Real estate investing is one of the most tried and true methods of building wealth, and more options than ever are available to get started investing in real estate.
Real estate investing is the purchase of land or property for the purpose of profit. Real estate investing has traditionally only been available to those with a high net worth. In the past decade, the internet and social media have dramatically changed the face of real estate investing making it more accessible to everyone.
Active vs. Passive Real Estate Investing
Real estate investing can be categorized into passive and active investing – similar to equities investing. For most people getting into real estate investing, starting with passive investing and then deciding whether active is also right for you usually works best.
Passive Real Estate Investing
Before the Internet, real estate investing was a very hands-on industry. To reap the benefits of investing in property, you would usually need to be involved with the daily inconveniences of managing that property. It’s not like investing in stocks where you sit on shares in a brokerage account. Real estate investing often required boots on the ground unless you had the money to pay for professional management.
Now investors can get their hands in the cookie jar through a number of different avenues. Real estate investment trusts (REITs) have long been available to investors through market exchanges, but with brokers reducing or eliminating commissions, these types of real estate stocks are more accessible than ever.
Passive real estate investing has also evolved into a crowdfunding movement where investors bypass brokers and REITs to stake ownership claims on individual properties. Companies like CrowdStreet allow investors to get in on the ground floor of real estate investing and benefit from both property appreciation and rental cash flows.
Active Real Estate Investing
Active real estate investing can be the path to higher profits, but you’ll need to get your hands dirty to be successful. You’ll also likely need a larger amount of capital to get started.
Active real estate investors locate land or properties and do the legwork required to obtain financing. Then they either manage the property themselves or outsource the work to a professional management team.
Active real estate investing is riskier than passive real estate investing. A building is expensive to maintain, and quality renters can be difficult to find.
If you choose to manage a property yourself, you need to be ready to perform daily maintenance, collect rent, find new tenants to replace outgoing ones, pay taxes and handle complaints. Managing a property can be a full-time job, which is why many owners choose to part with some of their profits by hiring a building manager.
Active real estate investing usually falls into one of two camps:
- Managing rental properties
- Flipping houses and apartment buildings
Rental properties can be leased out to commercial or residential tenants. One of the benefits of active real estate investing is the amount of authority you have in the decision-making process. You select the properties, negotiate the loan terms, choose your tenants and manage as you see fit. Rent prices and amenities are decided by you as the property owner.
Flipping houses is different but still requires a lot of hands-on work. The term flipping houses doesn’t just mean single-family homes, but any type of residential living space.
House flippers take beaten-down properties, fix them up as quickly as possible and sell them to new owners. House flipping can be a lucrative venture, but the capital required for renovation can be a lofty sum and setbacks are common. Plus, you’ll still need to find a buyer once your hard renovation work is complete.
Ways to Start Investing in Real Estate
If you are interested in investing in real estate, then the options for buying real estate listed below might be a good place to start.
Buying a Rental Property
Buying an investment property is the basic approach toward real estate investing, with renting being an obvious method to bring cash in. The landlord receives rent from the tenant after covering the costs associated with owning a property. These costs include a mortgage down payment, taxes and maintenance.
Pros of Buying and Managing Properties
Owning your own real estate where you can control rent could be more lucrative than investing in a REIT or crowdfunding platform. In this scenario, you are in control of your own situation and can stand to make substantial money. Property owners also have tax deductions they can work with to reduce their tax bill when tax season comes along.
Cons of Buying and Managing Properties
While this type of real estate investing can yield returns, it can also yield huge losses if you are not familiar with what you are doing. You will want to put a lot of effort into researching the property you want to buy and the neighborhood it’s in.
This form of real estate investing also comes with high maintenance requirements. Doing this yourself, depending on the size of the business, can be an arduous task. You may need to hire a property manager, which can be another expense.
The method with the lowest barrier of entry for real estate investing is a real estate investment trust (REIT). REITs are companies that make investments in income-producing residential or commercial buildings. The REIT buys new properties or improves existing properties. Investors are usually paid back in the form of dividends from profits generated by the properties.
Pros of REITs
REITs take much of the difficulty out of real estate investing and allow investors to reap the benefits of property ownership. Another positive about REITs is that they tend to have a higher historical return than traditional equities. According to DiversyFund, the S&P 500 has a 20-year average return of 10% while the 20-year average annual return for REITs is about 12.8%.
REITs can be great because they have a low barrier of entry because you may need just a few hundred dollars to be able to start investing. For traditional real estate investing, you often need at least $25,000 to start.
Cons of REITs
REITs are not without drawbacks. Investing in a REIT is like investing in a stock in that you are entrusting that business to carry out actions that will maximize your return. A REIT can be well-managed or poorly managed, the same as any corporation. Another noteworthy thing about REITs is that by law, they are allowed to invest upwards of 25% of their assets in non-real estate ventures as well. If you are keen on being able to have greater control over the properties being invested in, a REIT may not be what you are looking for.
Real Estate Crowdfunding
A trend that has gained popularity in the past several years is real estate crowdfunding. The passive benefits of crowdfunding real estate investments are similar to that of REITs. Both allow investors to direct money toward real estate properties and reap the returns without needing to actively manage the property.
The key difference is with crowdfunding you are directly investing in tangible real estate assets unlike with REITs where you are investing money with the company that invests money for you in real estate.
Pros of Crowdfunding
Crowdfunding affords the same level of passivity as REITs with a little bit more control over where your money is being directed. On platforms like Crowdstreet, you can directly pick real estate properties to funnel your money into. In terms of returns, Crowdfunding properties could outperform REITs. Crowdfunding platforms invest in properties with a greater amount of leverage (investing through debt) that may afford a higher overall return, although there is no guarantee.
Cons of Crowdfunding
The main drawback is that crowdfunding platforms tend to be more illiquid than REITs. If you want to invest in a crowdfunding platform, you should expect the money to be tied up for a while.
The second drawback relates to the inclusivity of crowdfunding platforms. Some platforms only accept accredited investors (those with 200,000+ income or $1 million net worth) in their network. While there are a few like Fundrise that allow non-accredited investors with an account minimum of $500, you may find you have fewer options than you would with REITs.
How to Invest in Real Estate
Investing in real estate requires time, tolerance and money. It may not, however, require hard work, steel nerves and lack of sleep. You can be an active landlord or house flipper — or you can be a passive real estate investor. There are many options open to you.
Investing in real estate can be a lucrative way to earn passive income or build long-term wealth. Do you know how? The following steps will show you how to invest in real estate.
Step 1: Do a Financial Assessment
The purpose of your financial assessment is to find out where you are and where you want to go financially. Determine your financial net worth — calculate your total debt, liabilities, property ownership, income and savings. If you don’t have a cash reserve for emergencies, you should build up one before you start. Many real estate investments can be illiquid for long periods of time.
Once you’ve determined your financial net worth, think of a goal for your real estate investment — visualize it in quantitative terms. Make sure your wealth goal extends for about 30 years.
Here’s an example. For a $400,000 property, let’s suppose you pay $100,000 cash and $300,000 from a mortgage loan at 2.5%. The U.S. real estate’s average annual return rate is between 3%–5%. With a 4% return, your 30-year equity would be $456,665, after deducting loan interest.
By using the historical dividend yield of mutual funds, online investors can do a similar calculation for their 30-year return. House flippers can use a projected return. Either way, make sure you have a spreadsheet-calculated goal in mind.
Step 2: Pick a Specific Real Estate Investing Strategy
The next step is to develop a real estate investing strategy. Select your target market and your trading forum. These are some of the most popular ways to invest in real estate.
A REIT is a firm that buys, sells and manages properties. Through a broker, you can buy shares of REITs and receive income from dividend yields or benefit from the increasing value of the shares.
REIT Exchange-Traded Funds (ETFs) and Mutual Funds
REIT ETFs gather a group of REITs into one fund. It allows you to spread your investment across the entire collection of funds. These ETFs give you low-risk exposure to some of the best real estate stocks — making these funds hard to pass up.
Real Estate Crowdfunding
Real estate crowdfunding is the GoFundMe of online real estate investing. It matches investors looking to invest in specific projects with real estate developers needing money to complete specific projects.
There are active and passive ways to buy property for the purpose of renting it out to individuals or businesses. Your return comes from the rental cash flow minus the mortgage payment, taxes and other expenses. Plus, you benefit from equity appreciation.
Flipping Investment Properties
Flipping homes involves buying an undervalued home and fixing it up to sell at its new market value. Does this sound easy? It’s not. Successful house flipping requires expert handyman skills, professional knowledge of the real estate market and great bookkeeping acumen.
In this strategy phase, it’s important to put together your team. Your team could include a real estate agent, partners, attorneys, insurance agents, contractors or bookkeepers. If you plan to try real estate crowdfunding, an online crowdfunding platform would be part of your investing team.
Step 3: Secure Financing
Fund your real estate investing plan. The amount of money in your asset pool will determine the type and depth of investments you can execute. You may start with your savings. If you plan to directly invest in real estate property, you can apply for a traditional mortgage through the FHA, VA, Fannie Mae and Freddie Mac. Many of online real estate platforms offer financing services as well.
Online brokers don’t require much money to get started trading REITs and other real estate mutual funds. You can increase your buying power by opening a margin account with an online broker. A margin account typically allows you to borrow 100% of your account balance — doubling your buying power (and losses you could incur). You have to be careful with margin investing because a southbound stock or ETF price can result in major losses and a devastating margin call.
Step 4: Shop for Investments
Take your time to use the resources available to help you make the best investment decisions. Online real estate listing sites like Zillow provide active real estate investors with comprehensive information about U.S. properties for sale. Online broker sites offer an incredible amount of free research tools for REITs, mutual funds and REIT ETFs. Crowdfunding offers a wealth of real estate-related research material.
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Step 5: Execute
Whether you’re online or in a real estate broker’s office, approach your initial real estate investment like a college intern. Here are a few tips:
- Get as much help from experts as you can. It’s okay to make some mistakes but learn from them.
- Try not to focus too much on the cost of the property or real estate share. Before making your decision, consider all other expenses like loan interest, closing costs and fees associated with buying stocks on margin.
- Let time be on your side. You can avoid making many mistakes by not rushing.
Taxes and Real Estate Investing
Getting into real estate investing means becoming well-versed in how taxes for real estate income work.
What is Considered Income Tax for Real Estate Investing?
These earnings are subject to income tax:
- Dividends paid by REITs or crowdfunding platforms
- Rent paid by tenants
Active and passive real estate investors can face income taxes from their investments through dividends or rent payments from tenants. This income is related to the value of the property. The appreciation of a property or any profit you generate from the value of a property is subject to a capital gains tax.
What is Considered Capital Gains Tax for Real Estate Investing?
Any of the following would be subject to a capital gains tax:
- Profit from flipping a home
- Gains from selling a property
- Profit from selling REIT or crowdfunding shares
Capital generated through these means is a direct function of the value of the home. It follows the same principle as selling stocks. If you buy a stock for $1 and sell it for $2, you make $1 in profit, and that profit is taxed as a capital gain. Same with a home. If you buy a house for $500,000 and sell it for $700,000, the $200,000 profit is taxed not as income, but as a capital gain.
Real estate investing has become more accessible to the broader public, presenting viable options for any type of investor. For most people, passive real estate investing will be the best way to go. Representing the lowest barrier of entry, as well as the least amount of work needed, it can be a reliable way for investors to see steady above-market returns.
Active real estate investing can be the most lucrative venture for those with the capital provided they are willing to put in the effort to do research and maintain the property.
Related content: HOW TO LEVERAGE REAL ESTATE
Frequently Asked Questions
Why invest in real estate?
Investing in real estate can be a smart financial decision due to its historical stability and potential for long-term growth. It can generate passive income through rentals and offers diversification benefits. Real estate investments also provide tax advantages and allow individuals to have more control over their investments. Overall, it offers various financial benefits and investment opportunities for wealth accumulation.
Why is real estate considered to be an inflation hedge?
Real estate is seen as a good investment during times of inflation because its value tends to rise along with inflation. As the cost of building materials and labor increase, the cost of new properties and the value of existing properties also increase. Real estate also provides rental income and can be sold at a higher price during periods of inflation, making it an attractive option for investors looking to protect their wealth.
Why are home prices impacted by interest rates?
Interest rates have an impact on home prices as they affect affordability and demand. Low interest rates make it more affordable to borrow money for a home, increasing demand and potentially raising prices. High interest rates make borrowing more expensive, reducing affordability and potentially lowering demand and prices.
Accelerate Your Wealth
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