How to Invest in Real Estate: 5 Simple Ways to Get Started
Real estate investment is not as big and scary as you might think. If becoming a "real estate mogul" is on your bucket list, here are some things you should know first.
November 20, 2020
By Mototext Homes
Photo by Evelyn Paris on Unsplash
Investing in real estate can help you build home equity and also generate passive income. Both happen through the process of appreciation and more direct methods we’ll get in to.
Unlike what you may have heard, owning your own home is not the only way to get into real estate.
Different investment methods have the potential to earn significant returns and add diversification to your portfolio. That’s a lot of wording to basically say real estate offers a range of ways to make money. Some are low maintenance while others require more attention. There are passive investments, those that are high-risk, and short-term ones.
When you hear the word “real estate”, many other words come to mind: residential vs. commercial, fix-and-flip, property management, etc. These are all components of real estate, but they are not a complete definition.
An identified parcel or tract of land, including improvements, if any.
The use of the word “improvements” is vital to understanding real estate. It alludes to the fact that real estate includes anything fixed or permanently attached to the land. This can refer to fences, roads, trees, etc.
In the context of real estate, “improvements” can include a home, store, office building, or another type of structure built on the land.
Additionally, real estate can include rights attached to a piece of property — such as air rights, water rights, and mineral rights to any natural resources beneath the ground. Most do not realize how broad the category actually is.
Granted, no kind of investment can offer 100% guaranteed profit or even protection of the money initially invested. With the many types of investment vehicles out there, historically, real estate has been one of the safest and most profitable.
Investing in real estate can offer specific benefits not associated with other types of investments.
Long Term Financial Security
A real estate investment like owning a rental property can bring investors a sense of security because of the property’s appreciation over time. Given that land and buildings are appreciating assets, the value of the property will increase throughout the years.
Tax Benefits
Real estate investors can benefit from tax exemptions when owning property. The government treats real estate profits as capital gains, which are profits from the sale of an asset, like a building. These are taxed at a lower rate than employment income.
Additionally, rental property is not subject to self-employment tax. That means if you are generating income from a rental property, you can enjoy those profits tax-free!
Control of Your Investment
As opposed to investing in something like mutual funds or cryptocurrency, real estate offers a greater amount of control in the success of the investment.
For example, when you buy stocks you wait for the value to increase and then sell. Your influence in company operations is low unless you are a major shareholder. It is not much you can do to directly improve your investment.
In real estate investing, however, you have a greater amount of control over the outcome. Improvements made to the property (upgrading appliances, adding laundry machines, painting, etc.) can increase the value of the and bring you bigger profits once rented or sold.
The real estate market can be a lucrative venture for investors. The problem is knowing where to start. Here are some of the best ways to make money in real estate as well as the advantages and drawbacks to each.
For investors who like to play it safe, at least in the beginning, house hacking as an investment strategy can be a great option.
The concept of house hacking is simple. It means living in a property that offers additional space like a duplex, a single-family house with a finished basement, or a guest house. The extra space is rented out for a period of time.
Homeowners can use this method to test the real estate waters, basically acting as a landlord for one or more tenants. Short-term rental companies like Airbnb and Vrbo handle the logistics of getting tenants, receiving payments, promoting the space, and tracking the length of the stay, for a fee of course.
The Benefits
House hacking can be an ideal investment strategy for homeowners who are willing to take the extra effort to learn how. Since most first-time buyers typically have less money to spend upfront, house hacking can be a good place to start. Not to mention finding creative ways to turn a profit.
Live for free: Mortgage payments can be expensive and having a separated unit paying rent will decrease your month-to-month costs. Depending on the home and how much you charge, you can even earn a profit, especially with multiple people staying at a time.
Smooth transition to rental properties: As a homeowner, you know your property well. You’ll also know what type of tenants and short-term stays you want to attract. If you move out or purchase a rental property altogether, you will be more comfortable with the idea. You can see first hand what people do to a space they don’t own and what to look for.
More flexibility: Hosting longer or shorter stays is completely up to you. When using a service like Airbnb, you can choose how long you want to open that spare room in your house to someone. Maybe just a few weeks in the summer to earn some extra income.
The Downsides
The concept of house hacking can be uneasy for some. It can potentially mean sharing your living space with another person. No matter the amount of money, the cost of privacy may be too much amongst other inconveniences.
Living close to your tenants: For some people, living too close to your tenants can be a real drawback. If you’re living in a single-family home, you’ll be sharing a kitchen, common area, and potentially a bathroom with one or more of your tenants. Lack of privacy can play a major role in deciding if house hacking is the right investment strategy to pursue.
Expensive upfront pay: Purchasing a multi-family property is more expensive than a single-family home. More bathrooms, bedrooms, and appliances mean higher initial costs in addition to the costs of the upkeep. Especially for first-time buyers, a down payment can be a stretch.
Need constant stays: If you choose to purchase a multi-family home to house hack, not having the property fully rented out can leave you paying for additional costs out of pocket (mortgage, taxes, insurance, and utilities). Not to mention if the location of the property is not sought after, investors can be more at risk for vacancies.
If purchasing an entire property is out of the question then a real estate investment trust (REIT) can be a possible choice. REITs allow investors to buy into real estate without owning the physical real estate.
Established by United States Congress in the 1960s, REITs give individual investors a passive way to earn high returns, strong dividends, and long-term capital appreciation.
Some REITs are publicly traded on an exchange like a stock. While others are non-traded which are not as easy to sell and are harder to value. Publicly traded REITs are generally a safer investment, which can be purchased through a broker.
The Benefits
REITs provide easier access to real estate investing for those not interested in managing a property or buying and flipping a home. Without any in-depth attention or a great deal of responsibility, REITs can bring certain benefits.
Minimal experience required: REIT investors do not outright own or manage their investments. They do not need extensive knowledge of real estate for an investment to be successful.
Access to commercial real estate: Everyday investors have the opportunity to put their money into assets that would be out of reach otherwise. Most people can’t buy a skyscraper with the money in their savings. With REITs, individuals can own a portion of a shopping mall, apartment complex, even the Empire State Building.
Portfolio diversification: REITs are technically stocks, but because they are real estate assets they tend to hold value better during tough economies. Instead of purchasing a single stock in one company, REITs allow investments in tens or hundreds of properties. This makes success much less reliant on the movement of a single entity and offsets the risk of an all-stock portfolio.
The Downsides
While REITs are a great way to get started investing in real estate without committing much time or money, it is also important to evaluate the disadvantages that come with it.
Property specific risks: Although REITs can bring diversification to your portfolio, most individual REITs are not very diversified. They tend to focus on a specific type of property.
Lack of control: Depending on your investment style, less responsibility may not be what you are looking for. REITs eliminate an investor's control in the real estate asset. This may be ideal for the passive investor or those lacking experience.
Single-use investment: Much like stocks, REITs are not a physical object. If their value is down the only options are to sell or wait until the value picks back up. On the contrary, if the value of a real estate property is down (like a single-family house) it can still make the investor money. Homes can be lived in, rented out, or converted to an Airbnb until the market value returns. A REIT can be worth close to nothing for years and have no other uses, so an investor may sell to get some return.
Rental properties are the go-to passive income generators for many real estate investors. For those seeking to take an active role in their investment, these can be great cash-flowing assets.
Along with the benefits of ownership and the tax advantages it may bring, being a landlord comes with its own set of responsibilities. It requires hands-on attention and a constant watch.
The Benefits
Investors with knowledge of how rentals operate and the time to manage them can find they are great opportunities. When a rental property operates as it should, it can bring the owner great benefits.
Consistent cash flow: Rental properties bring a steady stream of income as tenants pay rent each month. Annual and sometimes longer leases give the landlord peace of mind with expected pay coming in for that period of time. Renting out multi-family homes and larger complexes can reduce the risk of vacancies and increase income.
Asset appreciation: Rental properties earn money from tenants as well as appreciation. Ownership of the property gives the investor equity. As the property value increases, the potential profit upon sale does the same.
Tax deduction: Managing a rental property allows its owner(s) to deduct a majority of expenses from their taxes: insurance premiums, legal fees, operation costs, etc. Also, remember capital gains? If you sell a rental property and buy another with the profits, under a 1031 Exchange you can defer capital gains taxes.
The Downsides
There are a lot of moving parts when it comes to owning a rental property. For the investment to offer good returns and fewer headaches require a high level of attention and quality management. As a first time landlord, these may not come naturally. Before buying a rental property, an investor should consider these hurdles.
Active management: As a landlord, you are responsible for screening potential renters, ensuring tenants accept lease terms, timely repairs, the security of the property, evictions, etc. Hiring a property management company is an option, but that limits some of your control and your profits. The less time put into the management of the property the higher the risks of welcoming bad tenants or unchecked damages.
Cost of down payment: In most cases, the minimum down payment for an investment property can be 15%. However, what you are required to pay is determined by factors like your credit score, the property type, even your debt-to-income ratio. If producing the full down payment is not an option then securing a mortgage loan may be an alternative.
Lack of liquidity: From an investment perspective, rental properties are not liquid. They do offer steady income, but cannot be sold quickly for cash. The market for rental properties is not the same as it is for single-family residences. Buyers with substantial capital are needed.
The most active and probably most known way to invest in real estate is flipping houses, also known as a “fix-and-flip” strategy. In a house flip, an investor purchases a home (usually at a discount), makes renovations to improve the market value and then sells at a higher price to turn a profit.
Considered a short-term investment (less than 1 year), house flipping is a relatively fast way to see a return. Investors aim for a quick sale because the longer they own the home, the more expenses add up.
The Benefits
The goal for any fix-and-flip is to buy low and sell high. Often investors will not only put their own labor in to cut costs. Whether that be painting walls, fixing windows, or mowing lawns, they’ll get their hands dirty too. Provided there is a solid plan in place there are advantages to house flipping.
Quicker return on investment: In a fix-and-flip, investor money is tied up for a shorter period of time than a rental property. The average timeframe on a house flip is around six months. Expect to run into a few mishaps on your first flip, but the faster you flip the house the faster you will see a return on investment (ROI).
Not a long-term manage: As soon as all repairs are complete and the property is sold, the investor can collect their profits and move on to another project. There is no need to find tenants or maintain the property. Basically, there is no hassle of being a landlord or a homeowner.
More predictable: Unlike the stock market which is extremely volatile with stocks rising and falling daily, the real estate market is much more predictable. With fewer factors influencing the market and the stability of prices, investors can feel confident that their investment won’t take a turn for the worse because of an unexpected shift in the market.
The Downsides
Mistakes can be extremely costly and extend the date of a sale. There are countless stories of properties that turned vacant because the investor ran out of money. The risk can be high and there can be disadvantages.
Amount of risk involved: Not every house flip is an episode from HGTV where a house is transformed in under 30 minutes. There is a chance for investors to take a loss. Without understanding the real estate market, using a detailed budget, and having a workable plan there is a very real possibility that you can lose money as opposed to making it.
A large amount of capital needed: Flipping houses can be expensive due to the money required to purchase the home and the money needed to rehab and hold on to the property. Hard money loans can have high-interest rates and can be difficult to obtain without a good credit score.
Stress and anxiety: It is not often spoken about but house flipping comes with highs and lows. Even with the best plans and biggest budgets, things will not always work out how you think. Surprises like necessary rewiring, fixing a leak, our foundation issue can not only bring more costs but also push pack the timeline to get the home sold.
Real estate crowdfunding sources capital from many investors to buy or fund the development of real estate assets. Housed on a digital platform such as a website or app, they work in a similar capacity as a GoFundMe page.
The digital exchange provides a space where sponsors can advertise to investors, make sure investors meet the requirements for the investment, and collect invested funds. Crowdfunding uses small investments from many people to purchase real estate. Investors receive monthly or quarterly rental income distributions depending on the terms of the deal. They are also entitled to a share of the appreciation value once the property sells.
The Benefits
Crowdfunding platforms like Fundrise and Crowdstreet reduce the risk of finding the right investment opportunity. As is the case with many other investment types, real estate crowdfunding deals can be great for investors.
Low investment requirements: Traditional property investments have high acquisition costs ranging from tens of thousands to millions of dollars. Even if financed through a lender, investors are looking at a minimum of 20% down payment on a property. In the fractional ownership model of crowdfunding, investors can put up as little as $500.
Managed by professionals: Everyone wants to make money while they sleep. This is possible with crowdfunded real estate. Your sponsor handles most or all the responsibilities. Investors can sit back and collect rent and appreciation payments.
Ease of access and research: As opposed to direct investments in real estate that can require earnest money deposits, closing attorneys, and wet signatures, investments through crowdfunding platforms are a click away. Sign up doesn't take more than a few minutes. The platform will provide a fair amount of background and details on any investment.
The Downside
New investors can have trouble with the different terms and jargon that may come with crowdfunded real estate deals. The drawbacks can outweigh the gains depending on your knowledge and preferences.
Unsecured investment: Crowdfunded investments are not protected under the US Securities Investors Protection Corporation (SIPC), which protects investors from the failure of a bank or brokerage up to $500,000, including up to $250,000 in cash. This exposure heightens the risk for investors if the platform closes or the crowdfunding sponsor mismanaging investor funds.
Require accredited designation: Some crowdfunding platforms require investors to meet one of the following US Securities and Exchange Commission (SEC) guidelines for accredited investors: The investor must have more than $200,000 of earned income in each of the past two years. The investor has a net worth of 1 million dollars or more. The investor is an executive officer, general partner, or director working in concert with the issuers of the offered security.
A relatively new type of investing: Online platforms make it easier for companies to arise every day and entice inexperienced investors. Resources for vetting these platforms are limited as the government has yet to initiate full regulations for the new technology. Investors who are unfamiliar with more traditional forms of real estate investing may be drawn to crowdfunding’s seemingly simple and open access. Neglecting to perform due diligence on an investment is always a risk.
No one real estate investment strategy is a sure-fire way to skate to the million-dollar mark. Most investors combine different methods at different times. For example, you may start house hacking using your own home. Through that profit, you can transition into REITs and continue reinvesting your money into different places.
The best real estate investments are the ones that best serve you, the investor. Think about the capital you are willing to invest, how much time you have to learn, and if you want to be more hands-on or not in your investment. There are no right or wrong answers, just the ones that you can commit to and find success in.
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