Real estate investing can be overwhelming if you don’t know where to start. In this article, we’ll take a look at some of the benefits of investing in real estate as well as different strategies residential real estate investors use.
Why real estate?
Real estate is a tangible asset. You can visit the property and evaluate it for yourself. Compared to stocks which can drop dramatically and become worthless overnight, land will always retain some value. In many cases, the value appreciates over time.
Since there is little correlation with the stock market, real estate provides good diversification for investors.
Real estate is an industry where investors are not expected to have all the funds they need for a purchase. Being able to leverage other people’s money to purchase a property gives investors two advantages: one is they don’t have all their funds tied up in a single property; the other is their money is freed up to invest in other areas.
Investing in real estate provides some protection against inflation. When prices rise for goods and services, homeowners usually see an increase in property value and can increase their rent prices.
Finally, there are some compelling tax breaks available exclusively to property owners. Owners can deduct interest on mortgage payments and depreciation of assets. They can also take advantage of 1031 exchanges.
Types of Real Estate
If you’re interested in adding real estate to your portfolio (or adding more properties), it’s helpful to understand the different areas where you can invest.
Residential properties include single family homes (SFHs), condos, duplexes, triplexes, and quadruplexes. In general, residential real estate has the advantages of high appreciation and attractive financing options. Depending on your market, breaking into residential real estate is feasible, even with little capital. There are also more lenient zoning laws compared to commercial or industrial real estate. Some drawbacks include repair costs and higher turnover rates.
Commercial real estate includes office buildings, retail (stores and shopping malls), hotels, and special purpose buildings like bowling alleys or amusement parks. Leases are longer, typically at least three years, and commercial real estate investing usually offers high returns, often between 6-12%. However, getting started with commercial properties usually requires more capital upfront. Also, vacancies may be harder to fill. During an economic downturn, residential properties are usually still in demand since people always need a place to live. The same cannot be said of commercial real estate if companies go out of business.
Industrial real estate includes warehouses, factories, distribution centers, storage units, or special purpose real estate like car washes. Advantages include longer lease terms, higher yields, lower operating costs, and less risk (since fluctuations in the market have less impact on industrial real estate). One issue to keep in mind is the environmental impact your property may have, and the accompanying regulations and issues that may arise.
Just like the name sounds, this investment involves purchasing undeveloped land, usually for the purpose of new construction. A lack of existing structures gives investors plenty of flexibility to design the property of their dreams. The initial cost for undeveloped land is obviously cheaper, but there are high preparation costs for development, not to mention the permits and approvals required from the county or city before starting a project.
While there are dozens of different strategies for investing in real estate, we’ll take a closer look at five of them. Our focus will be residential real estate.
If someone purchases a property for $500K as their primary residence in a hot market and they sell it later for $650K, then they just made a profit. This strategy is good for owners who live in a hot market and don’t want to own multiple properties. Part of the beauty of homeownership is that even your primary residence can make you money if you play your cards right.
This strategy doesn’t involve many of the headaches reported from managing rental properties. Investors have more incentive to care for the home since it’s their primary residence. Depending on the market, the profits can be substantial.
Making a profit with property appreciation is both market dependent and timing dependent. It’s also a conservative strategy in most places.
Investors buy distressed properties below market value and remodel them so that they are habitable for tenants. After renting for several months (and having built up equity), owners can refinance for better interest rates and to obtain enough funds to buy their next property. This strategy is good for investors who already have experience rehabbing and renting out a property, especially since inspections and appraisals will often reveal unexpected issues.
This method takes advantage of different financing options available to leverage other people’s money for the next investment. It combines the best of multiple strategies to aim for maximum profits and a quick way to scale your real estate business with multiple properties.
Buying any distressed property comes with surprises, not all of them pleasant. Investors may quickly realize the cost of repairs is more than they anticipated spending. Depending on how quickly investors add more properties, refinancing may be difficult if their debt-to-income ratio is too high.
Fix and Flip
This strategy involves buying distressed properties, refurbishing them, and then selling them at a profit. Popularized across many different HGTV shows, this strategy is good for investors who have contracting experience and a solid knowledge of their local real estate market.
This method can maximize profits by buying the right house in the right neighborhood. It also doesn’t involve some of the problems associated with rental properties.
Like the BRRRR method, buying distressed properties comes with a lot of repairs, some of which are difficult to estimate. If investors do not have contracting experience or cannot do the labor themselves, the price of rehabbing the property will be higher and cut into profits.
This strategy involves providing a long-term home for tenants by renting out a property over the course of several months or years. Managing a rental property involves drafting a lease, making repairs, marketing the property, screening tenants, and finding an easy way to collect rent.
Long-term rentals have the advantage of stability; as long as your tenants pay on time, you know your mortgage will be covered. It’s also easy to add more properties once you’ve gotten the hang of your first. If your properties produce positive cash flow, you have a nice stream of passive income where you make money in your sleep.
An investor’s profits are often dependent on the quality of their tenants. All it takes is one bad tenant who damages your property or doesn’t pay rent, and you could be looking at significant loses. This is why most landlords emphasize a thorough tenant screening.
Unlike long-term rentals, short-term rentals are usually found on sites like Airbnb or VRBO; the focus is providing vacation accommodation for people who are traveling and don’t plan on staying in the area long-term. Short-term rentals can be very profitable, but managing them involves a different mindset from most real estate investments; it’s more like working in the hospitality industry than in real estate.
Short-term rentals are usually more profitable than long term rentals. Flexible scheduling allows owners to live in the property part of the time or choose the days in which they want renters. It’s also easy to get started by renting out a room in your home.
Turnover is high, and it takes a lot of effort to return a unit to rental-ready condition. Unlike long-term rentals, short-term landlords are usually expected to pay for internet and all utilities. Apartments also generally come fully furnished at the owner’s expense.
Investing in real estate starts with education. Learn more about your local market, which type of real estate is right for you, and how to implement different strategies. We’ll look at some more tips for getting started next week.