Investing in real estate is popular for several reasons. First, it has plenty of income-generating potential, allowing you to support your current lifestyle or acquire more funds to boost your savings or retirement accounts.
Second, it’s largely considered a proven approach. While no investment is guaranteed to succeed, real estate is often viewed as a pathway toward wealth, especially if you’re investing with the long-term in mind.
While investing in real estate may seem simple on the surface, there are some nuances to consider. Plus, there are multiple approaches that can help you add real estate to your portfolio. With that in mind, here is our ultimate guide to investing in real estate.
Buying Investment Properties vs. Investing in Real Estate
When it comes to investing in real estate, you can typically pursue one of two paths. First, you could buy properties on your own and use them to generate income. Normally, that means securing homes, storefronts, or facilities that you rent out to others. You generate income through rent payments, giving you a potential long-term source of incoming cash.
Second, you can invest in real estate-related assets. With that, you aren’t purchasing individual properties on your own. Instead, you’ll use alternative pathways to generate profits, like company stocks or shares in group endeavors.
Both options are viable ways to invest in real estate. Which option is best for you often depends on several factors. For example, the amount of cash you have available, your access to financing, and the amount of time you want to dedicate to personally managing the investment all play roles in the equation.
If you aren’t sure which option is best for you, here’s a breakdown of what each one involves.
How to Invest in Real Estate: An Overview
As mentioned above, investing in real estate usually takes one of two forms. Here’s an overview of how each option works, allowing you to determine which path is best for you.
Purchasing Investment Properties
Buying an investment property outright is relatively straightforward whether you’re interested in a single-family home, are buying a multi-family investment property, or are focused on a commercial real estate investment property. However, you need to approach the process correctly if you want to reduce risk and increase your profit potential. Here is an overview of some key considerations.
Choosing the Right Property
When looking for investment properties, you need to focus on what renters want, not what you prefer. Usually, this means focusing on desirable locations, preferably in stable or rising neighborhoods.
Choosing properties in strong school districts is wise if you’re looking at single or multi-family housing, as well as those near key amenities, like shopping areas, public transit, parks, and medical facilities. Low crime rates are also beneficial.
Beyond that, you need to consider what prospective renters want to find in properties themselves. For homes, the number of bedrooms and bathrooms matter, as does the design of the floor plan and the presence of outdoor space. For retail properties, traffic and visibility are often priorities.
As for the property’s condition, whether you choose move-in-ready or a fixer-upper may depend on your available cash, timeline, and how otherwise desirable a property is based on its location and similar factors. Either approach is potentially viable. However, you could possibly look at flipping opportunities with fixer-uppers, giving you another pathway for profits.
If you decide that a rental is the way to go, you’ll want to calculate your potential return on investment (ROI). Generally, you’ll want to review the net operating income (NOI) to estimate profitability. With that, you determine your operating expenses and subtract that figure from your total revenue. That’ll give you a pre-tax figure that you can use to assess the ROI.
If you’re wondering, “What is a good NOI for a rental property?” the answer is, it depends. Technically, an NOI is just one indicator in a broader situation.
You can’t always guarantee 100 percent occupancy rates with rentals, so you’ll need to consider that when reviewing the complete picture. Plus, expenses and rental prices often fluctuate over time. Whether you live in an area with rent-related limitations or regulations also matters. Since that’s the case, don’t use NOI alone to make your decision.
Funding Your Real Estate Purchase
In most cases, buying an investment property is essentially the same as purchasing a primary home. The main difference is that you won’t have access to financing designed specifically with owner-occupants in mind. Since that’s the case, the requirements are potentially stricter.
For example, you’ll usually need a 20 percent down payment at a minimum. Investment properties can’t typically have PMI, so the larger down payment ensures it’s unnecessary. Now, depending on your financial situation, you may be able to finance the down payment by getting a personal loan or using a similar debt-based approach. However, that may impact your eligibility for mortgages to fund the rest of the property purchase, so keep that in mind.
Otherwise, you can fund the remaining 80 percent with a mortgage if you don’t have access to enough cash. With a mortgage, interest rates are usually higher than you find on primary homes. Additionally, debt-to-income and credit score requirements are generally stricter.
You can also explore buying a property with cryptocurrency. While this isn’t a conventional strategy, it is an approach that many with large crypto wallets consider. When you purchase real estate with crypto, it allows them to tap the value of those assets to diversify their broader portfolio.
You may be wondering, “Can you use IRA to buy an investment property?” You can use a self-directed IRA to fund real estate purchases in some cases. However, the process of purchasing investment property this way is usually quite complex.
You’ll need to go through a custodian, and, in the end, the property isn’t technically yours. Instead, it’s owned by your IRA for your benefit. That means you can’t use it personally.
Plus, there are other rules regarding IRA-purchased properties. Since that’s the case, you’ll want to review them all carefully before proceeding.
Operating Your Investment Property
Once you have an investment property, you have to deal with management responsibilities. Tasks like screening tenants, creating leases, collecting payments, and handling maintenance are all part of the equation. In some cases, those activities are easy to tackle. In others, it’s incredibly complex.
Before you start searching for tenants, you need to decide if operating as a landlord is in your best interest. As a landlord managing your own rental property, you personally oversee practically everything. While you may outsource maintenance or repairs to contractors, tenant-related tasks are generally yours to handle.
Alternatively, you can hire a property manager (or property management company) to handle most of the legwork regarding tenant matters. Traditionally, they’ll assist with screening, leases, and payment collections and coordinate repairs and maintenance. Often, advertising your property is also part of the package. Plus, they’ll usually handle evictions if the need arises.
Which approach is best for you depends on your available time, the number of properties, and whether you prefer to be hands-on. A property manager might be a better choice for those looking for passive income real estate investing options. For those concerned about maximizing gains, you may want to opt for the landlord route.
Ultimately, both can potentially lead to significant gains, so they’re each worth considering. Additionally, you can always change course if you find that one strategy isn’t as ideal as you initially hoped, so keep that in mind.
Investing in Real Estate (Without Buying Property Outright)
While purchasing investment properties is typically what people envision with real estate investing, it isn’t the only option. Instead, there are several mechanisms that let you get into the market without having to own or manage physical properties.
With these options, the barrier to entry is often far lower. Plus, it could let you add real estate to your retirement account with greater ease, giving you another way to diversify that critical portfolio.
Real Estate Investment Trusts
A real estate investment trust (REIT) is a company that owns and manages real estate-related assets. Along with physical properties, a REIT may hold mortgages or mortgage bonds.
While a REIT can include assets outside of real estate, there are rules outlining asset allocation requirements. Otherwise, it doesn’t count as a REIT. Generally, at least 75 percent of the assets have to be real estate-related. Additionally, 75 percent of the gross income must be related to rent or mortgage interest.
As an investment, REITs are an attractive option in the eyes of many, particularly those interested in building passive income through real estate. One of the requirements is that REITs pay a minimum of 90 percent of taxable income out as shareholder dividends, creating a potentially significant source of cash flow.
Like many investment options, there are subcategories within the REIT market. For instance, retail REITs focus on spaces like malls and shopping centers, while residential REITs concentrate on properties like multi-family apartment buildings. There are also healthcare and office REITs, as well as mortgage-focused REITs.
There are publicly-traded REITs, giving you a way to invest through a traditional brokerage. However, there are non-traded REITs as well, many of which are accessible either directly through brokers or financial advisers.
Real Estate-Focused Company Stocks
A stock-based approach to real estate investing involves stock purchases in companies with a real estate focus. This can include businesses with property components, such as hotel chains or resort companies. Commercial real estate service organizations fall in this category, too, along with home construction businesses.
With this option, investing is typically straightforward. You can normally purchase stocks in publicly traded companies through a brokerage. In some cases, you may be able to add these to several kinds of accounts, as well, including traditional brokerage accounts or certain retirement accounts.
Real Estate Mutual Funds and ETFs
A real estate mutual fund or exchange-traded fund (ETF) is a solid option if you’re looking for diversification within your real estate investments. With these, a share actually represents a mix of assets, providing an innate level of diversification within a single purchase.
With these, you can find different compositions. Some focus on real estate-oriented company stocks. Others prioritize REITs. Since that’s the case, it gives investors a straightforward pathway into either investment approach, all while ensuring a solid degree of diversification.
Fractional Real Estate Investing
Fractional real estate investing isn’t technically a different type of real estate investing. Instead, it’s a variation on some of the previously discussed approaches.
A single investor doesn’t have to acquire enough funds to purchase whole properties or entire shares with fractional investments. Instead, they can buy a portion of a property or share.
Technically, REITs are innately a form of fractional investing, as they allow a person to easily pool money with others to purchase high-cost real estate or mortgage assets and reap the rewards of ongoing rent payments or mortgage interest.
There’s another model that relies on tokenized real estate investments functions similarly, with the token representing a stake in a physical property or portfolio of properties. In this case, there are similarities to cryptocurrencies, though it involves security tokens instead of utility tokens or other alternative approaches.
Fractional shares aren’t an inherent feature with stocks, mutual funds, and ETFs. However, many brokerages make fractional share purchases an option. That can make higher-cost stocks far more accessible.
Investing in Real Estate: Is It Right for You?
Ultimately, whether investing in real estate is a smart move for you is a personal decision. Each approach has its own benefits and drawbacks. Many of the passive real estate investing examples above allow you to get in the game without being overly hands-on, and while real estate is often profitable, losses are always a possibility.
When buying an investment home, the risk can be higher, mainly because there’s less diversification. However, the potential for significant gains is undoubtedly there, particularly if you choose a house strategically.
If you’re a first-time buyer of investment property, it’s wise to have a skilled real estate professional by your side. That way, you can buy an investment property with the most potential in your area, ensuring you have the highest chance of coming out ahead.