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How to Invest in Real Estate
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Including real estate investing in your portfolio is a great way to maximize the use of your money. Some 87 million Americans already invest in real estate trust stocks through their 401(k) funds, according to Nareit, a real estate investment voice for the global community. There are different types of real estate investment opportunities available and each has its own set of pros and cons. Here’s what you need to know before you invest.
Investing in real estate ETFs
Real estate exchange traded funds are in some ways similar to mutual funds since they are publicly traded. However, unlike mutual funds, which are priced at the end of the day and based on the closing holdings, ETFs can be purchased throughout the day with fluctuating prices. You can buy ETFs through a brokerage account that manages that type of fund, but not with the actual fund itself. Consider stock trading platforms like Robinhood, E*TRADE, TD Ameritrade — which was recently acquired by Charles Schwab — or Merrill Edge.
Getting started is simple. You can set up an account online, and some brokerages offer investment advice, while others offer self-guidance or informative content to help with your decision. However, there are a couple of cautions to take note of. Keep in mind that ETFs, as with most other investments, are not without some risk. It’s important to always do your research before determining which ETFs to add to your investment portfolio.
Investing in REITs
Real estate investment trusts are one of several options and are often traded on the stock exchanges, though some are held privately. A REIT is a company that owns or operates income-generating real estate. There are different kinds of REITs, like equity, which derives its income from rental properties and pays dividends to investors. There are also mortgage REITs, which earn income from selling properties or mortgage-backed securities and hybrid REITs, which are a combination of the two. Not all REITs are public or traded on the stock exchange; many REITs are listed with the SEC. Others are privately held and traded only among a select group of investors. There are greater risks and less transparency and liquidity involved among these REITs compared to others. Regardless of the REIT you choose, a brokerage company like those mentioned above is a good place to start your real estate investment journey.
Investing in REIGs
For some investors, joining a real estate investment group, which allows you to pool your money with other members to benefit from real estate investing, is another option. One way to look at REIGs is to view them as a form of crowdfunding, and some REIGs are formed and run that way. Fundrise, EquityMultiple, CrowdStreet and FundThatFlip are all examples of REIGs that have a crowdfunding feel to them, allowing investors to get started with as little as $5,000 in some cases. Another key point with REIGs is that your investment is larger than other real estate investing opportunities, but so is the return. If you have more to invest in real estate, REIGs might be a good place to start.
“Learning how to source and analyze good deals (is important),” said Andrew Chen, Founder of Hack Your Wealth. “Find a mentor or an experienced investor to apprentice with — you can add value back by offering to handle administrative work, scout out neighborhoods, etc., in return for learning their processes and strategies.”
When you invest in REIGs, you gain a return, often in the form of a dividend when the investment earns profits or is sold. A REIG often profits through property rentals, property management fees or lending opportunities to developers like real estate flippers.
Flipping real estate
Speaking of flipping real estate, this is another investment strategy to consider, but certainly not one to take lightly. It has potential for large gains, but not without substantial risk. The people flipping real estate often develop that same real estate by making property repairs and cosmetic changes that will appeal to buyers and boost property value.
Having the ability to flip real estate requires that you also have a large amount of investment funds with which to purchase the properties that you intend to flip, but it doesn’t stop there. Sometimes, real estate flippers will flip a property over a short period of time. Other times, repairs and reconstruction are needed to increase property value. This requires additional investment.
“Pay particular attention to repairs and maintenance, vacancy rate and property management fees. New investors tend to underestimate all of these expenses or ignore them entirely,” said Brian Davis, Director of Education at SparkRental.
There’s another risk when it’s time to flip the property. You assume the risk that you may not find a suitable buyer right away or that the market could take an undesirable turn, impacting your investment value. Of course, it could also take a turn for the better, too. There are well-documented cases of investors doing very well flipping real estate, like house flipper Justin Pierce, who was featured in the May 2013 issue of Kiplinger’s Personal Finance. If real estate flipping isn’t for you, though, there is another option: owning or leasing real estate.
Owning and leasing real estate
Buying ownership of real estate requires an up-front investment — usually 20% to 30% of the total property price. You gain control of the property, which includes certain tax advantages, especially if you have an amortizing loan. However, you assume all or most of the risk with the property as well, including the additional cost of maintenance and repairs during that time.
“Learn how to calculate cash flow. If you know how to accurately forecast a property’s cash flow, you’ll never buy a bad deal. Get these calculations wrong, such as assuming that your cash flow is just rent minus the mortgage payment, and you set yourself up for negative cash flow and expensive losses,” Davis said.
As with house flipping, once the property is ready to sell, you will have to find a suitable buyer. Market fluctuation can also impact the value of your investment, but this can be positive or negative depending on the market. Leasing offers a different perspective.
Leasing allows you to own the property and collect monthly rental income from tenants. Whether the property is residential, commercial or industrial, you’ll still assume much of the risk with property maintenance, but some of those liabilities can be passed on to the tenant in the rental agreement and in accordance with your state laws.
The bottom line
There are many ways that you can benefit from real estate investing, but as with all types of investments, knowledge is a powerful tool that investors can greatly benefit from. Get to know your options before you buy — and the advantages and disadvantages of each. Knowing what to expect can help you avoid or limit any potential real estate investing mistakes while improving your chances for a successful ROI. It’s also equally important to understand the market that you’re investing in: commercial, residential, industrial or even infrastructure, how it’s performing and where it’s trending. Arm yourself with knowledge and when you’re ready, make an educated leap.