Real estate investing is a time-tested way to put your money to productive use. The fundamental appeal of real estate investing is the ownership of a tangible asset. That asset can generate regular rental income as well as capital appreciation that can multiply your wealth over time. That’s a compelling proposition, but you will need to navigate the intricacies of this capital-intensive asset class in order to make sustainable returns.
To get the returns you want from real estate investing, you’ll need to identify properties of the type, location, and price that suit your investment goals. The expected returns on your investment should be sufficient to justify your risk. You’ll need to consider the usual costs of owning real estate. Those include utility bills, periodic maintenance, property taxes, and insurance. That’s a lot to assess, and overlooking any factor could put a serious dent in your returns.
Let’s take a closer look at some of those factors, and at some practical ways to start investing in real estate.
📚 In this post:
- How You Make Money From Real Estate Investing
- Challenges and Risks of Real Estate Investing
- 7 Ways to Start Investing in Real Estate
How You Make Money From Real Estate Investing
Real estate investment can produce two types of gains: value appreciation (growth) and rental revenue (income).
Real estate can rise in value. If it does you can eventually sell your asset for more than you paid for it. There are three main drivers for value appreciation.
- Overall market conditions. National real estate trends affect property values nationwide, and they rise and fall according to macroeconomic conditions.
- Local market conditions. Property values in specific neighborhoods can rise or fall according to local economic and demographic trends.
- The condition of your property. Investing in upgrades and maintenance can significantly increase the value of a property.
All of these drivers can work in both directions.
👉 National real estate markets can fall as well as rise.
👉 Neighborhoods can deteriorate and property values can decline.
👉 If you don’t keep a property up its value can fall.
You’ll have to assess market and local conditions and the maintenance needs of a property carefully before investing.
In this case, you invest in a piece of real estate, such as an apartment building. You operate it with the aim of collecting rent from tenants.
Apartment rentals are just one way to generate rental income. You can also generate a cash flow income from other types of real estate properties, such as commercial buildings (office or retail), warehouses, storage units, and rental houses.
Value appreciation and rental income usually move in sync with each other. Properties in desirable areas command higher rent and attract more reliable tenants. That makes the properties more attractive to buyers and moves the asset value higher.
Challenges and Risks of Real Estate Investing
Real estate investing sounds simple, but simple should not be mistaken for easy. A large capital investment is usually required. The costs of financing investment properties can be significant. Real estate investments may be illiquid, meaning that they can take considerable time and effort to sell.
⚠️ Considering the large size of the investment and its relative illiquidity compared to other asset classes such as stocks, your investment decision must be backed by astute market research.
Real estate investing is not something you can approach on a trial and error basis. Hope and luck are unlikely to deliver returns. Owning a rental property or operating as a home flipper carries risks. Your borrowing costs, repairs and maintenance, insurance and taxes are not going to wait if the market goes bad and you have a high vacancy rate. You’ll need the skills and knowledge to evaluate properties, predict market trends, manage your cash flow, and deal with tenants.
Risks of liability, risks of taking on too much debt, unforeseen repair and maintenance issues, changes in regulations, and macro-economic risks must be objectively considered before you take the plunge.
⚠️ Never base your estimated returns from a property on “ifs”. Answer some tough questions before you start as an investor. “Will I survive if this property performs 30 percent lower than the current market trends?” “Do I have an exit strategy in place?” These are questions you’ll need to answer before investing in real estate.
7 Ways to Start Investing in Real Estate
Here are some proven real estate investment strategies. These methods can work effectively for beginners as well as for seasoned investors.
1. Rent Out a Room or a Part of Your House
If your goal is to create passive income, you may consider renting out a part of your home or a spare room. Longer-term rental contracts can provide a steady stream of income. Short-term rentals (such as through Airbnb) could mean fluctuating monthly returns as tenants come and go. This strategy may be more effective if you live in an area that attracts tourists or other transient visitors.
👉 Because you already own the property, you may be able to make this investment without a large initial expense.
👉 You may still have to invest in home improvements before you can expect to rent out your spare space at home.
👉 Be mindful of the hidden costs, such as utilities, maintenance, and insurance.
👉 Consider potential vacancy periods, especially if you’re borrowing to fund renovations.
All of these factors have an impact on whether it makes financial sense to rent out a room.
💡 Research the costs of hotels or competing rental properties in your area to get an idea of how much you can charge.
2. REITs or Real Estate Investment Trusts
A REIT is a useful real estate investment vehicle when you want to avoid a large, capital-intensive real estate transaction. REITs are created when a trust or a corporation uses funds from a pool of investors to buy and
operate income-generating properties. You can buy and sell many REITs on stock exchanges, making them among the most liquid real estate investments.
Real estate investing through REITs is a simplified way to make smaller investments. 90 percent of the taxable annual profits from a REIT must be distributed to shareholders in the form of dividends. If you are seeking a relatively stable income from real estate, a REIT may be an option worth exploring.
If you want to devote a portion of your portfolio to real estate but don’t have the capital to buy a property, REITs can be a great option. They also allow diversification without excessive expense.
3. Investing in a Rental Property
Do you have some DIY and property renovation skills? Are you willing to go through the continuous exercise of screening and managing tenants? If you answered “yes”, investing in a rental property could be a lucrative option.
You need to have a significant amount of working capital upfront to finance the property acquisition, and you’ll need to consider some potentially significant costs:
- Interest (if you acquire the property with a loan)
- Maintenance and upkeep
- Tenant screening
- Vacant periods
Rental property investing gives you an opportunity to earn a regular income as well as the potential for capital appreciation over time. Through judicious use of leverage (borrowing to acquire an investment that generates enough return to pay for the debt and interest), it is possible to create a solid income while maximizing your tax deductions for related expenses.
☝️ Consider the risks of overleveraging, high vacancy rates, and tenant problems before you go ahead. Remember that taxes and other cost elements can change, and maintenance expenses are not always predictable.
Some rental property owners choose to engage property management companies to handle tenants and maintenance. These services come at a significant cost, which can cut into your returns.
💡 Worried about overleveraging? One way of mitigating the risk of investing in rental properties that grew in popularity over the past couple of years is house hacking: buying a property, living in one part of it, and renting out the spaces you don’t occupy.
4. House Flipping
House flipping is a form of active real estate investing. This may not be the best option for beginners who are not well-versed with the property marketplace or do not have the renovation and marketing skills that are often necessary in this form of investing.
In a sense, you can compare house flipping to stock day trading. House flippers typically buy and sell undervalued properties for a small profit in six months or less. In some cases, the real estate flipper may not even invest in fixing the property and may focus on properties that have an intrinsic value that is higher than the current buying price.
☝️ Property flipping requires agility and experience. If a hot market begins to cool, you could be stuck with your investment, while its related costs continue to snowball. You’ll need to have a keen awareness of national and local market trends. You’ll also need to evaluate how much repairs cost and how much they add to the property’s value.
5. Real Estate Crowdfunding
This is a digital form of real estate investing. Crowdfunding investors pool their funds to invest in a relatively large residential or commercial property. A number of reliable online real estate platforms offer this type of real estate crowdfunding opportunity to investors. Some amount of capital investment is still required, but it will be significantly less than what you may have to fork out to purchase a property on your own.
This form of investing can provide geographic diversification as well as project diversification, if you invest in several projects. However, you must take into consideration the management fee involved and the minimum lock-in period for your investment. You will take a passive role and have minimal input into management. That can be useful if you don’t have the skills or the time to manage a property. It can be a problem if the property managers make mistakes.
6. Online P2P Real Estate Lending
P2P or peer-to-peer lending is another virtual way to invest in real estate. When you make an investment through online P2P real estate lending, you are financing someone else’s project. To diversify your risk, you can make small loans to multiple borrowers and create a portfolio of real estate loans with potentially high annual returns. As a beginner to real estate investing, it makes sense to loan only to top-rated borrowers, unless you have a high appetite for risk.
P2P real estate lending investments can be placed in some retirement accounts, such as IRAs. This can bring significant tax advantages.
☝️ You may consider P2P lending as a part of your portfolio diversification strategy, but choosing this vehicle alone for your real estate investments may bring too much risk.
7. Timeshare vs. Fractional Ownership
Timeshares and fractional ownership properties are also popular forms of real estate holding. You should understand the subtle distinctions between the two before you consider these investments.
Fractional ownership, as the name suggests, is a partial or co-ownership in a particular property. The fraction of ownership depends on the number of co-owners in a property. You are permitted to use the property every year for a specific period (usually in weeks) in proportion to your share of ownership. Fractional ownership entails expenses related to repairs and maintenance, property management and insurance, and taxes. If the co-owners wish to sell off the property at some point, each fractional owner will receive their proportionate share of the proceeds.
Timeshare investors do not have true ownership of the property. When you enter into a timeshare contract, you will simply get the rights to have access to the property and enjoy its pre-determined facilities for a specified time period. Annual costs are included in timeshares as well. If you do not wish to vacation at your timeshare in a particular year, you may be able to rent out the unit. Timeshares often involve rigid long-term contractual conditions that may make it difficult to transfer or end the agreement.
⚠️ Review all agreements carefully and consider seeking a lawyer’s advice.
The Bottom Line
Real estate investment can be a powerful way to create wealth, but it usually involves more intricacies than stocks and mutual funds, and the investment size is often large. It’s not always easy to sell real estate investments and the costs can be considerable. An impulsive investment could leave you with a property with large continuing expenses and a declining value. You’ll also have to watch for real estate investment scams and real estate seminar scams.
As with any investment, you’ll have to consider opportunity cost: real estate can be a good investment, but is it the most profitable use of the money you have to invest? Consider alternative ways of investing in real estate with little money or other investment classes before committing to this, and decide what percentage of your portfolio you want to allocate to real estate investing.
Begin with realistic expectations and recognize that you won’t start building wealth overnight. Learn to identify and evaluate various real estate investment options and make well-considered decisions that match your risk tolerance and the amount you have to invest. Real estate investment can be a great way to build income and generate long-term value, but the risks are real, and avoiding them takes expertise and commitment.
Real Estate Investing For Beginners is a part of our guide Alternative Investments For Beginners. Read up on other popular types of alternative investments: