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How to Invest in Real Estate: 5 Investing Strategies

How to Invest in Real Estate: 5 Investing Strategies
16 Aug
3:38

Updated on Monday, August 16, 2021

Learning how to invest in real estate doesn’t necessarily mean you need to buy property. And it may be easier than you think to get started. Real estate is one of many ways to invest outside of your traditional portfolio, and it can offer some important diversification benefits.

There are several ways to invest in real estate: You can buy a property and rent it out, buy products like mutual funds or REITs, or even channel your inner HGTV star and flip a house. These strategies range from very hands-on property management to hands-off investments.

5 ways to invest in real estate

So, you want to learn how to invest in real estate? Or just try to answer, once and for all, what is a real estate investment? There are numerous ways to invest outside of the traditional assets (think: stocks and bonds) in your portfolio, and things to consider if you do so. Here are some of the main ways that investors can start investing in real estate:

1. Rental properties

As of the end of 2020, there were around 42 million renter-occupied homes in the U.S. For prospective real estate investors, that is an opportunity to make money by purchasing a property and renting it out.

Tenants pay rent, bringing in revenue, and there’s a chance that the property could gain value over time, providing investors with additional returns when or if they choose to sell it in the future. Some investors are drawn to rental properties as a way to generate passive income.

But this route to real estate investing also involves becoming a landlord, which can be a lot of work. You’ll need to manage a property, make sure that mortgage payments and taxes are paid, the building is up to code (per local rules), and that tenants are actually paying the rent.

The average rate of return on rental properties is around 9%. That’s more or less equal to the long-term average annual return for the S&P 500 for the past 10 years.

2. Real estate mutual funds

If becoming a landlord doesn’t sound all that appealing and you’re still looking at how to invest in real estate, you can always turn to the markets. Real estate mutual funds are, effectively, a way for investors to pool their money (mutual) and buy a basket of investments (funds) that have exposure to the real estate market.

These mutual funds offer investors a way to invest in real estate with a high degree of liquidity, meaning you can convert to cash relatively quickly (and without incurring a lot of fees). Real estate mutual funds are also easier to invest in than buying a property, flipping or renting it out, and then selling it. They’re also very similar to another market-based approach to real estate investing: REITs.

Funds come in many different shapes and sizes, but generally offer investors average returns of about 9%.

3. REITs

REIT is an acronym that stands for “real estate investment trust,” and is another type of investment that gives investors direct exposure to the real estate market.

There are many different types of REITs — some that invest in real estate in certain areas or regions, while others that invest in commercial buildings, for example. Investors may be able to purchase REITs directly from their brokerage accounts, like they would a stock. Like mutual funds, price moves in REITs are largely at the whim of the markets, so there are risks associated with investing in them.

Returns on REITs can vary in a big way. But they often do outperform the stock market. Between 1990 and 2020, annual returns on REITs outperformed stocks 56% of the time.

4. Flipping houses

If you’ve seen any HGTV show in the past decade or so, you’re likely familiar with house-flipping. Essentially, flipping a house means an investor or company purchases a property (usually a run-down one, perhaps in a rough neighborhood) for relatively cheap, renovates and restores it, and then relists it for significantly more than the purchase price.

When the house sells, these real estate investors stand to reap big-time returns. Obviously, though, there are a lot of variables in the mix, and things can (and do) go wrong for house-flippers. But again, the returns can be big: Recent data shows that the typical profit from a successful flip can add up to a return on investment of more than 41%.

5. Micro-investing platforms

There are a number of online platforms investors can use to gain exposure to the real estate market. Generally, these platforms allow investors to make micro-investments, in which they pool their money with other micro-investors to purchase a property or fund the construction of a new property.

Real estate micro-investments are a similar model to a REIT, and for investors who lack significant capital, this can be a good way to get in the game and to own specific properties. And what is real estate investment anyway, if not just another brick in your portfolio’s wall?

As for returns, your mileage may vary. But some micro-investing platforms boast average annual returns of more than 9% over the past several years.

Investing in real estate: How to get started

Now: How do you actually get started investing in real estate? It may come down to a series of relatively simple steps. Consider this a “real estate investing for beginners” flash class.

Step 1: Find out how much money you need

Real estate investing can require a lot of money — or you may be trying to figure out how to invest in real estate with very little or no money. The amount of money you need really depends on the type of real estate investment you’re eyeing. You may need tens or hundreds of thousands of dollars to purchase property, for instance, and use “leverage” (or, other people’s money) to help fund the rest.

Or you can invest in a popular REIT, like the Vanguard REIT ETF (VNQ) for far less money, for example. In other words, costs vary wildly. Luckily, the various options make real estate investing for beginners more feasible. To figure out the best way to invest in real estate with your budget, sit down and think about how much money you have to invest.

Step 2: Choose the type of real estate investment

If you’re learning how to get into real estate investing, knowing what dollar figure you have to invest can help you narrow down the type of real estate investment you’ll want to make. Again, for investors who are trying to figure out how to get into real estate investing, or who don’t have much to invest, the best route may be to look at mutual funds, REITs or micro-investing options.

But those investors who have a significant amount of capital can aim bigger: They may be able to flip a house or buy a rental property. It’ll depend on your risk tolerance and capital constraints.

Step 3: Get funding for your investment

For those looking to flip or purchase a rental property, funding is important. Investors can go about getting a loan to buy property much in the same way you’d get a mortgage to buy a home. There are some differences — these mortgages can be harder to get and pricier, for instance — but if you don’t have the capital reserves, investment property loans are available.

Step 4: Invest in real estate

Now comes the easy part: With capital in hand and an idea of how you want to invest it, you get to actually make the investment. Again, how this step actually plays out will depend entirely on an individual investor’s goals — some people will buy REITs or invest in mutual funds, while others will want to find properties to purchase.

Step 5: Network with other real estate investors in your area

Now that you’re in the game, you’ll want to keep up with the latest news, laws, and market movements. It’s important to understand the dynamics that will affect the return on your particular real estate investments — for example, there are some markets where investing in housing beats the S&P 500’s return.

This type of research can be daunting, so it may be a good idea to network or join a group with other investors in your area. It can be easier than you think to track people down, too: Meetups may be fairly common, and you can also look for local classes, social media groups or even visit open houses to meet other investors.

This can help complement all of the “real estate investing for beginners” research you’ve conducted.

Pros and cons of real estate investing

If you’re really trying to get a sense of the risk-to-reward dynamic, here is a short list of the pros and cons of real estate investing:

Pros

  • Cash flow: The rent needs to be paid every month, and if you own property, that’s (hopefully) providing a steady stream of income. After the bills are paid, landlords can keep the remainder as profit. And there may be attractive opportunities to invest in vacation homes.
  • Appreciation: Real estate tends to increase in value over time. While the market can enter a correction period, and there are numerous variables that affect a property’s value, the average home appreciates between 3.5% and 4% per year.
  • Tax breaks: Property owners may be able to take advantage of a slew of tax breaks and deductions open to property owners. That includes writing off depreciation, and even deferring capital gains taxes.

Cons

  • Illiquidity: Aside from REITs, real estate is an illiquid investment — it’ll take time and money to sell, if you need to.
  • Barriers to entry: As discussed, it can be expensive for beginners to invest in real estate. Buying property requires capital, and even once you’ve made an investment, there can be a steep learning curve to learn the ins and outs of the market.
  • Ongoing costs and upkeep: Real estate requires an active hand — you can’t simply “buy and hold” as you might with stocks. If you own property, it requires upkeep and management, all of which will cost an investor.

Investing in real estate vs. stocks

How does investing in real estate compare with investing in stocks? Investors may be interested in either or both strategies, of course, but it’s important to have a broad overview of the pros and cons when comparing the two — and, of course, their potential returns.

Investing in real estate vs. stocks: Pros and cons
Real estate Stocks
Pros
  • Regular cash flow
  • Appreciation
  • Tax breaks and deductions
Cons
  • Often illiquid
  • High upfront costs
  • Ongoing costs
  • Market volatility
  • High competition
  • Often highly risky

Is investing in real estate worth it?

Finally, when you get down to it, it’s worth asking yourself: Is investing in real estate worth it? Unfortunately, there’s no clear-cut answer. It depends on your goals as an investor, and other factors like how much risk you’re willing to take on and what you’re hoping for in terms of returns.

That said, whether real estate investing is “worth it” may come down to factors like how much you’re looking to invest, and how you plan to do it — buying some REITs versus flipping a house, for example. If you like to take an active hand in managing property, or if you’re particularly handy around the house, you might make an excellent landlord. If you’d rather take a “set it and forget it” approach to investing, on the other hand, it may not be the best choice for you.

Investing in real estate FAQs

How much money you should have to invest in real estate will depend, primarily, on how you plan to invest. If you want to take a market-based approach via REITs or mutual funds, you can start with almost any amount, whereas acquiring property could cost tens or hundreds of thousands of dollars.

It’s possible to get a mortgage with no cash down via certain types of home loans, which could then be turned into a rental property. But if you have no money, it may be a good idea to work on building your savings before building out a real estate portfolio. In short, it’s difficult to invest in real estate with no money.

While “best” will vary from person to person, the easiest first real estate investment is likely a real estate mutual fund or purchasing shares of a REIT. But you should speak to a financial professional if you want more guidance.

How much money you can make investing in real estate depends on many things. If you own property, your returns will depend on factors including, but not limited to, where that property is located — again, property in San Francisco is likely to generate more cash flow than one in Rapid City, S.D. That said, the average ROI for rental properties is around 9% annually, and for investments like REITs, it’s roughly the same — 9.4%, according to data from the National Council of Real Estate Investment Fiduciaries.

The “Find a Financial Advisor” links contained in this article will direct you to web pages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.

Source: https://www.magnifymoney.com/blog/investing/how-to-invest-in-real-estate/

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