Real estate is not an investment for everyone, but thinking of real estate solely as purchasing and then renting a property is shortsighted. In today’s market, there are a number of different ways to get involved with the real estate market, even for those who do not have the capital necessary to purchase properties outright.
Below is a look at some of the most popular paths to real estate investment, as well as a look at the advantages and drawbacks of each.
Become a landlord.
This approach is the most common method of investing in real estate. Individuals purchase a property and then rent it to a tenant, either directly or through a management company.
In this arrangement, the landlord maintains responsibility for the mortgage, maintenance expenses, and property taxes while the lessee pays a fixed rent. In an ideal setting, the rental income covers all expenses associated with the property and provides a small monthly profit that becomes larger once the mortgage is paid in full.
However, it is difficult to gauge the potential expenses involved with a home. Unexpected maintenance may mean that during some months, the property owner will operate at a deficit. At the same time, the US Census Bureau reports that value of properties has increased overall since 1940. This means that the property itself is likely to appreciate while the mortgage is being paid.
The other major risk involved in this strategy are tenants who miss rent payments or, worse, cause damage to the property. Also, there are likely to be months with no tenant at all, during which time the investment causes negative cash flow. To keep vacancy to a minimum, individuals should ensure that there is a demand for rental properties in the area where the home is purchased.
An even more hands-on approach to real estate investment involves property “flipping.” This strategy is very different from the one outlined above, since with flipping, the idea is to own a property for no more than three or four months.
During that time, owner-investors may make improvements to the property in hopes of reselling at a profit. Flipping properties is not a viable option everywhere. Additionally, investors can only make a profit if they are in an extremely “hot” market or they have a means of identifying appropriately undervalued properties.
Some property flippers do not invest money into their projects, instead relying on the intrinsic value of the land and the existing structure. Other individuals will do simple or even major renovations to add value. The latter strategy involves a significant investment of time and may limit individuals to dealing with one property at a time.
With either strategy, there is a financial risk that the property will not be resold quickly. Long-term mortgage payments cut into a flipper’s profits. Failing to flip a property quickly can destroy the investor’s liquidity and cause a major financial crisis.
Invest in a REIT.
A real estate investment trust (REIT) uses the pooled money of its investors to purchase and then maintain a large portfolio of rental properties. Like stocks, shares in REITs are sold and bought on major exchanges.
Corporations that list themselves as REITs are required to pay out 90 percent of taxable profits through dividends to maintain their status. By doing so, the organizations avoid paying corporate income tax.
These investments are ideal for people who do not have the money to purchase a property on their own, or who do not want the responsibility of personally maintaining a property. Also, REITs allow individuals to invest in malls, office buildings, and other commercial properties that are typically inaccessible to everyday investors.
Generally, REIT investors are people who expect regular income, much like those who invest in income-generating stocks. As with other types of investments, there is risk involved, and individuals should do their due diligence before choosing a REIT.
Different types of property carry different types of risks, and it is important to inform yourself before making a purchase. Fluctuations in the real estate market, especially the rental market, can have a major impact on dividends.
Join a real estate investment group.
A real estate investment group is similar to a mutual fund, but for properties. When investors do not want the personal hassle of becoming a landlord, real estate investment groups can be an ideal option.
Companies construct or purchase a block of condos or apartments that investors can then buy through the company. Each investor becomes part of the group and can own one or several units, depending on investment strategy. The home company manages all of the units and handles maintenance. To offset these costs, the company will take a certain percentage of the monthly rent off the top.
Real estate investment groups come in many different varieties. The most basic has the lease in the name of the investor.
Typically, all units in a building contribute a small percentage of their rents to a pool that safeguards against vacancy. That way, investors can still pay their mortgages if their individual units are not rented. When selecting this option, however, it is critical to investigate fees and ensure that the investment is worth the cost.