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Housing

Real Estate

How to Invest in Real Estate

Real estate investing can be a great way to earn passive income and build wealth over time.

Although investing in the real estate market might seem intimidating to first-time investors, there are different strategies you can choose depending on how much time and effort you want to put in.

It’s also possible to start investing in real estate without having to put down a lot of money upfront.

Read on to learn about how to invest in real estate and some key considerations on how to make good investment decisions.

Real estate investment trusts (REITs)

Listed and easily traded on stock exchanges
Don't need a real estate agent to cash out your investment
Offer strong dividend payouts
No hands-on management

Some charge management and administrative fees
Can't control or manage the assets in which the REIT invests
Depending on the real estate sector in which the REIT operates, it could underperform other real estate investments

A real estate investment trust, or REIT, is an investment group that owns and manages a diversified portfolio of real estate properties, mortgages or construction loans. Much like mutual funds, these trusts pool capital from multiple investors to invest in income-generating properties. In exchange, investors earn regular income through monthly or quarterly dividend payouts.

One of the most appealing features of REITs is that, by law and IRS regulation, they’re obligated to pay shareholders at least 90% of taxable profits in the form of dividends. This makes them particularly appealing to income investors.

The main difference between REITs and other real estate investments is that REITs are highly liquid. Publicly-traded REITs can be bought and sold on the major exchanges in the same way as stocks or exchange-traded funds (ETFs). You can simply log into your brokerage account or trading app and search for the individual REIT you want to invest in or a REIT ETF.

REITs focus on specific sectors — such as commercial, industrial and residential properties — mortgages or a combination of properties and mortgages, meaning you can choose the type of exposure that best suits your risk tolerance. REITs can also be a solid entry point for beginners looking to invest in real estate with a small amount, since many REITs have shares that can be purchased for less than $50.

However, investing in REITs won’t give you the same exposure that buying an actual property does, according to Gary Beasley, CEO and cofounder of Roofstock, because REITs tend to trade more in line with the stock market than their underlying real estate assets.

Real estate investment groups (REIGs)

Access to a diversified portfolio, if run appropriately
Offers hands-off investing experience
Opportunity to share knowledge with other investors

Can be challenging to exit the group
Management fees can be costly, and may eat into your returns
Must register as an LLC to create your own

A real estate investment group, or REIG, is a business that engages in real estate transactions and leasing. Family homes, apartment rentals, condos, office buildings and other commercial real estate can be held in an REIG investment portfolio. The major difference between REITs and REIGs is that the former must be organized as a trust, corporation or association and is subject to certain IRS regulations, whereas the latter isn’t subject to the same regulations and can be organized as a corporation or partnership.

REIGs involves working with other real estate investors. There’s no limit to how many shareholders or partners can join a REIG. Depending on its size, a REIG could manage a few — or many — real estate properties. When investors pool more capital together, it opens up more attractive opportunities.

REIGs are ideal for high-net-worth individuals who can dedicate a large portion of their wealth toward real estate opportunities. The returns can be good and will vary depending on strategy, but there are also potential downsides.

REIGs are highly illiquid, meaning you can't easily access the money you invest. It will also take time to find a REIG with a solid track record of good management that matches your investment property goals. Fees can also eat into investors’ bottom lines, and the distributions can be less than expected in certain cases. The Securities and Exchange Commission (SEC) does not regulate REIGs, so this type of investment is best for those with real estate experience.

Real estate crowdfunding platforms

Platforms handle properties, upkeep and administrative aspects
Typically have low initial investment requirements
Can provide high average returns

Short-term illiquidity
Dependable opportunities can be limited
Some platforms are limited to accredited investors
Elevated investment risk

Real estate crowdfunding is still fairly new in the world of investing. In 2012, after the JOBS Act was signed into law, retail investors gained the ability to invest in startups and crowdfunding efforts through the Securities and Exchange Commission (SEC) Regulation A. As a result, crowdfunding real estate platforms began to arise, offering you the ability to invest in real estate on a fractional scale.

This approach to real estate investing allows you to invest in real estate projects in different locations. Basically, these online platforms pool funds from multiple investors and use it to purchase a range of real estate, including residential, commercial and industrial properties.

Generally, you can choose the type of property you want to buy into and become a shareholder. Depending on your ownership stake, you then receive a portion of the rental income generated from the property. Additionally, many real estate crowdfunding platforms pay shareholders dividends, increasing their appeal to income investors.

One benefit of investing through crowdfunding real estate platforms is the cost of entry. It doesn't require a significant investment, and, in some cases, you can start with as little as $10. This eliminates the typical high-cost barrier of entry associated with real estate investing and makes it accessible to the average individual while also not requiring investors to take an active role.

While all investments carry risk, the best real estate crowdfunding platforms — like Fundrise and Arrived Homes — take measures to mitigate risk where possible. They take responsibility for investor funds and act as intermediaries between individual investors and the real estate company. Crowdfunding platforms will generally also vet properties based on factors such as appreciation and income potential and then present investment opportunities to you.

However, there are certain risks associated with real estate crowdfunding. It’s illiquid (like most real estate) and a minimum holding period may be required — typically between five to seven years. Most platforms also charge fees, which could diminish your profits, though fee-free platforms do exist. Ideally, it’s best to shop around to see which structure fits your needs and investment values.

Invest in house flipping

Offers a relatively short timeline compared to buy-and-hold investing
Opportunity to earn substantial profits when you sell the property at a higher price

Required startup capital can be high
Extra costs associated with down payments, closing, renovations, insurance and property taxes
Requires a deeper understanding of the real estate market

House flipping is the process of buying run-down properties — that is, fixer-uppers, short sales and foreclosures — to repair and sell them for profit. Many flippers prefer this option because properties can be purchased at lower prices and then be resold at a higher price after renovations are complete.

But house flipping definitely isn’t for everyone. This type of real estate investment typically requires a significant amount of money upfront and the need for some expertise in particular geographic markets. It can also involve unforeseen renovation costs, project delays and market variations (e.g., decreased home-buying demand due to high mortgage interest rates).

“[House flipping] is really more for somebody who's a little bit more experienced and maybe has some ability to do some of the improvements themselves,” Beasley says. “The exception could be if you're looking to buy a house, live in it, make some upgrades and then sell it opportunistically.”

Depending on the state of the property, you could also be looking at months or years of renovations. Cheaper properties may look attractive, but the labor and materials costs for renovations can add up quickly, and both are subject to inflation, meaning the longer the project takes to complete, the more you can end up paying.

Choosing homes that require less work in order to resell can mitigate your risk to a degree, but also increase your upfront costs. The less time you spend holding onto the property, the less risk you carry if house prices begin to decline. However, in a property market downturn, it could take longer before you can profit from your investment.

Additionally, location is vital in house flipping, so you'll want to research housing demand trends wherever you're looking for property. If you’re just starting out, consider a partnership with someone who’s more experienced in flipping houses.

Invest in rental properties

Buying a property to rent out allows you to focus on something simple and more easily manageable, like a single-family home. You can choose to use it as a short-term rental (e.g., an Airbnb vacation rental) or find tenants for long-term leases.

The following section discusses the pros and cons of each.

Long-term rentals

Offers a steady and predictable stream of passive income
Longer lease durations
Operating expenses are tax deductible

Leases may not adjust quickly to market changes
Screening tenants and finding a good fit can be time consuming
Property owners have limited access to the property during the lease term

Long-term rentals can be part of a real estate investment strategy that involves purchasing and leasing a property — such as single-family or multifamily homes — to a tenant for one year or longer. One of the advantages of long-term rentals is that you can have steady cash flow for an extended period.

“Oftentimes the tenants renew and you have them in for three or four years at a time, so you don't have to remarket the property all the time,” Beasley says.

Although long-term rentals can provide stable income and property appreciation over time, there are some important things to consider. In most cases, it requires careful market research, financial planning and effective property management to be successful. It can also be time consuming, especially if you care about maintaining a positive relationship with your tenants and want to keep your property well maintained.

For this reason, you should also factor in the cost of managing a rental property. This involves making a budget for maintenance, repairs or refurbishment. If you don't have the time to take on the role of landlord yourself, consider hiring a property manager.

Most property management companies offer a wide range of services for a fee, such as rent collection, performing home inspections and overseeing maintenance. They can also take full charge of marketing the property and running background checks on potential tenants.

Short-term rentals

Can generate higher income compared to long-term rental
Flexibility to use the property during vacant periods
Operating expenses can be deducted

Exposed to frequent turnover and off-peak seasons
Requires more upkeep and maintenance
Owners are responsible for utility bills

Short-term rentals — also known as vacation rentals — consist of renting any residential home unit for a short period of time, typically ranging from a few days to weeks. There are different options when it comes to short-term rentals, especially now that properties can be easily listed on online platforms like Airbnb, Vrbo and HomeAway. You can rent an entire home, a room or a portion of your own home.

This practice of renting out parts of your home to generate income and pay for the mortgage or cover other expenses is also known as house hacking. It can also be a means of making additional mortgage payments or saving for the down payment of another investment property.

One advantage of short-term rentals is that they give homeowners the opportunity to occasionally use the property as a vacation home during periods of vacancy.

“You could potentially make more money,” Beasley says, “but because the occupancy [is] more nightly or weekly you have more variability.”

This variability can make your rental income less predictable compared to the steady income you can earn with long-term rentals. Investing in short-term rentals can also be more competitive, since success may depend on factors such as location, property condition, guest reviews and your hospitality.

Is real estate a good investment?

Real estate can be a good investment for some individuals. It’s a way to diversify your portfolio, can act as a hedge against inflation and provides a steady source of income when used for renting. However, whether it’s a good investment for you will depend on factors like your financial goals, risk tolerance and current real estate market conditions.

If you're new to the real estate market, you may want to consider speaking to a real estate agent to help you find the best investment opportunities. If you're unsure if a real estate agent is worth it, consider what your information gaps are and how much this might cost you in the long run.

Pros and cons of real estate investing

The following are some general advantages and disadvantages of investing in real estate that you should consider before investing in any of the strategies detailed earlier in this guide.

Pros

Cons

Real estate can appreciate in value over time, especially in areas with economic growth and increasing housing demand. This means you can potentially sell at a profit under the right market circumstances.

Real estate markets can be subject to fluctuations and local conditions. As a consequence, properties may not always appreciate as expected, which can significantly impact the value of a particular real estate investment.

Long-term rental properties can provide steady cash flow, and short-term rentals are capable of generating higher income.

Compared to stocks and bonds, real estate investments are generally illiquid since selling property takes time. However, that's not the case with publicly traded REITs.

Real estate investing can diversify a portfolio by spreading your investment over alternative assets with different risks than traditional securities like stocks and bonds.

Real estate typically has high entry costs, requiring substantial upfront investments to cover down payments, closing costs and other fees.

Investors can benefit from various tax deductions, including mortgage interest rate deductions, tax-deferred exchanges, property depreciation and operating costs.

Owning and managing multiple properties can be time-consuming and require funds for unexpected repairs and maintenance.

Real estate investments can act as a hedge against inflation, as property values tend to increase during inflationary periods.

Renting properties can involve dealing with problematic tenants, property damages and rental defaults.

Direct vs. indirect real estate investments

The difference between direct and indirect real estate investing comes down to the degree of involvement you’ll need to have.

Direct real estate investments give you complete autonomy over how you run your properties. You receive all the profit if any is generated, and you hold the asset. But you also have to face the risks, costs and issues related to real estate markets and property management.

Indirect real estate investments offer a hands-off approach with similar exposure, but you have little to no say in decision-making or how the properties are managed. Despite that, you’ll still receive passive income on a regular basis.

How to choose a real estate investment

When it comes to choosing a real estate investment, Beasley recommends considering three main factors: (1) type of property, (2) supply and (3) demand trends.

Type of property: Think about the property you’re planning to buy: Is it a property that’s rentable? Is it located in a neighborhood that will support its value? Does it have enough rooms to attract tenants in the area? For instance, it may be harder to rent a house that only has two rooms and one bathroom, if most houses in the area have three bedrooms and two bathrooms.

Supply: What is the market inventory like in the area? “If you're looking to buy a home and you want to rent it out but there's a 20% vacancy of homes in the area, you shouldn't anticipate being able to rent it very quickly”, says Beasley. “[But] if you go around and there's no for rent signs, you probably have a tighter supply dynamic there. That’s really going to be helpful in getting regular cash flow.”

Demand trends: Consider the demand drivers in the area, such as job and population growth, whether there are good schools around or new factories being built. “That type of activity tends to not only support home values, but creates robust rental demand,” says Beasley. “That would drive demand for people who either want to buy these homes someday or live in them as renters.”

Beasley also recommends considering factors like your investment horizon, your willingness to take on risk and how actively you want to manage your property. The latter can be particularly important if you’re planning to buy a property that’s in another state or far from where you live.

In particular, be mindful that real estate investing is more of a long-term proposition, and that in most cases, you must be willing to lock up your money for an extended period. However, if you’re willing to invest your money for the long term, the potential gains can be substantial. The average return on investment in the U.S. real estate market is 10.6% for residential properties and 11.8% for REITs. By comparison, over the past 20 years, the S&P 500 has produced a return of 9.75%.

No matter what you decide, be sure to do thorough research before settling on any approach to investing in real estate.