Intro: Investing in Real Estate | Guide on How to Invest in Real Estate
You may already be investing in traditional stocks and bonds, but have you ever considered investing in real estate?
It may sound like something only moguls and high net worth individuals engage in, but that could not be further from the truth. While wealthy people can invest in real estate at a higher scale, millions of Americans are technically investing in real estate. How? By being homeowners.
For most people, their home is how they invest in real estate—although they may not think of it that way. In the public’s imagination, “investments” are associated with things you cannot touch like stocks.
But a home is one of the most tangible investments you can make. Its value has growth potential, but it also has the distinct benefit of being a place to live. Unlike a stock or a bond, you can enjoy your home every single day.
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Investing in real estate has many positives, but it also carries some downsides. In fact, its biggest perk—its existence in the physical world—is the cause of one of its biggest negatives: the need for maintenance.
Understanding how to invest in real estate involves an appreciation of the physical responsibilities owners must take for their property.
Real Estate Investing for Dummies: How to Start Investing in Real Estate
There are several ways for a person to invest in real estate and a number of different options. Those who are familiar with investing but new to investing in real estate will be surprised at how intuitive the basic options are.
If you are deciding how to invest in real estate, there are two initial questions you need to answer:
- Do I want to invest in the public market or the private market?
- Do I want to invest in debt or equity?
How to Start Investing in Real Estate: Private Markets
One of the most common ways in which everyday people invest in real estate is through income-generating property via direct homeownership. A person or group of people will buy a piece of property and then rent it out to somebody else. They then collect the rent and use it to either pay the mortgage on that house or use it for other expenses. They can raise the rent depending on any increase in the property’s value (within certain guidelines stipulated by tenant rights) and have control over selling the house.
This can be scaled up. Somebody with a high net worth (or a group of people who pool their money) can buy a large piece of property and rent it out to multiple individuals. Normally, this kind of arrangement requires a property manager who can maintain the property on behalf of the owner or owners.
Deciding how to invest real estate could be as simple as renting out your basement or buying an entire building and seeking tenants.
There are advantages and disadvantages to investing in real estate in this way. The advantages are pretty clear. Your asset is physical, and it has a distinct purpose outside of generating income (i.e., providing shelter).
The negatives include the number of responsibilities that are tied to making money from the property.
Not only are you responsible for property taxes and maintenance, but you can also be held liable for tenant issues that result from any negligence. Additionally, property prices can fluctuate, and if they go down, this can affect how much money you can make from future tenants.
How to Invest in Real Estate with No Money: Public Market
If you do not have enough money to buy property, but you are set on real estate investing, investing in real estate in the public market is an option.
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A popular way to do this is by investing in a Real Estate Investment Trust, also known as a REIT. They trade on major exchanges and invest in property or mortgages. REITs provide investors with a highly liquid way of investing in real estate.
They have the same functionality as a stock in the sense that they are traded. The difference is that the trust is required to invest in property. REITs make investing in real estate accessible to people with varying income levels, much like a mutual fund.
How to Start Investing in Real Estate: Investing in Equity
If you invest in equity, you are essentially a partial owner of the property whether it’s privately as somebody collecting rent from their income-generating property or as an investor in an REIT.
Investing in real estate equity means that when the market is doing great, you will benefit greatly through an increase in the value of your REIT and the dividends you receive.
REITs are not the only option for those who wish to invest in real estate equity. Another option is to look for property-owning companies that are publicly traded and invest in them.
A helpful comparison to traditional investing is to think of investing in real estate equity in the public market like investing in stocks. You have a stake in the property (company), and you benefit or lose depending on how well the property (or company) does.
How to Start Investing in Real Estate: Investing in Debt
Another option is to invest in real estate debt. At the private level, this would mean investing in mortgages by lending others the money they need to buy a house.
At the public level, investing in real estate debt would mean an investment in specific kinds of securities, like a mortgage REIT or a mortgage-backed security (MBS). The role of mortgage-backed securities in the 2008 financial crisis has sullied their reputation.
How to Invest in Real Estate: Do Your Research
No matter which of those four ways you choose, remember that all of them have underlying physical properties. This means that when you invest in real estate—whether directly or through the public market—it is important to do your research to understand the value of the property, factors that could affect that investment, and, in the case of property owning companies, its management history.
There are two important factors to consider when purchasing a piece of property. You already know the saying: “location, location, location.” If you plan to invest in real estate, take a good look at the surrounding area of the property you are interested in.
Naturally, property that is located in already popular areas will carry steep prices, but if you’re smart and have your sights set on the long game, educated guesses about the future popularity of an area can be very profitable. If there are plans to develop an area within the next few years, a pricey but relatively low investment now could mean high returns later when a neighborhood becomes more popular.
When it comes to what exactly you want to purchase, remember that different kinds of property perform differently based on different factors. One property type may do exceptionally well in certain economic conditions while another does not. Consider the sort of property you are buying (e.g., residential, commercial, warehouse) carefully before purchasing.
Directly Investing in Real Estate: Deciding on the Rent
If you choose to rent out a piece of property to tenants, you benefit in two ways: a monthly income in the form of rent and, if the housing market treats you right, gains in the value of your home. But keep in mind that you should not just arbitrarily pick a number to charge your tenants.
Investing in real estate through renting out property is not as simple as charging your tenants the same amount as your mortgage payment. Be mindful of things like maintenance fees, property taxes, and your desire to see some profit. These are all things you should take into consideration when deciding on a number.
Best Places to Invest in Real Estate
Forbes reports that 2016 will not be a great year if you are hoping to purchase a home, but a good year if you plan on investing in real estate.
Their suggestions for where to invest in real estate in 2016 include Grand Rapids, Michigan; San Antonio, Texas; Charlotte, North Carolina; and Seattle, Washington, among others.
If you choose to go the REITs route, there are several factors to consider. Investors should consider the company’s dividends, how often they’ve cut their dividends, and whether they pay their dividends using borrowed money. This gives investors a good indication of companies’ cash flow. If the dividends have been raised, that’s an indication of a safe bet.
Another attractive feature of REITs is that they allow modest investors to enjoy the benefits of investing in large-scale properties like office buildings or shopping malls.
How to Invest in Real Estate: Flipping Houses
You’ve heard of day traders? The high risk, high rewards traders, also known as speculators, who buy securities, hold on to them for a short period of time (usually less than a day) and then sell them quickly with the hopes of making quick money. A relative of day traders exists in the world of investing in real estate, but these people flip houses instead.
People most often think of house flippers as people who buy a house, spruce it up, then sell it for a higher price. Real house flippers do not put any additional money into their property. Instead, they buy them under the assumption that they are worth more than listed. On average, house flippers hold homes for three to four months.
This way of investing in real estate can be particularly tricky. If a flipper has difficulty selling the property, they are in for a serious cash flow crisis. Oftentimes, house flippers purchase homes without the intention (or resources) to pay the mortgage long-term.
If they are successful, house flippers have the opportunity to make a lot of money in a short period of time, but if they aren’t, they also stand to lose a fair amount.
There are also the house flippers people are more familiar with, who buy homes for a decent price, invest some money into renovating it, and then sell it for a higher price. This is normally a less risky strategy since these kinds of house flippers must plan for the long term.
How to Invest in Real Estate: Look at the Big Picture
Investing in real estate has the potential for regular income and can be a relatively safe investment, but that does not mean it is a guaranteed one. Additionally, real estate investors should be wary of other factors that could limit their return on investment.
The most straightforward way of real estate investing—direct investing in property—can be used to demonstrate this.
If you buy a house without any plans to rent it out in the hopes that it will be worth more later (while you enjoy it in the meantime), keep in mind that even if the price goes up, there will be additional costs that either make that gain negligible or end up costing you.
Expenses like renovations and landscaping to make the house more attractive to buyers, advertising of the sale, appraisal costs, brokers’ fees, and lawyers’ fees are all things that need to be taken into consideration.
When investing in real estate it’s important to consider the big picture.
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