If you’ve been paying attention to the real estate market at all, you know that the coronavirus pandemic instigated what some are calling the “craziest market they’ve ever seen.” With low inventory, historically low mortgage rates, and notably high home prices in some areas, many people are wondering whether or not they should start investing in real estate.
Many individual investors and experts believe that real estate investing is a sound investment. That being said, it’s not the type of thing you want to make a snap judgment about. Investing in real estate in any form comes along with risks as well as potential benefits, and it’s important to do your research before diving in.
Are you interested in learning more about real estate investing but are just getting started?
Let’s take a look at what you need to know about property investing. This way, you can examine the different avenues and weigh the pros and cons of each. For some people, they might find that directly owning property is more suitable for them, while others might desire a more hands-off approach.
How to Invest in Real Estate: The Different Types of Real Estate Investing
There are a variety of different ways that an investor can invest in real estate. It can range all the way from directly owning a property and acting as a landlord all the way to having no hands-on control over the property.
There isn’t necessarily a right answer when it comes to the question of which type is best. It has to do with your reasoning for investing in real estate as well as your investment style. You’ll also want to consider how much time and energy you want to put into this investment.
If you choose to go the route of investing in rental properties, you earn a new title: landlord. This is a job that comes with a number of responsibilities, so you’ll want to consider whether or not you’re realistically interested in taking on that role. Some of the things that you’ll have to deal with as a landlord include:
- Maintaining the property
- Finding tenants
- Dealing with any problems with the property or tenants
- Paying property taxes
- Paying the mortgage
- Paying insurance
Some people choose to hire a property manager to help take care of the details. Those who don’t are taking on a very hands-on investment.
People can have incredibly varied experience being landlords, for some it is a very small time investment and generally pleasant, while others are basically working a job they never have any time off from. In some instances, landlord-tenant issues and other occurrences can create nightmare scenarios for landlords, both personally and financially.
That being said, many people happily own rental property and it has been financially productive for them. Being very careful when it comes to choosing both your property and your tenants can help to reduce your risks but you can never totally eliminate the risks.
Landlords make money in a number of different ways. The first is through rent collection. Depending on your location, you might be able to charge quite a bit for rent or not so much. The type of property and its condition is also a factor.
Another way that landlords make money is through property appreciation. Over time, the property can appreciate in value, allowing landlords to sell the property for a profit when the time is right. They also have the ability to tap into funds for their next investment by borrowing against the equity.
There are a lot of benefits when it comes to being a landlord, but it can also cause frustration and difficulty. Before purchasing a rental property, you will want to familiarize yourself with your state’s landlord-tenant laws as well as any that apply in your municipality or county.
Real estate flippers are a completely different kind of real estate investor than people who invest in rental property. Their intention is to buy properties and sell them rather quickly, often in three or four months or less. People who buy a rental property, on the other hand, are making an investment that they often plan on keeping for many years if not decades.
Many flippers buy a property that they then fix up and resell for a higher price. These people try to get the work done as fast as possible. It’s also essential that they are able to sell the homes for more money than they invested, including both the cost of the property and the cost of repairs and upgrades.
Other flippers simply hold houses and resell them after a few months. They do this in what they expect is a quickly rising market but skip the step of rehab.
For a long time, real estate has been considered a good investment. Before 2007, it seemed like the prices of houses would continue to rise infinitely with no disruption insight. However, the Great Recession threw a wrench in those rising property prices and now the coronavirus pandemic has also greatly affected real estate markets.
Some people choose a more hands-off approach when it comes to real estate investing. An REIT (real estate investment trust) is created when a trust or a corporation forms in order to use the money of investors to invest in income-producing properties. These investment trusts are traded on major exchanges, just like ETFs and stocks.
Real Estate Limited Partnerships
This is an entity that is created in order to buy and hold properties in a portfolio, or in some cases, just one property. These partnerships only last for a certain number of years, though.
If you’re interested in more hands-off real estate investing, consider looking into virtual real estate investing.
Real Estate Investment Groups
These are basically like small mutual funds that exist for rental properties. If you don’t want to be a landlord but are enticed by the idea of investing in rental property, you might be interested in a real estate investment group.
In this model, a company either builds or buys a set of buildings. These are often apartments. They then let investors join the group by buying them through the company.
A single investor is able to purchase either multiple units or one unit of living space that is self-contained. However, all of the units are managed by the investment group, meaning they take care of advertising, finding tenants, and maintenance.
In return for providing these services, the company takes a percentage out of the monthly rent you receive.
Real Estate Mutual Funds
This is a way for investors to gain diversified exposure to real estate without too much in the way of capital. These mutual funds primarily invest in real estate operating companies and REITs. These are fairly liquid funds much like REITs are.
Why Would You Want to Invest in Real Estate
Investing in real estate can offer competitive risk-adjusted returns by enhancing the risk-and-return profile of an individual’s portfolio. It also provides an attractive yield when compared to other conventional income return sources.
Real estate is capable of hedging against inflation, which is an attractive prospect for most investors. This ability stems from the positive relationship between demand for real estate and gross domestic product.
The demand for real estate drives rents higher as economies expand. This leads to higher capital values.
In this way, real estate is able to bypass some of the inflationary pressure onto a landlord’s tenants. At the same time, it also benefits from inflationary pressure by way of appreciation.
Protection and Diversification
Many people invest in real estate in an effort to diversify their portfolios. Real estate has a relatively low and even sometimes negative correlation with some of the other major asset classes. This means that when the stock market is down, real estate is frequently up.
Basically, having real estate as a part of your portfolio in one form or another is a way to provide a higher return per unit of risk and lower your portfolio’s volatility.
The more directly you are investing in real estate, the better it is able to hedge against inflation. Ways of investing in real estate that are less direct, such as REITs, are going to be a lot more reflective of the overall performance of the stock market.
Real estate is backed by a brick and mortar asset, and the more directly you own it, the less you are dependent on the competence and integrity of debtors and managers.
Investors are also able to use real estate investing as a tool in a way that they can’t use the stock market. This is in the form of leverage.
Most of the time, a conventional mortgage will ask for a down payment of 20% of the purchase price. Depending on where you live, though, you might be able to lock in a down payment of as low as 5%.
This means that you only have to pay a fraction of the total price in order to control the equity of the property as well as the property itself. Of course, you are not fully in control and the amount to which you are is dependent on your equity. That being said, as soon as the papers are signed, you are largely in control of the asset.
Both landlords and real estate flippers can use leverage in one property to invest in another. They can put down payments down on two or three other properties by taking out a second mortgage on their homes.
At that point, they can either rent the property in order to pay for those mortgages, or they can hold the house in order to sell it at an appropriate time to make a profit.
Even though they’ve only paid for a part of the properties, they are in control of the asset. With other forms of investment, this is not possible in the same way.
Real Estate Investing: Is It Right For You?
Real estate offers the potential of having a steady income as well as building wealth at the same time. For this reason, many feel that it is a sound investment and a good way of diversifying their portfolios.
There are some drawbacks to investing in real estate, though. Real estate is illiquid, meaning that it is fairly difficult to turn an asset like real estate into cash and vice versa.
Real estate transactions can take months, as opposed to bond and stock transactions which can happen practically instantaneously. Even when you have the assistance of a broker, it can take several weeks of work to find the right counterparty.
There is better liquidity when it comes to real estate mutual funds and REITs, as well as better market pricing. However, you don’t get the same diversification benefits as you do from investing in brick and mortar properties more directly, and it also comes with higher volatility. These less direct ways of investing in property are more highly correlated with the overall state of the stock market than simply owning a rental property or flipping a property.
It is best to always keep your expectations realistic when it comes to any type of investment, and real estate is no exception. Before you make any big decisions, it’s best to do your homework.
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