With real estate prices steadily rising, signaling a full recovery from the Great Recession, you may be interested in learning how to start investing in real estate. Read on to learn more.
Table of contents [Hide]
What is Real Estate Investing?
Real estate investing is the purchase of land or property for the purpose of profit. Real estate investing can be done in several different ways. Real estate investing has traditionally only been available to those with over $100,000 available to invest. 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.
5 Ways to Get Started with 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
The following three methods are our most recommended ways of breaking into passive real estate investing
1: Invest in 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.
List of REITs
Here is a list of REITs where you can get started:
2: 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.
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.
3. Real Estate Mutual Funds
Real estate mutual funds operate like normal mutual funds and offer many of the same benefits. Investing in a real estate mutual fund over a REIT is akin to investing in a stock mutual fund vs an individual stock.
Pros of Real Estate Mutual Funds
Real estate mutual funds overall offer a greater level of diversification than a standard REIT. This can shield investors for single bad investments a REIT may be invested in. Real estate mutual funds are also better for those who want to buy and hold long term. Mutual funds generally see their returns stemming from the appreciation of a property, which takes time to develop.
Cons of Real Estate Mutual Funds
Real estate mutual funds can be a bit more expensive than REITs. Mutual funds are actively managed by a fund manager, who is making adjustments to the funds investments. To compensate the fund manager, the mutual fund has to charge a higher fee to those investing in it. Mutual fund fees can be upwards of 2%. REITs on the other hand can have less than 0.5% management fees.
Active Real Estate Investing
Active real estate investing is generally what people picture when they think of real estate investing. Active real estate investing includes buying residential buildings, flipping houses, and leveraging short term rentals.
1: Buying and Managing Rental Properties
Buying an investment property is the basic approach toward real estate investing, with renting being an obvious method to bring cash in. On buying a property and renting it out to a tenant, the landlord gets enough money to pay off the costs associated with owning a property, namely mortgage payment, taxes and maintenance costs. Most often, the rent is 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 should 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 in a lot of effort into researching the property you want to buy, but also the neighborhood it is. 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.
2: Flipping Houses – Buying, renovating and selling properties
Flipping houses is one of the most well known real estate investing tactics. You find a home on the market, buy it (preferably at a below market rate), fix it up and sell it for a profit. It sounds simple and is a reason why it is highly popular. However, while it sounds simple, flipping houses can be quite risky, take a lot of hard work and can be quite stressful if you are inexperienced.
Pros of Flipping Houses
If you can execute on it right, flipping a house can net you well over $100,000 making it one of the most lucrative forms of real estate investing. If you can successful flip a house, you can then use the profits to fund another property, which can yield even more profit. Flipping houses gives you as much control as you want in the real estate process of any other method listed in this guide.
Cons of Flipping Houses
Like buying a rental property, flipping houses can also go entirely wrong if you are inexperienced or do not give respect to potential pitfalls. One of the biggest mistakes people make when flipping a house is underestimating the cost of renovating properties. Setbacks and added costs can end up sinking your profit margin or just allow you to break even. You can end up spending countless hours on a property for it to only net you back your original investment, or worse, net you a loss.
Wholesaling is similar to flipping houses minus the renovation part. Wholesaling can be a risky but lucrative venture where you buy the contract or deed for a piece of property at a below market rate and sell it to a home flipper who believes they can renovate the house and sell it for an even higher profit.
Pros of Wholesaling
Real estate wholesaling takes out the hassle of managing the property but keeps the potentially lucrativeness of home flipping. Wholesalers can make huge profits with almost zero physical or managerial work.
Cons of Wholesaling
Wholesaling can be a risky business however. To be successful at wholesaling requires patience, commitment and savviness with real estate. For you to make a profit, it will require you to be able to find a homeowner willing to part with their home at a below market rate, and then being able to find an investor willing to buy it at a higher price. To be successful in wholesaling, you should already come prepared with a network of potential investors you can rely on to buy the homes you find.
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
- Profit 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.
For those who have the capital, active real estate investing can be an even more lucrative venture – 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.
Find Professional Financial Advisors Near You
Do you have 5 minutes to connect with financial advisors in your area? SmartAsset is equipped to match you with local advisors that can help you with all of your financial needs. The candidates have been thoroughly vetted by SmartAsset so you can rest assured that you’re working with the best, with your best interest in mind. Get started now for your perfect match.