When most people think about real estate investing they likely think of a few things: slumlords in huge cities and rich billionaires. But the average investor can and should also seriously consider investing in real estate.
If you have no idea where to start – you’re not alone.
Luckily, there are many ways to get started as a real estate investor – some of them require as little as $500!
What’s Ahead:
What is real estate investing?
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Put simply, real estate investing is the purchase or sale of land and buildings to earn money. There are a few different categories of real estate:
- Residential real estate includes houses, apartment buildings, vacation properties, and anywhere else people live. This is typically the easiest area of real estate for a beginning investor to enter.
- Commercial real estate (CRE) involves office spaces, retail storefronts, or any building used for business purposes. It’s more expensive than residential real estate, and you’ll manage more property. The best way for individual investors to get into CRE is to buy shares in a real estate investment trust (REIT) — more on those below.
- Industrial real estate includes warehouses, storage units, and other large “special purpose” structures like car washes that generate sales.
Why invest in real estate?
Leverage
Your typical stock market investment doesn’t give you much leverage, or the opportunity to increase your returns through borrowed funds.
Real estate, on the other hand, lets you use borrowed money to finance properties. If you know what you’re doing, you can really maximize your returns this way.
For example, if you buy a property for $200,000 and put 30% ($60,000) down, and a few years later you can sell the property for $300,000, you’ve just scored a 166.67% return on your investment.
Of course, this is a simplified explanation, since you do need to account for any repairs or maintenance needed over the years you own the property, as well as outside factors like the real estate market as a whole. But, you get the gist.
Diversifying your portfolio
Stock, bond, and equity investments can be volatile – their value can change with the market, due to factors you simply can’t control.
But real estate isn’t affected the same way. In fact, real estate investment performances tend to follow different patterns than stocks. Even if other investments plummet in value, the real estate portion of your portfolio could still be earning steady returns.
That’s why diversification, or adding a mixture of different types of investments to a portfolio, is so important.
Improved returns over the long term
Above all, real estate is an investment in your future.
Eliot Bencuya, CEO of Streitwise, an investment platform that specializes in commercial real estate, says:
“It’s important for young investors to understand that their investment portfolio should be setting themselves up for whatever their futures have in store.”
The superpowers of compounded annual returns, or investment growth calculated over a period of time, can help fund major down-the-road goals like retirement. You’ll get even more value if you start early. Bencuya says:
“The power of compounding over many years is greater than most investors realize. Young investors, in particular, can benefit over the long run.”
Purchase a rental property
The residential real estate investor with time to commit can buy a property and become a landlord.
This means monthly income, as long as you can find tenants, and it’s one of the most common ways to make consistent money in real estate.
You can choose between single-family or multifamily properties. Michael Albaum, a Program Manager at Roofstock, an online real estate investment marketplace that frequently works with new investors, recommends single-family properties as a good starting point.
“You’re going to make mistakes, and it’s better to make them on a smaller deal where there’s less at risk.”
Residential properties may technically be passive investments, but they require pretty active involvement. So make sure you’ve got the time as well as the money. Many landlords outsource building maintenance to management companies; others handle repairs themselves.
The good news is if you’re on top of building upkeep, the property should increase in value over time.
Read more: A Proven Formula For Buying Rental Properties
Pros of rental properties
- Monthly income from tenants.
- Your tenants are essentially paying your mortgage down for you.
- You could live on the property while renting other units out.
Cons of rental properties
- You need to maintain the property, which takes time and money.
- You’re paying a second mortgage (if you don’t live on the property).
- You may not always have the most respectable tenants, which could lead to lawsuits.
- Your property isn’t a liquid investment.
Real estate investment trusts (REITs)
Investing in a REIT isn’t that different from investing in a stock. As an investor, you give money to a trust or corporation which purchases a property. You’ll get a portion of the dividends as the property appreciates.
This is the easiest way for a beginning investor to get into the commercial real estate world. It comes with a potentially high yield. Corporations pay out at least 90% of their incomes on the property as dividends to investors. Plus, your investment is liquid; you can sell your shares and cash out without having to deal with selling the building. And the corporation does all the management work for you.
Most likely you’ll be dealing in publicly-traded REITs. Accredited investors with a high net worth may be able to access private REITs — these trusts aren’t registered with the SEC, and the upfront investment required is much higher.
Read more: Investing In REITs: Everything You Need To Know
Pros of REITs
- You’ll earn income from dividends.
- You can own real estate without having to purchase a property (aka, you don’t need to be a landlord).
- They’re easy and fairly affordable for beginner investors.
Cons of REITs
- You’re taxed on dividend earnings.
- They’re long-term investments, so you’ll need to hold on to your investments for years.
Crowdfunding platforms
An increasingly popular option for small-time real estate investors, crowdfunding platforms are passive investments similar to REITs. But instead of going through a trust or corporation, investors pool their assets and match with interested real estate developers or sponsors. There are platforms for commercial and residential real estate.
Since these investments are illiquid — you can’t sell them easily — and depend on the variables of the real estate market, they can be riskier than REITs. But they can also get you dividends on properties you wouldn’t be able to access as an individual. You might have to wait longer for returns — most crowdfunding deals require several years of commitment — but the returns tend to be pretty high.
Read more: Real Estate Crowdfunding: Should You Invest?
Pros of crowdfunding platforms
- You can own real estate without purchasing property yourself.
- Returns tend to be on the higher end.
- You can invest in commercial and residential real estate.
- They often have a lower cost requirement to start investing.
Cons of crowdfunding platforms
- They’re not liquid investments (aka, they’re not easily sold).
- They’re long-term investments.
- They can be risky if a real estate deal goes under; you may lose some or all of your investment.
Short-term and vacation rentals
What if you don’t want to go through the stock market or buy a property, but you’d still like to generate some real estate income?
Try renting out a room on a nightly or weekly basis. You can even rent out an entire home for short-term periods. The amount you’ll earn will vary depending on the local rental market. If you live in an area with high tourist traffic, whether the traffic is seasonal or year-round, you can really turn a profit. You don’t need a ton of cash to get started; just the extra space. And you’ll start seeing a cash flow pretty quickly compared to stock investments.
Think of these rentals as a “side hustle” or part-time gig. You’re responsible for furnishing and maintaining the property and bringing it up to code, as well as communicating with renters.
Lots of renters find it easier to go through a third-party website. Airbnb is the most well-known.
Read more: Airbnb Alternatives: How Other Short-Term Rental Sites Compare
Don’t forget to check your local laws to see what regulations you need to meet. Many cities and states are cracking down on the short-term rental market in response to rising housing costs.
Pros of short-term vacation rentals
- You can make a lot of money for very little work.
- Third-party sites like Airbnb make listing your rental a piece of cake.
- You can rent out property you already own.
Cons of short-term vacation rentals
- Many large cities have imposed restrictions on short-term rentals.
- You have to maintain the property – or hire someone to do so.
Trade or “flip” real estate
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After you’ve been in the real estate investing game for a while, you get to know what you’re doing. For investors ambitious enough to embark on construction projects, trading or flipping real estate can bring in big returns in just a few months.
Here’s how it works: an investor buys an undervalued residential property, renovates it, then sells it at a higher price.
It’s possible to be a pure “property flipper” who leaves their purchase unrenovated and waits for the market to improve. This strategy is also known as “hold and resell.” Properties should already be in good condition and located in markets that are on the upswing.
Selling isn’t guaranteed, of course, and you’re still on the hook for the mortgage if you can’t get tenants or buyers.
“House flipping” is best for seasoned real estate investors who know how to hedge their bets with the local market. You should be able to:
- Assess a property’s current AND potential value.
- Estimate repair costs as accurately as you can (this isn’t easy to do!).
- Tap into cash reserves if you need more than you thought.
- Land on a price that hits the “sweet spot” of being attractive to buyers while making you a profit.
Pros of flipping real estate
- These are often short-term projects so you can see a return fairly quickly.
- If you time everything correctly, you can make a large profit.
Cons of flipping real estate
- You need to purchase a property (so count on at least a 20% down payment).
- You need to DIY the renovation or hire a company, which can be costly.
- You need to really know the market, or else you could end up losing money on the deal.
Read more: How To Be A House Flipper — And Make A Killer Profit
What to know before investing
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According to Albaum, the right real estate investment “depends on someone’s risk tolerance and experience level.”
Read more: How To Determine Your Investing Risk Tolerance
Of course, it also depends on your budget.
Commercial property investors, for instance, should have around $50,000 ready to go. If you don’t have anywhere near that much, there are less pricey ways to invest.
Though Albaum mentions $100,000 as a typical starting point, he says “there are cheaper ways to [get started] in every market.”
Bencuya notes that many young investors these days are maximizing their dollars by
“looking in suburban-urban locations where there are urban elements in a more spacious and less expensive environment.”
These days people are willing to pay more to live near a city, without the hassle of actually being in the city. If remote work is here to stay, this trend might continue.
Real estate research hub iProperty Management recommends smaller apartments, multi-family properties, and suburban homes for the best returns. But the details may differ depending on specific variables in the location where you’re investing.
Down payment
Before you pick your first investment, you should decide how much you’ll want to spend on a down payment.
The standard down payment is between 20% – 25%. Even if you bought a home with a smaller down payment percentage, be prepared to cough up the full 20%+ for an investment rental property, which won’t have mortgage insurance.
Calculating return on investment
For a basic estimate of how much your investment might pay off, take your net profit (aka, how much you think you’ll make) and divide it by your initial costs, including down payment, mortgage, property taxes, maintenance costs, and funds for emergencies.
The number you’re left with is your potential ROI, or return on investment.
King Harbor Wealth, a California wealth management company, suggests you aim for a 10% ROI – but even a 6% ROI is great for a first-year landlord, since the first couple of years tend to bring smaller returns.
However, experts recommend erring on the side of caution. Avoid “offerings that seem too good to be true,” Bencuya advises.
“It’s difficult to achieve high returns in this market and too many investment offerings flat out lie about what probable outcomes look like. The past year [2020] has conditioned many investors to expect returns that are, on a longer timeline, not persistently achievable.”
Making practical choices
If you’re a homeowner – even if you’re a renter – you probably have some emotional stake in where you live. Maybe your house is close to family or in a neighborhood you like, or you just fell in love with the property.
But investing is a different process, so be careful about letting feelings and biases get in the way. Just because you love a certain area of town doesn’t mean it’s smart to invest there. On the flip side, Albaum advises,
“there are places I’d never want to live [that] would make great investment opportunities. If [you] can divorce investment from emotion, you can make better investments.”
Playing it safe
Albaum says one of the biggest mistakes young investors make is
“assuming the numbers you put on paper are going to be reflective of reality.”
He especially warns against “assuming too little on the expense side of the equation.”
Take some precautions, even if you have the cash and comfort level for a lot of risk.
- Leave plenty of cash for an emergency repair fund – more than you think you’ll need.
- Have an “exit strategy,” preferably more than one, in case the deal falls through.
- Real estate can be a risky business, so don’t invest any money you can’t afford to lose.
“Your tenants don’t care what numbers you put into your spreadsheet,” says Albaum. “Neither does the weather.”
Real estate can also be a significant investment of time. Fixing up a property isn’t easy, and even basic maintenance is a regular task you’ll have to keep up with. Some real estate investors outsource maintenance to management companies at an extra cost.
It’s a good idea to talk to a qualified attorney before making your first purchase. Holding investments through limited liability companies (LLCs) is a lot less risky than making an investment in your own name. If the investment fails, you want your assets protected, and you don’t want legal liability if you can avoid it.
Summary
Real estate investing can be exciting and lucrative, but it takes practice and a lot of money.
And like any other major financial decision, real estate investing should help you meet your overall short- and long-term goals. As Bencuya says:
“First and foremost, investors under 30 should be investing in themselves … and in their ability to create wealth from their own skills.”
There are tons of options when it comes to real estate, so you’ll need to think through which investment would be best for you before signing on the dotted line.
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