Complete Guide to Real Estate Investing

Real estate investing is one of the most tried and true methods of building wealth, and there are now more options than ever to get started investing in real estate.

Real estate investing is the purchase of land or property for the purpose of profit. Today, real estate investing can be done in several different ways. 

Real estate investing has traditionally only been available to those with a high net worth. In the past decade however, the internet and social media have dramatically changed the face of real estate investing making it more accessible to everyone with just a few hundred dollars.

Active vs Passive Real Estate Investing

Real estate investing can be categorized into passive and active investing – similarly to equities investing. There are multiple ways to get started in either category. For most people getting into real estate investing, we recommend starting with passive investing and then deciding whether active is also right for you.

Passive Real Estate Investing

Before the days of 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 simply sit on shares in a brokerage account. Real estate investing used to require 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 dropping 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 the brokers and REITs to actually stake ownership claims on individual properties. Companies like DiversyFund, CrowdStreet and RoofStock 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 is 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 themselves and do all 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 the 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 between residents. Managing a property is 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 1 of 2 camps:

• Managing rental properties
• Flipping houses

Rental properties can be leased out to either 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 aren’t decided upon by outside forces but by you as the property owner.

Flipping houses is a bit 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

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 to receive cash flow after covering the costs associated with owning a property. These costs include mortgage payment, taxes, and maintenance. The rent is often fixed to accommodate a premium over the costs to the owner of the property.

Pros of Buying and Managing Properties

Owning your own real estate where you can control rent could be more lucrative than simply investing in an 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 numerous 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 huge 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, but also the neighborhood it’s in. You want to make sure you are buying a property that will appreciate in value and in a place people want to live.

This form of real estate investing also comes with a lot of necessary effort. If people are going to be living or businesses are going to be operating out of your building, you will need to maintain the property. Doing this yourself, depending on the size of the business, can be quite an arduous task. You may need to hire a property manager, which can be another large expense.

REITs

The method with the lowest barrier of entry for real estate investing are REITs or Real Estate Investment Trusts. REITs are companies that make investments in income producing residential or commercial buildings. The REIT takes investors money and uses it to either buy new properties or make improvements on existing properties in their portfolios. Investors are usually paid back in the form of dividends from profits generated by the properties.

Pros of REITs

We like REITs because they take much of the difficulty out of real estate investing. Investors often enjoy the idea of real estate investing because it can be quite lucrative, but often underestimate the difficulty of researching properties, the process of acquiring those properties and finally maintaining those properties so they may generate revenue.

Investing in a REIT takes out that difficulty and simply allows investors to reap the benefits of a property.

Another positive about REITs is that they tend to have a higher historical return than traditional equities. According to DiversyFund, S&P 500 (a broad index of some of the biggest stocks in the world) has a 20-year average return of 8.6% while the 20-year average annual return for REITs are about 11.8%. 

Finally, REITs are also great because they have a low barrier of entry, often just needed 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 however. The most obvious drawback being you don’t have much control over what the REIT is doing with your money. Investing in an REIT is just 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 highly 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 who in turn goes and invests money in real estate.

Get Top Offerings

Pros of Crowdfunding

Crowdfunding affords the same level of passivity as REITs with a little bit greater control over where your money is being directed. On platforms like Croudstreet you can directly pick real estate properties to funnel your money into. In terms of returns, Crowdfunding properties should outperform REITs in most cases. Crowdfunding platforms invest in properties with a greater amount of leverage (investing through debt) therefore should afford a higher overall return. Though it is no guarantee.

Cons of Crowdfunding

There are two main drawbacks to crowdfunding real estate as compared to REITs. The main drawback is 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 200k+ 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 less 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 the active landlord or house flipper — or you can be a passive real estate investor. There are many options open to you.

Low interest rates and stable housing prices make it a great time to start investing in real estate now. It 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. To assess, 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 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 ETFs or 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. It is time to select your target market and your trading forum. These are some of the most popular ways to invest in real estate.

• Real estate investment trusts (REIT): 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 for the shares. 
• REIT exchange-traded funds (ETF) and mutual funds: REIT ETFs gather a group of REITs into 1 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.
• Rental property: 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 you 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 skill, professional knowledge of the real estate market and great bookkeeping skills. 

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.

This is the time to 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, Fanny Mae and Freddie Mac. Many of the 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. Also, 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. However, you must be careful with margin investing. A southbound stock or ETF price can result in major losses and possible overdraft fees. 

Step 4: Shop for Investments.

Take your time to use all the resources available to help you make the best investment decisions. Online real estate listing sites like Zillow (NASDAQ: ZG) provide active real estate investors with comprehensive information about U.S. properties for sale. Online brokers sites offer an incredible amount of free research tools for REITs, mutual funds and REIT ETFs. Also, crowdfunding offers a wealth of real estate-related research material.

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 versed with how taxes for real estate income works. All in all, there are two important distinctions to make for real estate taxes. What is considered income and what is considered a capital gain.

What is Considered Income Tax for Real Estate Investing?

Any of the following would be subject to an income tax should you earn them from your ventures:

• 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. If you notice, neither of these are 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 are 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 overall 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 taxes not as income, but as a capital gain. 

Final Thoughts on Real Estate Investing

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 lucarative venture for those with the capital - provided they are willing to put in the effort to do diligent research and maintain the property.

If you're interested in real estate investing and want to learn more, check our Benzinga's picks for the best real estate investing books or the best online real estate investing courses for this year.

Related content: HOW TO LEVERAGE REAL ESTATE