Different ways to invest in real estate
When you think about investing in real estate your home is probably the first thing that comes to mind. Of course real estate investors have many other options when it comes to choosing an investment and they're not all real assets.
Real estate has become a popular investment vehicle over the past 50 years or so. Here are some of the top choices for individual investors and reasons to invest.
KEY TAKEAWAYS
- Real estate is considered its own asset class and should be at least part of a diversified portfolio.
- One of the main ways investors make money in real estate is by becoming the landlord of a rental property.
- Flipper tries to buy undervalued real estate and restore it and sell it for a profit.
- Real estate investment trusts (REITs) provide indirect real estate exposure without the need to own operating or financing properties.
Historical Prices
Real estate has long been considered a sound investment and for good reason. Before historical housing data from 2007 it seemed like home prices could continue to climb indefinitely. Between 1963 and 2007 the average selling price of a home in the U.S rose every year with few exceptions. Great Depression. Home prices did take a small hit in the spring of 2020 when the COVID-19 pandemic began. But as a vaccine rolls out and pandemic fears recede home prices accelerate to record highs in 2022.
This chart from the Federal Reserve Bank of St. Louis shows average selling prices between 1963 and the first quarter of 2022 (the latest data available). The light gray shaded area indicates a U.S recession.
FAST
Rental Properties
If you invest in rental property you will be a landlord - so you need to consider whether you are willing to take on that role. As a landlord you will be responsible for things like paying mortgage property taxes and insurance maintaining the property finding tenants and handling any question.
Unless you hire a property manager to handle the details being a landlord is a hands-on investment. Depending on your situation looking after the property and tenants can be a 24/7 job - and it's not always pleasant. If you choose your property and tenants carefully but you The risk of major problems can be reduced.
One way landlords make money is by collecting rent. 2 How much rent you can charge depends on where the rent is located. It's still hard to determine the best rent because if you charge too much you will drive out tenants and if you charge too little you will keep the money table. A common strategy is to charge enough rent to cover expenses until the mortgage has been paid at which point most of the rent turns into profit.
Another major way landlords make money is through appreciation. 3 If your property appreciates in value you can sell it for a profit (when the time is right) or borrow equity for your next investment. While real estate does appreciate in value there are no guarantees.
This is especially true during periods of extreme housing market volatility including most recently throughout the COVID-19 pandemic. From February 2020 to March 2022 median U.S real estate prices rose by a staggering 38%4. Wondering if prices will crash.
Flipping Houses
Like those day traders who are far removed from buy-and-hold investors real estate speculators are a different breed from buy-and-rent landlords. Flippers buy properties for short-term holdings - usually no more than three to four months - and quickly Sell them for profit.
There are two main ways to flip properties:
- Fixes and updates. With this method you can buy a property that you think will increase in value with certain repairs and updates. Ideally you get the job done as quickly as possible and then sell for more than your total investment (including renovations).
- hold and resell. This flip works differently. Instead of buying a property and fixing it you buy in a fast-rising market for a few months and then sell at a profit.
Regardless of the type of flip you run the risk of not being able to unload the property at a price that can make a profit. This can present challenges as flippers often don't have enough cash to pay their mortgages over the long term. still flip can be It is a profitable way to invest in real estate if done the right way.
REITs
A real estate investment trust (REIT) is created when a company (or trust) is formed to use investor funds to buy operations and sell income-producing properties. REITs are traded on major exchanges just like stocks and exchange-traded funds (ETFs). 5
To qualify as a REIT the entity must pay shareholders 90% of its taxable profits in the form of dividends. By doing so the REIT can avoid paying corporate income tax while ordinary companies will be taxed on their profits eroding the returns they can distribute to shareholders. 5
Just like regular dividend-paying stocks REITs are suitable for investors looking for regular income although they also offer opportunities for appreciation. REITs invest in properties such as shopping malls (about a quarter of REITs specialize in these) healthcare facilities mortgages and office building. Compared to other types of real estate investments REITs have the advantage of being highly liquid. 5
Real Estate Investment Groups
Real estate investment groups (REIGs) are sort of like small mutual funds that rent out properties. If you want to own a rental property but don't want the hassle of being a landlord a real estate investment group may be your solution.
A company will buy or build a building usually an apartment and then allow investors to buy them through the company thus joining the group. A single investor can own one or more separate living spaces. But the company that operates the investment group manages all the units and Responsible for maintaining advertisements and finding tenants. In exchange for this management the company charges a percentage of the monthly rent. 6
There are several versions of investment groups. In the standard version the lease is in the name of the investor and all units have a pooled portion of the rent to prevent occasional vacancies. This means that even if your unit is empty you will receive enough money to pay the mortgage.
The quality of an investment group depends entirely on the company that provides it. In theory it's a safe way to invest in real estate but groups can charge the kind of steep fees that plague the mutual fund industry. As with all investments research is key.
Real Estate Limited Partnerships
A real estate limited partnership (RELP) is similar to a real estate investment group. It is an entity established to buy and hold a group of properties or sometimes just one property. However RELPs have a limited lifespan.
Experienced property managers or real estate development companies as general partners. Outside investors are then sought to finance the real estate project in exchange for a limited partner's share of ownership. Partners may receive regular distributions from income Generated by RELP's properties but the real payoff is when the property is sold - luckily for a decent profit - and the RELP dissolves down the road.
Real Estate Mutual Funds
Real estate mutual funds invest primarily in real estate investment trusts and real estate operating companies. They offer the ability to gain diversified exposure to real estate with relatively little capital. They offer investors a wider range of assets based on their strategy and diversification goals Opt-in rather than by purchasing individual REITs.
Like REITs these funds are highly liquid. 7 Another important advantage for retail investors is the analytical and research information provided by the fund. This can include details about the acquired asset and management's views on the viability and performance of the particular property Investment and as an asset class. More speculative investors can invest in a range of real estate mutual funds strategically adding to certain real estate types or regions to maximize returns.
Why Invest in Real Estate?
Real estate can enhance the risk and return profile of an investor's portfolio providing competitive risk-adjusted returns. Generally speaking the real estate market is one of the low volatility markets especially when compared to stocks and bonds.
Real estate is also attractive compared to more traditional sources of income returns. This asset class typically trades at higher yields than U.S Treasuries and is especially attractive in an environment of lower Treasury rates.
Diversification and Protection
Another benefit of investing in real estate is its diversification potential. Real estate has a low and in some cases negative correlation with other major asset classes - meaning that when stocks fall real estate usually rises. This means that adding real estate to a portfolio can reduce its volatility and provide a higher return on risk per unit. The more direct a real estate investment is the better the hedging: The less directly publicly traded vehicles such as REITs will reflect the performance of the broader stock market.
Because it is backed by physical real estate it also reduces principal-agent conflicts or the extent to which investors' interests depend on the integrity and competence of managers and debtors. Even the more indirect forms of investment have some protection. REIT For example requiring a minimum percentage of profits (90%) to be paid out as dividends.
FASTFACTSome analysts believe that REITs will become more closely correlated with the stock market as REIT stocks appear in the S&P 500.8
Inflation Hedging
The inflation-hedging power of real estate stems from the positive correlation between gross domestic product (GDP) growth and real estate demand. As economies expand their demand for real estate rents rise which in turn translates into higher capital values. Therefore it is Real estate tends to maintain the purchasing power of capital by passing some inflation pressure on to tenants and absorbing some in the form of capital appreciation.
In addition to REITs investing in real estate provides investors with a tool that stock market investors cannot: leverage. Leverage means using debt to fund larger purchases than the cash you have. If you want to buy shares you must pay the full value The stock at the time of your order - unless you bought it on margin. Even then thanks to the magic of financing a mortgage the percentage you can borrow is still a lot less than real estate.
Most traditional mortgages require a 20% down payment. 9 However depending on where you live you may find that a mortgage requires as little as a 5% down payment. This means that you pay a fraction of the total value to control the entire property and the equity it holds. Of course your size The mortgage affects the amount of ownership you actually have in the property but you control it the moment the document is signed.
This is what encourages real estate flippers and landlords. They can take out a second mortgage on their home and make payments on two or three other properties. Do they rent these out so the tenant can pay the mortgage or are they waiting for an opportunity to sell for a profit they control These assets despite paying only a fraction of the total value.
How do I add real estate to my portfolio?
In addition to buying properties outright ordinary investors can also buy REITs or funds that invest in REITs. REITs are collective investments that own and/or manage real estate or own mortgages.
Why is real estate considered an inflation hedge?
Home prices tend to rise with inflation. That's because homebuilders' costs rise with inflation which must be passed on to buyers of new homes. 10 However existing homes have also risen with inflation. If you hold a fixed rate mortgage when inflation rises your fixed monthly payment will become Effectively more affordable. Plus if you're a landlord you can increase your rent to keep up with inflation.
Why are house prices affected by interest rates?
Since real estate is such a large and expensive asset loans must often be taken out to finance their purchases. Because of this rate hike mortgage payments on new loans (or existing adjustable rate loans like ARMs) are more expensive. This may deter buyers who have to factor in cost Carry possessions each month.
The Bottom Line
Real estate can be a sound investment and has the potential to provide steady income and build wealth. Another disadvantage of investing in real estate is illiquidity: the relative difficulty of turning assets into cash and cash into assets.
Unlike a stock or bond transaction which can be completed in seconds a real estate transaction can take months to complete. Just finding the right counterparty can take weeks even with the help of a broker. Of course REITs and real estate mutual funds offer better liquidity and markets Price. But they come at the cost of higher volatility and lower diversification returns as they are much more correlated with the overall stock market than direct real estate investing.
As with any investment keep your expectations realistic and make sure you do your homework and research before making any decisions.
Warning:
Mortgage discrimination is illegal. There are steps you can take if you believe you have been discriminated against because of your race religion marital status use of public assistance nationality disability or age. One of the steps is to file a report with the Department of Consumer Finance Conservation Bureau (CFPB) or U.S Department of Housing and Urban Development (HUD).
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