Investments

How To Invest In Real Estate


Key points

  • Investors can access real estate investments directly or indirectly. 
  • REITs, online investing platforms, rental properties and house flipping are four ways to invest in real estate.
  • Different real estate investments have different levels of liquidity, costs and returns. 

Investing in stocks isn’t the only path to building wealth. Beyond buying shares of public companies, you can put your money into real property, or real estate. 

Real estate encompasses a range of assets, from land to buildings and other physical properties or improvements. Examples include houses, apartments, retail spaces and warehouses. 

The methods of investing in real estate vary, and each has unique risks and potential returns. You must understand these differences to make informed decisions. 

In this guide, we’ll explore how to invest in real estate and help you navigate the options and their trade-offs.

4 ways to invest in real estate

The way you access an asset can significantly impact your risks and returns. 

Investors typically consider four methods of investing in real estate: real estate investment trusts, online investing platforms, rental properties and house flipping. They vary significantly in terms of capital requirements, investor involvement and regulatory complexity.

Real estate investment trusts

REITs are holding companies that own and sometimes operate real estate or related assets. Many REITs are publicly traded.

REITs invest in a diverse range of property types, including retail stores, cell towers, data centers, warehouses, self-storage facilities, medical buildings and residential units.

By purchasing REIT shares, you gain exposure to the capital appreciation of the underlying assets and a regular income stream from their rents. This income is a key feature of REITs, which must distribute at least 90% of their taxable income to shareholders in the form of dividends.

REITs may be particularly appropriate for investors with limited capital who prefer a hands-off approach. You can buy REIT shares through a brokerage and either reinvest or spend the dividends.

Historically, domestic REITs have shown solid performance. The S&P United States REIT Index, which measures publicly traded REITs in the U.S., has recorded an annualized total return, including reinvested dividends, of 6.60% over the past 10 years as of Feb. 12.

A basic introduction: What is a REIT?

Online investing platforms

Online investing platforms like RealtyMogul and Fundrise have opened up new ways to gain exposure to private real estate and public nontraded REITs. 

These platforms offer a range of real estate investments that might otherwise be difficult to access directly, including unique property types and geographies. Some investments may use leverage, which can enhance returns.

But there are important considerations. One key downside of these platforms is the issue of illiquidity. Unlike with publicly traded REITs, you might face restrictions or delays when attempting to withdraw your funds. 

Additionally, many of these platforms have minimum investment requirements, which might be higher than the typical stock investment. Be aware of management and performance fees too. 

Rental properties

Investing in a rental property offers an opportunity to become a private landlord — an endeavor that requires significant capital and a large time commitment. 

To start, you need a down payment. Given that the median national home price was about $417,000 in the fourth quarter of 2023 and the average down payment was 14.7% in the third quarter of 2023, you’re looking at approximately $61,300. 

But owning a rental property isn’t as simple as collecting rent checks. As a landlord, you’re responsible for property taxes, maintenance costs, homeowner or landlord insurance, and other related expenses.

Tenant management is another vital aspect of being a landlord. Vet prospective tenants to avoid issues like delinquent payments. Delegating this responsibility to a property management company entails additional expenses.

There’s also the matter of mortgage payments, which fluctuate based on prevailing interest rates. As of Feb. 12, the average rate on a 30-year fixed mortgage stood at 7.27%, while it was 6.57% for a 15-year fixed-rate mortgage. Remember that these rates change over time.

Given these variables, determining the return you can expect as a landlord is challenging. Unlike investing in REITs, which generally requires less active involvement and has lower upfront costs, being a landlord demands significant capital, a hands-on approach and a higher risk tolerance.

Flipping houses

House flipping is a shorter-term real estate investing endeavor, akin to day or swing trading in the stock market. 

The process begins similarly to investing in a rental property, with a down payment, real estate agent fees and mortgage arrangements. But the goal is to sell the property for a profit, not to generate rental income.

This strategy can be particularly effective in a rapidly appreciating housing market or when dealing with a fixer-upper — a property that requires repairs and renovations before it can be sold at a higher price. 

Just like in stock trading, due diligence is paramount in house flipping. Carefully assess neighborhood property values and trends to ensure a profitable sale.

The return on a house flip is determined by the sales price minus the initial investment, real estate agent fees, financing costs and renovation expenses and the holding period. Consider these factors when calculating potential profits.

Moreover, if the house is financed rather than bought outright with cash, the investment is effectively leveraged. This leverage can increase risk, particularly if the housing market experiences a downturn and the property can’t be sold at or above the cost basis, potentially leading to a loss. 

How much you need to invest in real estate

The amount of capital you need to invest in real estate depends largely on the method you choose.

For REITs, it’s essentially the cost of a single share. For example, a share of Simon Property Group, Inc. (SPG), which specializes in shopping, dining, entertainment and mixed-use properties, traded at around $146 per share as of Feb. 12. 

When it comes to REIT exchange-traded funds, you can invest in hundreds of REITs under a single ticker, often at similar price points.

In the realm of online real estate platforms, the minimum investment varies depending on the provider and offering. For instance, RealtyMogul has a minimum investment of $5,000 for private REITs and between $25,000 to $50,000 for equity investments in commercial real estate.

For rental properties, the initial costs can be substantial. Based on national average property prices, down payment percentages and mortgage costs, you’re looking at an upfront investment of approximately $61,300. This estimate doesn’t include additional expenses such as real estate agent fees, property taxes, mortgage payments, maintenance costs and insurance.

House flipping requires a similar initial outlay but tends to be more capital intensive, particularly if you’re paying the full cash price and need significant funds for renovations. Flipping a house also involves the added costs of buying, renovating and selling the property within a shorter time frame, which increases risk and demands more liquidity.

Pros and cons of real estate investing

Before diving into real estate investing, balance the potential advantages and disadvantages against your investment goals and risk tolerance.

Pros

  1. Potentially high returns. Historically, real estate investments have offered substantial returns. According to the Dow Jones U.S. Real Estate Index, the U.S. real estate sector as a whole has recorded an annualized total return of 6.74% over the last 10 years as of Feb. 12. 
  2. Inflation hedge. Real estate often acts as a hedge against inflation. As living costs rise, so can rent and property values, which may help protect the purchasing power of your investment.
  3. Income generation. Real estate can provide a steady income stream. Rental properties offer rent payments, while REITs can provide regular distributions from the income generated by their property portfolios.

Cons

  1. Low liquidity. Real estate is generally a less liquid investment, especially compared to stocks and bonds. That means it may take longer to sell a property and access your funds — except in the case of REITs, many of which are more liquid because they trade on stock exchanges.
  2. Sector-specific risk. The real estate market can be subject to dramatic fluctuations, as seen during the 2008 financial crisis. Such downturns can significantly impact property values and rental incomes, posing a risk to investors.
  3. Leverage risk. Using a mortgage to finance a property is a form of leverage. While it can amplify returns, it also increases the risk. If interest rates rise or housing prices fall, you could owe more than the property is worth or risk losing the property.

Should you invest in real estate?

Whether you should invest in real estate depends largely on your available time and capital and familiarity with the sector. Different forms of real estate investment cater to different investor profiles.

Hands-on investments like rental properties and house flips are typically more appropriate for people who have significant capital to risk and are well versed in real estate. These methods require a substantial time commitment to manage the investment effectively, deal with tenants and oversee renovations.

Online real estate investment platforms are often a good fit for investors who already have traditional investments in stocks and bonds and are looking to diversify their portfolios with alternative exposure to private assets. But these platforms might involve liquidity gates and higher fees, so comfort with these aspects is essential.

For the average investor, REITs are the most accessible way to gain exposure to real estate. They allow you to invest in various sectors of the real estate market, from health care facilities to residential buildings and self-storage units. Publicly traded and public nontraded REITs must register with the Securities and Exchange Commission and provide regular disclosures.

Additionally, investors can choose to invest in a REIT ETF and benefit from exposure to the broader real estate sector without analyzing individual REITs.

Frequently asked questions (FAQs)

With $5,000, you can start investing in certain forms of real estate. This amount is enough to buy shares in individual REITs or a REIT ETF. 

In the realm of online real estate platforms, $5,000 might be just enough to begin. For example, RealtyMogul’s Income REIT and Apartment Growth REIT have minimum investment requirements of $5,000 and report annualized distribution rates of 6% and 4.5%, respectively.

But when it comes to more direct forms of real estate investing like rental properties or house flips, $5,000 is typically not enough for a down payment. These methods generally require a larger upfront capital commitment.

There are tax advantages associated with real estate investing, especially with rental properties where earnings deductions play a significant role. 

Investors can deduct expenses related to ongoing property maintenance, property insurance, payments to independent contractors, mortgage interest payments, property taxes and depreciation. These deductions can substantially reduce the taxable income generated from rental properties, enhancing their overall profitability.

On the other hand, REITs tend to be less tax-efficient because of how their distributions are taxed. The dividends from REITs are often allocated to ordinary income, which can be taxed at a higher rate than capital gains. 

Therefore, it is generally advisable to hold REITs in a tax-advantaged account, such as a Roth individual retirement account, to optimize their tax efficiency. In such accounts, the distributions from REITs can grow tax-free, which can be a significant advantage for long-term investors.

Investing $10,000 in real estate is a nuanced decision that hinges on your risk tolerance, time horizon and objectives. Options like purchasing a rental property or flipping a house are typically off the table, as this amount is insufficient for a down payment on most properties.

The most accessible option for this amount is likely a REIT. But your objectives play a crucial role in the type of REIT you should consider. While a high-yielding REIT might offer greater income potential, it can also be more volatile and possibly distressed.

A more prudent approach might be to invest in large-cap, well-capitalized REITs with strong track records or a low-cost diversified REIT ETF. This strategy may offer lower immediate income potential, but it tends to be more conducive to long-term capital appreciation, providing a more stable and growth-oriented real estate investment avenue for your $10,000.



Source link

Leave a Reply