Table of Contents
What is real estate investing?
How to start real estate investing: 5 strategies
Potential benefits of real estate investing
Potential risks of real estate investing
The bottom line
Oct 17, 2022
8 min read
There are many ways to invest in real estate. Investors looking for short results can buy shares in real estate. Rental properties is long-term and may cost more upfront.
There are many different ways to invest in real estate, and they can all help diversify a portfolio. For instance, investors can buy shares in a fund that invests in real estate or they can buy property and build wealth by collecting rent and selling the property later. Each strategy comes with its own potential benefits, drawbacks, and time commitments.
Real estate investing is an investment strategy that can take on many forms. Some investors purchase and manage properties, which can provide monthly income and potential profits when they sell the property. Others buy and sell shares in real estate funds and real estate investment trusts, which allow investors to earn money from real estate without buying property. The major types of real estate investments and strategies include:
, or REITs, are companies that usually own income-producing real estate such as commercial properties. Investors can buy shares in a REIT, which by law must pay out most taxable net income as dividends.
are typically mutual funds that invest in securities tied to real estate. Investors can buy shares in the fund and may earn dividends from them.
may include residential real estate, such as houses and vacation properties, or commercial real estate, such as shopping malls and office buildings. Investors buy a property and either manage it directly or hire a company to do the work.
allows investors to buy undervalued or neglected properties, repair them, and potentially sell for a profit.
connects real estate investors with developers looking to fund large projects.
Those who wonder how to start real estate investing can research the main methods and figure out how much time they want to devote to the investment.
REITs make it possible to invest in real estate without buying property. Most REITs are companies that own income-producing real estate such as shopping malls, office buildings, hotels, and apartments. A REIT may either focus on a specific property type or invest in multiple properties.
Investors can buy and sell shares of many REITs on publicly traded stock exchanges, or they can invest in REITs that are privately managed. REITs must pay out at least 90% of their taxable income to their shareholders in the form of dividends. Compared to rental properties and flipping houses, REITs are highly liquid investments that require less time and energy than buying property directly.
A privately managed REIT is not traded on a stock exchange; instead, investors buy shares through brokers or financial advisors. Because it’s not publicly traded, it may be difficult for investors to value such a REIT and also difficult to sell it later on.
A real estate fund is a type of mutual fund, real estate exchange-traded fund (ETF), or private real estate investment fund. These funds pool money from many investors and then invest in securities tied to the real estate industry, such as REITs.
An investor can typically buy shares of a real estate fund through a brokerage and can choose between passively managed funds and actively managed funds. Passively managed funds track the performance of a benchmark index, like the Dow Jones U.S. Real Estate Index, while actively managed funds employ a manager who chooses the investments.
Investors can also buy a residential home or commercial property and rent it out for monthly income. The investor can either manage the property or hire a company to deal with lease agreements, collect rent, pay property-related bills, field tenant requests, and maintain the exterior.
This method of real estate investing is often long term and hands-on, which allows for more control compared to REITs and real estate funds. An investor can buy properties in several high-demand rental markets, for instance, and hire local companies to manage them. Another option is buying a multi-unit residential property and living in one of the units. This is one form of so-called house hacking, in which someone finds ways to generate income from their own home.
Investors will need to research local rental markets, source the property, and cover a down payment and closing costs. They should also be aware of recurring expenses in the form of maintenance, repairs, and potentially property management fees.
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A real estate investing platform is a digital venue that connects investors with real estate developers looking to finance projects. For instance, a developer may list a project, pool money from several investors, and purchase a large, income-producing commercial property. Or, the developer may give investors partial ownership in a share of existing holdings. The investors provide capital for the project and may also have to pay a fee to the platform. In exchange for the risk they take on, investors expect to receive monthly or quarterly distributions from the project.
It may not be possible to liquidate the investment early, unless the platform offers this option. But this type of investment may provide better returns compared with some publicly traded REITs.
Flipping an investment property involves buying an undervalued home, renovating it, and then selling it for a profit. This type of investment has a shorter horizon compared to buying a rental property, which involves months or years of managing a property and collecting rent. Investors who are interested in flipping will need to research housing markets, find a property at a low price, and make sure the repairs are affordable and make economic sense. The investor can either do the renovation work themselves or hire others to do them.
There are some risks involved. It may be difficult to estimate the cost of repairs, which will reduce profits, and the housing market dictates the selling price of the home. And the longer the investor holds the property, the less money they'll earn because they're carrying mortgage payments and paying real estate taxes and other expenses. Some investors who flip properties will find a partner who is good at estimating expenses or managing projects.
Investing in real estate has a number of potential advantages, including:
Some forms of real estate investing, such as REITs and real estate funds, are passive. The investor contributes capital upfront and lets others make decisions and manage the investment, which frees up the investor's time and helps diversify their portfolio.
If real estate values increase, then investments tied to real estate can increase, too. Appreciation isn't guaranteed with every property, and there have been a few notable peaks and valleys in the U.S. housing market, but property valuations generally have increased during the past six decades.
There are several tax breaks related to real estate investments. For one, it's possible to take tax deductions on some of the expenses related to investment properties, such as property taxes, mortgage interest, and property management fees. Additionally, rental income is not subject to Social Security tax.
Investing in real estate, however, can have disadvantages, including:
It may be possible to sell REIT shares quickly, but an investor may not be able to sell a property instantly if they need to right away. It takes about two months or more to list and close on a property, not accounting for the time it takes to prepare the home for sale. In addition to any waiting period, the investor may also get less profit if they sell during a market dip than if they sold during a strong market.
Some forms of real estate investing, such as buying a rental home or flipping a property, require a lot of cash upfront. Those who want to know how to invest in real estate with little money may do best sticking with real estate funds and REITs, because buying shares generally costs less than buying a home.
Real estate investing may be subject to several types of taxes. Investors will likely pay property taxes on an investment property. They may also have to pay the net investment income tax on interest and dividends from REITs and real estate funds.
Property investors will need to fill their rental units, whether they own residential homes or commercial buildings. Vacancies equal lost rental income. Additionally, the investor will need to have the time and patience to work with tenants unless they pay a management company to handle the details.
There are many ways to invest in real estate, depending on an investor's time horizon and experience. Investors who are looking for shorter-term opportunities with lower entry costs may choose to buy shares in real estate funds and real estate investment trusts. Rental properties are a long-term, hands-on approach, and this may cost more money upfront. Investors with renovation experience can also flip properties for a shorter-term gain. Each real estate investing strategy may help the investor diversify their portfolio and potentially build wealth over time.
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