flow||Subject to the same risks as the real estate market|
|They are required to distribute 90% of profits via dividends||Passive income flow depends on occupancy levels|
|May help protect your portfolio if other investments underperform|
2. Use an online real estate platform
Effort required: Low
Online real estate platforms connect real estate developers with individual investors who want to finance projects, either through debt or equity. You might think of them as crowdfunding platforms specifically for real estate. Generally, investors pay a fee to the platform and take on a significant amount of risk with the hope of receiving monthly or quarterly distributions. While online platforms make real estate investing a bit more accessible to investors who don’t want to own or maintain property directly, the income requirements may be prohibitive. Many of the platforms are only open to accredited investors, people who’ve earned more than $200,000 in each of the last two years, or who have a net worth exceeding $1 million. However, there are some alternative platforms with lower account minimums available to nonaccredited investors. You may be able to get started with $1,000, $500, or even as little as $10.
|Portfolio diversification||Lower returns compared to buying property on your own|
|Less capital required than purchasing real estate on your own||Mostly available to accredited investors only|
|Usually no fees like closing costs or commissions||Lack of control over the property development|
|Passive investment vehicle||Illiquid investment (cannot be easily converted to cash)|
3. Rent out a room in your house
Effort required: Medium
If you already own a home, you may consider renting out extra space to generate income. Rental income from a spare room, basement apartment, or converted garage can help offset the cost of your monthly mortgage payment. Knowing that you’ll be sharing expenses may also make the prospect of financing a more expensive property feel within reach. But unlike splitting rent with a roommate, when you own the home, the person living with you is your tenant. That means your passive rental income stream comes with obligations like tenant management, property maintenance, and adhering to strict landlord-tenant laws. You may also wish to keep in mind that living with a stranger may be uncomfortable or pose safety risks, especially for vulnerable people who are often the targets of hate-based violent crime.
|Passive income stream||Rental income is taxable|
|Possible to charge higher rent to offset the tax bill||Renter may cause damages|
|Possible shared utility expenses||Risk of violating housing codes and other laws|
|Can make financing a more expensive house more accessible||Potential risk of inviting a stranger into your home|
4. Buy a rental property
Effort required: High
While this option may not be accessible to most average investors, purchasing a property specifically for rental to long-term tenants or short-term vacationers definitely gets you into the real estate market. If you’ve got the financial means and the inclination to be a fair and responsible landlord, buying a rental property might be the right investment for you. Long-term, single or multi-family rentals can generate monthly passive income from rental contracts. Short-term rentals, properties typically rented for vacations or stays of less than 12 months, are also passive income generators. But your passive income stream won’t come without the hard work of property maintenance and tenant management. There are also risks like damage to your property, low demand leaving the space sitting vacant, and the inability to quickly and easily sell if you want to convert your investment to cash.
|Portfolio diversification||Illiquid asset|
|Passive income vehicle||Maintenance and management expenses can decrease income|
|When real estate values increase, so does the value of your investment||Capital and credit needed|
|Interest paid on your property loan may be tax deductible||Must pay fees and upkeep property even if it’s vacant|
|Rental income is not subject to Social Security tax||Tenant management responsibilities|
|Direct control over the investment||Property taxes|
5. Try your hand at house flipping
Effort required: Highest
If you’re a truly adventurous investor, you may want to try your hand at flipping houses. House flipping involves buying a property, holding onto it for a short time, and selling it for profit. Sometimes the flip involves renovating a fixer-upper before selling, but it may be as simple as holding the property until you can sell it for more than you bought it. In either case, the goal is to buy low and sell high, usually within a year. House flipping generates active income rather than passive, and it’s a classic spend-money-to-make-money scenario: you’ll need to pay the costs associated with buying and selling a house, which can eat into your return. This kind of real estate investment can turn into a full-time job before you know it; even if you don’t renovate the property, it’s a lot of work to find the right house, secure a mortgage, make the purchase, maintain the property, and get it sold. You’ll need a strong knowledge of the local real estate market, but at the end of the day, you could be set to make a tidy profit if you make smart moves.
|Diversifies investments||Capital and credit required|
|Potential for high returns depending on the local market||High pressure|
|Potential for quick profit||Home might not sell quickly|
|Real estate markets tend to be more predictable than stock markets||Holding costs and property taxes|
|Control over the investment||Renovation costs could be significant|
Real estate investing within reach
Investing in real estate can take a significant amount of capital and credit, so options like purchasing a rental property or flipping a house may not be accessible to all investors. It’s also worth noting that financial barriers aren’t the only challenges to buying investment or rental property; discrimination against marginalized populations can make it harder to get a mortgage loan for some people, and growing public concern about the effect of house flipping on home prices in historically lower-income neighborhoods can make that route unappealing to some.
Lower barrier options like investing in REITs or using an online investment platform make it easier to dip your toe into the real estate market and diversify your portfolio. When you’re deciding how to invest in real estate, you might look for options with the lowest barriers to entry, like REIT ETFs that offer fractional shares, to get you started.
As with any type of investing, the real estate investing strategy you choose should align with your risk tolerance, time horizon, current financial state, and future financial goals. If you’re ready to start investing, consider building a diverse portfolio that includes multiple types of investments and focus on building wealth for the long term.
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