Many consumers invest in assets to build long-term wealth. These investments can gain value over time and pay cash flow along the way. Although investors can choose from numerous assets, many investors gravitate toward real estate.
Real estate investing is a time-tested strategy to build wealth over time. Real estate is a tangible investment that acts as an inflation hedge, generates rental income, and provides many tax advantages. This guide will help you understand the basics of real estate investing and how to make it work for your portfolio.
Basics of Real Estate Investing
Real estate investing involves buying and selling properties in an effort to realize profits. Investors can use many strategies to achieve this objective, such as flipping properties or accumulating rental units. Real estate investments have several factors that impact their value, but location is the most critical component. A rising population and plenty of amenities can lead to property appreciation. However, rising crime and declining populations can hurt a property’s value. Investors have to monitor several variables to assess if a property is the right investment for them.
How Does Real Estate Investing Work?
Real estate investing involves buying properties and maximizing potential gains. Some investors buy and hold properties for the long run and collect monthly rent payments. These investors rely on low vacancy rates to receive consistent rent payments. Every year, many of these landlords raise rent equal to the rate of inflation or higher. Landlords have to review the state’s rules to determine how much they can raise the rent in a given year.
Some real estate investors use a fix-and-flip strategy. Investors take a short-term approach with these properties and usually take out hard money loans for them. The investor buys an underappreciated home in a promising neighborhood that needs some work. After renovating the home, the investor sells the home at a higher price to realize profits. The investors have to estimate their costs with close accuracy to minimize the likelihood of selling at a net loss.
Real estate investors look at various indicators that can tip them off on the future price movements of properties. They analyze macroeconomic elements, such as consumer spending, inflation, and interest rates. Investors also monitor changes in the local area, such as new schools, population growth, and other factors.
Best Places That Offer Real Estate Investing
Real estate investing is an accessible opportunity to build wealth in the long run. Investors can find properties through listing sites like Realtor and Zillow. These listing sites have many pictures of each property, making comparing and contrasting areas easier.
However, not everyone has enough money for a down payment. Real estate investment trusts and crowdfunding are two paths to real estate investing that make these assets more accessible.
The Benefits of Real Estate Investing
Real estate investing offers several advantages. These are some of the perks you can expect.
Build Wealth Over Time
Every mortgage payment increases your equity position. You can make mortgage payments through the rental income you receive from a property. Your properties can also appreciate over time and increase your net worth.
Real estate properties are filled with tax deductions, such as depreciation. It’s a key advantage real estate investments have over stocks. Investors can even defer all of their capital gains through a 1031 exchange. If the investor purchases a similar property within 180 days of selling their initial property, they can defer capital gains taxes.
Consistent Cash Flow
Rental properties can generate steady cash flow for investors. Some tenants stick around for several years and reliably make payments. While you can get some squatters and encounter challenges from time to time, long-term real estate investors can perform well. The steady cash flow can eventually replace your full-time job if you invest in enough properties.
Cash Flow Hikes
Real estate investors can expand their earnings by raising rent each year. These rent hikes expand their profit margins and help them counter inflation. If you obtained a fixed-rate mortgage for your property, the mortgage payments will stay the same even as rent payments increase. Expanding the gap between rental income and mortgage payments can help you get out of debt sooner.
Real estate is one of the best assets for leverage. You can acquire a property with a down payment as low as 3% and get out of private mortgage insurance once you have 20% equity in your home. Many real estate investors sue 30-year mortgages because they value higher cash flow instead of getting out of debt sooner. You also have the option of paying off your mortgage sooner with a 15-year term.
Borrowing Against Your Properties
Some real estate investors take out home equity lines of credit and home equity loans on existing properties to fund a new purchase. This type of leverage can work well in a bullish market and lead to higher returns. It’s possible to retire sooner with this leverage, but taking on too much leverage can be incredibly risky. Each investor should assess their risk tolerances and financial objectives before accumulating real estate properties.
You can raise the rent based on the rate of inflation. Even if you do not raise rent, your property is likely to appreciate over time as long as population growth and other factors remain good. Since properties are in limited supply, they can gain value due to inflation, similar to gold.
The Risks and Challenges of Real Estate Investing
Although real estate investing has great potential, knowing the risks before getting into the asset is important. These are some of the risks and challenges to keep in mind.
The real estate market has several risks that revolve around macroeconomic and local factors. Rising interest rates make it more expensive to borrow money and can lead to lower housing prices. This development can hurt people who want to sell their homes, but landlords will still receive monthly rental income as long as the tenants stay put.
Lower consumer spending can hurt your ability to attract and retain tenants and can force property owners to reduce their prices. However, a property owner must also consider the location, as some areas are more resilient to macroeconomic conditions.
Real estate investors also have to monitor changes in the area and think about what an area could look like in a few years. Many commercial real estate investors are leaving San Francisco due to the city’s decline. High crime rates, homelessness, and population declines have hurt investors. Some investors look for high-risk, high-reward opportunities, but not every investor wants to get into those areas. For troubling areas, investors have to look for signs of improvement, such as a lower crime rate and more amenities.
Property Management Risks
If you have one rental property, it’s still possible to do the property management on your own. However, property management takes a bit of work and becomes unfeasible for real estate investors who have many properties. You will eventually have to delegate property management to an individual or company.
These costs will minimize your profits, and there is a chance that some damages will get unaddressed. If your property management company doesn’t do a good job, many issues can arise, such as mold growing on your property. A neglected property can lose considerable value and require a large investment for repairs.
Hiring a reputable property manager or company will minimize your risk. You can look for online reviews and see how each property manager and company operates. You should see how much you have to pay the manager or company and see if it is in line with other offers. Real estate investors should reach out to several property managers, investors, and agents in the area for recommendations.
Real estate investors may avoid legal issues if they have small portfolios, but this risk can truly affect any investor. Tenants and landlords may have disputes about the relationship and what is expected from both sides. If a tenant destroys your property or a property management company fails to take care of your property, you may end up in court. Sometimes, you will be the damaged party hoping to get reimbursed. At other times, an individual or entity will sue you.
Legal fees can get expensive in a hurry, but they are a necessary evil for many real estate investors. Building up a savings fund with your real estate proceeds can help you navigate legal cases. It is a good idea to clearly lay out the terms of the lease agreement and other details and have the tenant sign them. That way, you can present these documents in court if necessary.
Mitigating Risk Through Due Diligence
You can’t avoid risks. Bad things happen to savvy investors due to the level of unpredictability in real estate. Unpredictability extends to all investments, but you can mitigate your risk through due diligence. Analyzing properties and locations can minimize the likelihood of making unprofitable investments. You can review tenant applications to determine which one is the most likely to make on-time payments and not give you any issues. Due diligence goes a long way for real estate and other investments.
Direct vs. Indirect Real Estate Investing
Direct real estate investing gives you direct ownership over the property. You did the research, made the down payment, and now must maintain the property. A direct approach involves more capital, but it also comes with more tax breaks and greater potential. You can make more money with direct real estate investing, but it also comes with more work.
Indirect real estate investing involves giving your capital to another entity that gives you exposure to their real estate portfolio. Real estate trusts make properties more accessible to investors. You can get exposure to industrial properties, self-storage facilities, and other real estate assets just by purchasing REIT shares. Many REITs trade on the stock market and offer more liquidity than direct real estate investments.
You can also use real estate crowdfunding sites or partner with a real estate syndicate to get indirect exposure to real estate. You won’t make as much money with this strategy, but someone else does all of the work for you. Investors who buy real estate indirectly do not have to worry about finding properties, conducting research, managing them, or receiving calls from tenants.
Direct real estate is more challenging and requires more capital, but you can achieve higher returns with that approach. Indirect real estate still generates cash flow but has lower returns. However, indirect real estate requires far less time than a direct real estate investing strategy.
Ways to Invest in Real Estate
Wondering how you can invest in real estate? Investors have several paths to get exposure to real estate. Some investors stick with one of these strategies, while other investors incorporate several of these strategies simultaneously.
Rental properties generate stable cash flow from tenants. You don’t need a large multi-family property to get started with this investment strategy. Small single-family homes offer an easy path to entry. Some investors buy duplexes so they can live in one unit and rent out the other.
You don’t even have to go through the hassle of buying another property to get started. Some people experiment with being landlords by listing their homes on Airbnb. You can list an extra room and see if you enjoy the experience. It’s possible to earn a nice side income by listing empty rooms in your house on Airbnb. However, you will make more money by purchasing rental properties instead of limiting yourself to extra rooms in your home.
Real Estate Investment Groups (REIGs)
A real estate investment group is an entity that prioritizes real estate investments to generate returns for investors. These entities are similar to REITs but do not meet the qualifications for becoming REITs. Real estate investment groups use pooled capital from many investors to acquire properties. Some REIGs immediately distribute cash flow to investors, while others wait to exit a property before distributing returns to investors.
Real Estate Investment Trusts (REITs)
Real estate investment trusts have vast real estate portfolios and focus on a sector. Some REITs specifically focus on industrial properties, while others focus on multi-family properties within specific parts of the United States. You can look at a REIT’s investor relations page to determine its objectives and how it seeks to generate returns for shareholders.
Real estate investment trusts are required to distribute 90% of their taxable income to investors. That rule results in higher dividend payouts than most stocks. However, cash distributions from REITs are treated as ordinary income. It’s less favorable than receiving cash as qualified dividends, but the high cash flow often compensates for this difference.
Real estate investment trusts that trade on the stock market are highly liquid. If you wanted to, you could day trade a REIT throughout the day. This capability is not possible with REIGs, real estate syndicates, or owning property. However, most real estate investors experience the highest gains by holding onto assets for many years.
Real Estate Limited Partnerships (RELPs)
Real estate limited partnerships follow the same basic concept as REIGs and REITs. Multiple investors team up and pool their money together to acquire properties. Each RELP has a general partner who has liability and makes acquisitions. The general partner receives the highest payout compared to the limited partners. Limited partners make passive investments and are protected from liabilities.
Real Estate Mutual Funds
Real estate mutual funds give you exposure to several REITs and real estate firms. A professional fund manager oversees the assets and adjusts the portfolio based on developments in the market. The fund manager aims to generate the highest possible return for investors.
Real estate mutual funds don’t require as much work as buying REITs. When you buy REITs, you have to conduct due diligence for each asset. However, a real estate mutual fund manager takes care of that for you. Instead of analyzing many REITs, you only have to analyze mutual funds to see if your money is in good hands.
Real estate investors can look at a mutual fund’s portfolio concentration to see how it distributes investors’ money. This information can help real estate investors choose mutual funds that align with their portfolio goals and offer optimal diversification.
Multi-family Real Estate Investments
Multi-family real estate properties have high down payment requirements due to their value. You may have to put hundreds of thousands of dollars into the down payment and then contend with high mortgage payments.
Despite these requirements, many investors flock to multi-family real estate investments. These properties consolidate your tenants into one area, which minimizes property management costs. Instead of having 10 tenants within a 50-mile radius, you can have 10 tenants who all live in the same building.
Many multi-family real estate investors get their start with smaller rental properties. After accumulating enough of these rental properties, investors sell them and use the proceeds to buy a multi-family property. A high income can accelerate the process of acquiring multi-family properties, but it usually starts with a small portfolio that the investor scales over time.
Flipping Investment Properties
You don’t have to hold onto a property for many years to make a profit. Some investors prefer to part ways with their properties within a few years. Walking away from properties quickly can minimize the headaches and gives investors the ability to take a break when needed.
Flipping investment properties is a popular strategy. Investors look for beat-down homes in desirable locations that can use some work. Since these properties need repairs, it’s possible to acquire them for lower than their market value. The investor looks at the property and calculates how much it will cost to renovate the property. After buying the property and making the necessary renovations, the investor resells the property at market price.
Keeping renovation costs low will increase your returns, but low-quality renovations can scare away buyers. Real estate investors have to maintain this delicate balance if they get involved with flips. You can reduce your monthly expenses for property flips if you use a hard-money loan. These loans start off with interest-only payments and give you enough time to fix and flip the property before you have to make monthly principal payments on your loan.
Real estate crowdfund allows you to explore investment opportunities and contribute to the project. You will receive cash flow and other profits from the property based on its performance. Investors don’t have to make large payments to get exposure to these properties, and each crowdfunding project has different rules about when you can realize your profits.
Real Estate Investing Tips & Tricks
Knowing the foundational real estate investment strategies can help you avoid beginner mistakes. While your real estate investing journey will have ups and downs, these tips & tricks can get you on the right path.
Assessing Your Current Financial Situation
Real estate investing is not for everyone, and it is important to review your finances before committing to a property. Some people have enough money to make a down payment, but that down payment can hinder your ability to diversify into other assets. Putting all of your eggs in one basket is very risky, and it’s not worth it for most investors.
You can receive comparable returns by investing in real estate investment trusts and teaming up with other investors instead of doing it on your own. You can use these real estate investment opportunities to build up your portfolio and eventually make your own acquisitions. Investors should consider their financial profiles, goals, risk tolerances, and alternatives before acquiring real estate properties.
Research Your Area and Market Trends
Real estate investors have to monitor their area and market trends to assess if now is the right time to acquire a property. Investors who skip this step may end up with bad deals and see their properties lose value due to predictable circumstances that they overlooked. Researching your area and branching out can help you discover promising properties that help you build wealth.
Finding the Right Investment Property/Strategy
The top real estate investors continue to look for opportunities even if they are not interested in buying properties at this time. Each property listing will help you build your portfolio criteria and can guide you to better investment decisions. You can also get a better understanding of which investment property and strategies work for you.
Some investors prefer to buy small single-family homes. Smaller properties have lower valuations, which makes it easier to acquire several of them. Other investors prefer to fix and flip properties so they don’t have to worry about the asset for many years. You can only discover the right investment property and strategies by assessing your choices and considering your preferences.
Conducting a Real Estate Investment Analysis
Real estate investment analyses allow investors to gauge how a potential acquisition target will perform. These analyses can also help investors assess properties in their portfolio and look for opportunities to improve returns. Real estate investment analyses can get as simple or as complex as you desire, but they all consist of a few components.
Investors look at a property’s net operating income (NOI). This metric reveals how much rental income is left after operating expenses. Investors will also look at an acquisition target’s cap rate to assess the property’s risk and reward dynamics. A higher cap rate indicates a higher risk that can result in higher yields if it pays off.
Real estate investors gather as much data as possible to make their decisions. Investment analysis involves looking for key insights that can help you feel more confident with your investment decision. Investment analysis can reveal a promising property or make you realize that a potential acquisition target isn’t as promising as it initially appeared.
Closing on Your Investment
Closing on an investment allows you to acquire the property. You can then start receiving monthly rental income or fix it up so you can resell the property in the future. However, the steps leading up to the agreement can help you save money if you negotiate well.
Negotiation is a critical component of real estate investing. You can mention key points to demonstrate why the seller may benefit from lowering their price. For instance, if you can make an all-cash offer, many sellers will agree to a lower price for quicker access to cash.
A quick close can also help with a smooth transaction. Any delays may cause the seller to reconsider your offer and see if any other buyers are interested. Quickly providing the necessary documents can lead to a seamless and timely close.
Maximizing Rental Income
Once you have a property, it’s time to maximize your rental income. A real estate investor can compare market rates and set their rent payments accordingly. If the area they invest in experiences population growth, investors have the opportunity to raise the rent each year. Those rent hikes can lead to higher rental income.
Many investors start by purchasing a nearby property, but expanding your search to areas out of your state can help you discover more promising properties. Distributing your real estate portfolio across multiple states can help you tap into areas that are experiencing the highest population growth and rent increases. Investors can also maximize their rental income by looking for other opportunities to charge tenants, such as for parking. Some real estate investors have the flexibility to charge a monthly fee for parking.
Tax Strategies for Real Estate Investors
Real estate investors can use several tax strategies to minimize their expenses. They can use depreciation to write down their property’s value and save on taxes. It’s also possible to defer your taxes after selling a property through a 1031 exchange. This rule gives you 180 days to buy a similar property to defer capital gains taxes.
If you sell a duplex, you must buy one within 180 days for the 1031 exchange to take effect. You might have no issue with buying a triplex or a quadplex with the same funds and capitalizing on the tax benefit. However, if you sell a duplex and use those proceeds to buy a primary single-family residence, you won’t get the benefits from the 1031 exchange.
You can also borrow from your property through a home equity line of credit instead of selling it. The home equity line of credit gives you access to significant capital, but you don’t have to pay taxes on any capital gains. You might even be able to write off interest payments that go toward the HELOC, depending on how you use the capital.
Real estate investors can capitalize on many deductions, and it is best to speak with a professional to see how much you can trim from your taxes. Property taxes, maintenance costs, advertising costs to get new tenants, and legal fees are some of the expenses you can deduct from your taxes.
Should You Invest in Real Estate?
Real estate investing can help you achieve your portfolio objectives and have financial security. The cash flow from rental properties can exceed your monthly expenses and help you retire sooner. Real estate properties also give you more flexibility and access to capital when you need it. You can take out a home equity loan or use a home equity line of credit to access additional funds. The tax write-offs can trim your tax bill, and real estate offers more tax advantages than stocks.
While real estate offers many benefits, this asset is not for every investor. Real estate investing can quickly become a full-time job since you have to manage the property, ensure workers perform well, and receive tenant calls. A lot of work goes into being a landlord. You can delegate these responsibilities and minimize your involvement with each property, but hiring those people and companies costs money.
Real estate leverage provides a viable opportunity to scale your portfolio. As long as your monthly rental income exceeds your monthly mortgage payments, you can scale with ease. However, not every investor wants to take on that level of risk. Rising vacancy rates can surprise investors and create financial stress, especially for investors who use high leverage.
Real estate has its risks and is capital intensive. However, it is an inflation hedge that can generate substantial wealth in the long run. If you do not want to invest in real estate directly and don’t want to deal with tenants or issues, you can invest with a group of investors instead. Real estate investors have many opportunities to pool their money with investors, such as REITs, REIGs, and crowdfunding sites. These paths require less capital and tend to have more liquidity than real estate properties.
REITs, in particular, are highly liquid. You can start a position and leave it on the same day. Real estate properties do not provide that level of liquidity.
Investors have many ways to gain exposure to real estate. They can do as much or as little work as they desire and receive returns from their investment. Owning property comes with more advantages but also more responsibilities and costs.
How to Get Started Investing in Real Estate
Real estate investing gives people many ways to generate wealth. You can make money from rental income, flipping properties, and other strategies. Investors have many ways to pursue this investment opportunity.
The way you get started with real estate depends on your risk tolerance, financial goals, and the amount of capital you have available. If you do not have enough capital for a down payment or don’t want to take that risk yet, you can get started with real estate investment trusts. Many REITs trade below $100/share, and you can also buy fractional shares to initiate positions.
Investors with more cash to spare may want to consider a down payment on a property. Whether you are committed or on the fence, you should look at real estate listings in your area. Checking out several listings can give you a better idea of what types of properties fit your criteria. It’s important to see good listings and bad ones so you can tell the difference.
Your first property or share in a REIT or mutual fund will give you a taste of real estate investing. When the cash flow arrives, you can decide to keep the money for expenses or reinvest it into other properties.
Real estate gives investors many opportunities to scale, but you have to consider your risk tolerance and financial goals. Some real estate investors can retire happily with 5-10 rental properties. Other investors want to get more ambitious and own multi-family properties. You can start investing in real estate with any amount of capital. As you make investments, you will learn more about the industry, become a better investor, and potentially see your returns grow.