If you are anything like us at 40PlusFinance.com, for a long time you’ve thought about how to invest in real estate, but never really knew how.
It often seemed confusing, expensive, and even potentially risky.
However, at the same time, we were worried about the continued instability in the stock market. While stocks are a good investment in the long run, they can be speculative and subject to the emotional whims of the market and other short term economic forces.
An easy way to expand the number of investments you have is to put some of your equity into real estate. The returns on investments are similar to the returns on stocks, and often more reliable.
This raises the question of how to invest in real estate. To everyone’s surprise, there are many ways to do it, some without even having to get dirty.
- 1 Why Invest In Real Estate?
- 2 Advantages Of Investing In Real Estate
- 3 Ways To Invest In Real Estate
- 4 Should You Invest In Real Estate?
Why Invest In Real Estate?
Most investment advisors believe that the average investor should have most of their portfolio in stocks. Real estate can be considered an equity investment, though it is generally lumped in with stocks. There is a similarity between stocks and real estate in that they both represent ownership of underlying investments.
Real estate can help to diversify your portfolio and allocations. Rather than investing all of your equity in stocks, you can diversify by also investing in real estate, which can provide long-term capital appreciation.
That point alone is worth a deeper discussion. Strictly speaking, stocks are financial assets. That is, they’re tied to the financial markets. When there are financial market turbulences, stocks usually decrease just like the others.
In contrast, real estate tends to be a slower moving investment. Although it has longer cycles, it may still do well even when stocks and other financial assets are not doing well. This will allow you to keep making money from your equity portfolio, even when the financial markets aren’t doing well.
Advantages Of Investing In Real Estate
Real estate has two major advantages over stocks: the ability to use leverage to finance a purchase, and the potential to claim depreciation as a business expense.
With a small amount of capital, you can control a much larger investment. This is often done with 20% or less. With a capital contribution of $50,000, you can own a property worth $250,000.
Assuming a 5% annual capital appreciation rate, an investment of $250,000 will be worth $12,500 after one year. This return on investment (ROI) of 25% is based on the original $50,000 investment.
It is possible to make such high returns on investment in real estate because you can use leverage to invest. This means that you would only have to invest a small amount of your own money, while the rest is covered by a loan. Compared to stocks, real estate can only be leveraged up to 50%.
Real estate’s other advantage is depreciation. Depreciation is an accounting term for an expense that is deducted for tax purposes, but does not cost anything out of pocket. This means that although your taxable income from real estate will be lower, your actual income will not be affected.
What are the best ways to participate in investing in real estate?
Ways To Invest In Real Estate
Here are 7 great ways to invest in real estate:
1. Owning Your Own Home
There is debate whether a primary residence is primarily for shelter or primarily an investment. Probably the best answer is both. And that’s a big part of the homeownership advantage. Your home can provide stability and a sense of security while also increasing in value over time.
In fact, the family homestead offers two ways to earn long-term returns:
- Capital appreciation, from the slow, but steady (and sometimes not so slow) rise in the value of the property. At an average annual rate of 3%, the value of a home can double in less than 25 years. At 5%, it will only take 15 years. And at 7%, it’ll double in just ten years.
- The paydown of your mortgage balance. Even if you think a 30-year mortgage will go on for what seems like forever, your outstanding mortgage balance is still gradually declining each and every year. And at the end of 30 years, it’s completely gone, and you’ll have 100% equity in your home.
This is another example of how real estate investors have an advantage when it comes to leverage. You can buy a home with as little as a 5% down payment, and sometimes even less. If your home is increasing in value by 5% per year, it will be like earning a 100% return on your equity each year.
Over the long term, the returns are obvious.
If you purchase a home for $300,000 with a 5% down payment, you will have to pay $15,000 upfront. In 30 years, the house will be completely paid off, and if it appreciates at a rate of 5%, it will be worth four times as much.
Over a period of 30 years, your $15,000 investment in a home will grow to be worth $1.2 million.
2. Real Estate Investment Trusts (REITs)
REITs are investment funds that focus on commercial real estate. A trust can contain many different properties within it. Investments in commercial real estate can take many different forms, such as office buildings, retail shopping centers, large apartment complexes, or warehouses. These types of investments can generate income through rent or lease agreements.
REITs offer both consistent income and the potential for long-term capital growth. The money that is left over after the operating expenses are paid is given back to the people who invested in the form of dividends. REITs are required to give at least 90% of their profits to investors through dividends. At least some of the income earned will be reduced by depreciation expenses and will therefore be partially exempt from taxation.
The appreciation in value of the properties held by the trust can be distributed to the beneficiaries when those properties are sold. Investors will be able to take advantage of lower long-term capital gains tax rates if they wait to sell their properties.
REITs have an excellent long-term investment performance. Bonds outperformed stocks in terms of return over a 38-year timespan from 1978 to 2016, with a 12.87% return compared to stocks’ 11.64%. A difference of 1.23% may seem small, but over a 20 or 30 year period it can have a significant impact.
HGTV is filled with these. The two most popular home improvement television shows are Flip or Flop and Fixer Upper. These shows make the process of renovating a home appear to be easy.
Is it easy to invest in property? It can be if you know how, but it can also be a disaster if you don’t know what you’re doing.
Why invest in real estate, just to flip it?
The intention is to purchase a property that is very outdated and in need of significant renovations. This means that you should be able to purchase a home for less than what other, similar homes in the area are currently selling for.
You’re paying $100,000 for a house that’s worth $200,000. After spending $40,000 on renovations, you sell the property for a $60,000 profit.
On TV it always works. If you want to be successful in investing in real estate, you need to be aware of the property values in the area where you’re looking to invest. It’s also important to be able to purchase a property for less than its eventual market value.
You also need to be able to accurately estimate renovation costs. The more work you can do yourself, the better.
What could go wrong? Investment in real estate can be done in various ways, but flipping houses is the most hands-on method. This can be a riskier method as well, however. The two biggest issues when buying a property are either paying too much money upfront, or finding out that what you thought was a small repair is actually a much larger problem.
For example, the small amount of wood rot on the doorframe is masking the larger problem that the whole frame of the house is infested with termites and needs to be replaced.
A veteran flipper will always get a thorough home inspection to determine if the property is an extreme fixer-upper.
- Always know the market value of the property on completion,
- the true physical condition of the house, and
- have an accurate estimate of the renovation costs.
If some element is absent, the entire project may be unsuccessful.
If you’re skilled with your hands, know how to invest in real estate, and don’t mind a challenge, flipping properties could be the best way to go.
4. Rent Out Space in Your Home or on Your Property
Capitalizing on real estate through direct participation is most likely the simplest way to generate income. If you own a home, you can earn additional income by renting out space.
I’m saying “space” for a reason. Most people think about renting out a room to a boarder. That’s one way to do it.
You can also rent out part or all of any of the following:
- Your basement
- An outbuilding on your property
- A corner of your land
You can make extra money by renting out any of these spaces in the same way you would by renting a room to a boarder. People and businesses have all kinds of space needs. Many people simply need more room to store belongings or vehicles.
This is easier to do in some places than in others.
If your home is located in a rural area, an older downtown area, or in a community that has less strict property use restrictions, this can be a more viable option.
However, if you live in an area with strict rules on how land can be used, you may face legal problems. You won’t be able to get away with putting up a clothesline if you live in a neighborhood with a homeowner’s association.
If your house is located in the right area and you have extra space, making extra money in real estate is pretty easy. To be successful in real estate investing, you need to know where to invest.
5. Real Estate Limited Partnerships (LP)
Why invest in Real Estate limited partnerships?
REITs are investment vehicles that are similar to mutual funds. There is a general partner who is responsible for managing the properties that are held in the partnership. All other investors are limited partners.
That means that while you could potentially earn a profit, you would only lose what you initially invested. This is referred to as “limited liability”.
You can invest in larger, more complicated real estate deals with just a few thousand dollars by investing in a limited partnership.
Real estate limited partnerships are a lot like owning stocks, in that you are investing in a property and becoming a partial owner. If the partnership is managed well and invests in lucrative ventures, it can be highly profitable. You have the potential to earn dividends that exceed those of stocks.
If you do not manage your LP well, you could lose all of your investment. This investment can be very profitable for LPs with extensive knowledge of how to invest in real estate to mitigate risk and provide consistent gains. Many are set up primarily as tax shelters.
LPs generate large amounts of depreciation, which results in a tax loss. This may be more important than producing any actual profits.
Real estate investment trusts that focus on owning and operating income-producing real estate are considered to be “proceed with caution” investments.
Limited Partnerships are a good investment option for experienced investors who are looking to grow their money over the long term while sheltering it from taxes.
6. Real Estate ETFs and Mutual Funds
rather than investing in real estate directly, you can invest in funds that invest in real estate. Instead of owning the real estate directly, you own shares of an ETF or mutual fund that invests in real estate. The funds invest in the shares of companies whose primary business is real estate.
Why invest in real estate using ETFs and Mutual Funds?
The funds invest in the stocks of builders and developers, building material suppliers, or even in REITs. ETFs have the advantage of being highly liquid, making them perfect for investment portfolios of all types, including retirement plans.
” The cons of investing in real estate through ETFs and mutual funds is that they are subject to real estate market cycles. real estate can be profitable when the market is doing well. Real estate can be a bad investment during a bust cycle.
7. Single Family Rental Property
Our own, personal favorite way of investing in real estate is purchasing single family homes via the turnkey real estate process and renting them out to families.
Every person or family does and will continue to need housing so in our minds it makes for a fantastic investment.
There are many pros and cons of owning rental property, but our favorite aspect of it is that you can earn in several ways, including: cash flow, appreciation, taxes, and amortization. If one particular way doesn’t happen to be working, then the other 3 pillars kick in and you continue to earn money.
It’s sort of like having multiple ways to win a game.
Should You Invest In Real Estate?
I stated earlier that there are many ways you can go about investing in real estate. While we largely think it’s a personal decision, we feel that most people should make at least choose at least one investment in real estate and commit to it because it is a good long-term investment and it diversifies your equity away from stocks.
For many people, owning your own home is the default choice. Even if you have other investments, it’s a good idea to add a REIT or two to your portfolio. This is especially true if you don’t have other investments. Real estate investment trusts (REITs) are investment products that give you exposure to commercial real estate.
If you have a high net worth and want to get involved in commercial real estate deals, look into real estate crowdfunding. Nowadays, there are many platforms that allow you to choose specific investments you want to make.