The term "real estate" itself refers to the buying, selling, and ownership of land and buildings upon it.
The real estate industry can be extremely complicated and nuanced, but that shouldn't deter new investors from exploring their options. The real estate business can be very lucrative, so the first step is understanding a few of the basics. We've got you covered!
There are numerous ways to invest in real estate. Here are a few of the fundamental real estate investments.
Buying property to live in
By far the most common form of real estate investment, and usually the very first one made by someone new to real estate investing, is to purchase a property in which you reside.
Residential real estate -- single family homes, condos, and apartment buildings -- is the largest class of property in the US. So, from a purely volume perspective, it makes the most sense as a starting point for a new investor. The US housing market has also demonstrated solid long-term economic growth (yes, even taking into account the crisis of 2008 and other similar blips) so it is generally considered a "safe" investment.
It also follows all practical logic, as everyone needs somewhere to live. Why burn money in monthly rent when you can pay the same amount (or less) in mortgage payments and acquire an asset at the same time? There are also additional financial incentives and tax breaks for homeowners that are worth exploring.
Buying property to rent out
In this case, an investor purchases a property with the intention of renting it out to tenants. The investor collects rent from the tenants and is responsible for maintaining the property.
This is among the more straightforward real estate transactions for investors. Becoming a landlord is a great way to hold an asset that will (presumably) appreciate over time, but also holds tangible value as real property. If you don't mind managing property, a rental can produce income steadily. You can also try selling real estate quickly for a profit, known as "flipping houses."
Rental properties also have their own financial benefits, like the ability to do a 1031 exchange to avoid paying tax on capital appreciation. Also, this route allows an investor to dip their toes into commercial real estate (shopping centers, strip malls, office or educational buildings). Commercial properties can often generate more cash, due to corporate leasing structures.
Real estate investment trusts (REITs)
REITs are companies that own and operate income-generating real estate properties (residential, commercial, or industrial). Investors can buy shares in a REIT, which gives them ownership in the underlying real estate assets. The rental income is paid out as dividends to shareholders.
If you don't have the money, or don't want to assume all of the risk and stress, you can join a larger group to invest in property. REITs are a great way to do just this! They also have a larger portfolio of assets, which helps insulate you from an potential lemon properties.
The downside is you are a far more passive investor, who may have a vote in management decisions, but ultimately will not have final authority over decisions on behalf of the trust. There may also be a lower return on your investment, since some of those gains will be used to cover the costs of running the fund.
Real estate crowdfunding
This is a relatively new way to invest in the real estate industry, in which investors pool their money to purchase a property or a stake in a property.
This is similar to the way REITs operate, except they are usually less rigid in structure. This can be interpreted positively in you prefer flexibility, different time horizons, and lower capital thresholds. It can also be seen negatively since shares are less easily tradable in a marketplace, and is regulated differently by governing bodies.
Crowdfunding also allows for different goals for a real estate transaction (as opposed to REITs which are all about maintaining and growing continuous streams of rental income). A crowdfunded project could be about flipping homes; buying undeveloped property or vacant land, investing in improvements, then selling properties for a significant profit.
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Real estate options
An investor can purchase the option to buy a property at a future date, giving them the right to buy the property but not the obligation. Like traditional option trading, real estate options can quickly become complicated. Buying and selling property in advance carries a number of implications. The main goal of options is trying to secure an investment that will position you on the right side of future interest rates. You really need to understand your local market to spot this type of inefficiency.
Wholesaling
In this case, an investor finds a property at a discounted price, then resells it to another investor at a higher price, without actually owning the property. Sound confusing? It's a perfectly ethical way of doing business, albeit one that leverages a technicality.
Once a group of potential buyers have a home under contract, then they are technically the property owners and are free to sell it to another party. While the idea of quick profits can be enticing, there are definitely a few reasons new investors avoid this practice. Usually this is done rapidly, offline of the MLS (multiple listing service), and with distressed properties rather than high value homes. It requires extreme discipline to move resale homes rapidly without incurring significant holding costs and wasting time on the market.
Final Thoughts
To invest in real estate, an individual or company must typically have the financial resources to purchase a property or a stake in a property. The value of real estate can fluctuate based on market conditions, so it is important for potential real estate investors to carefully consider the risks and potential returns before making an investment. Things like long-term appreciation must be measured against short-terms gains and liquidity concerns.
One final caveat, is that for any and every real estate transaction, you will need a great real estate agent to help close the deal. There's no point in going through all the trouble to invest in real estate if you're going to throw money away on the transactional costs by rolling with the first agent from the first real estate brokerage you meet. An expert real estate broker can make of break your return.
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