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How to Invest in Real Estate

how to invest in real estate

Investing in Real estate

According to Forbes, real estate is the 7th most successful industry for creating billionaires. So, investing in real estate should be as ‘safe as houses’ right? After all, everyone needs a roof over their head. 

That may often be the case but that doesn’t mean the process is simple for everyone. Jargon can be frustratingly complicated – daunting even – and you might think it’s impossible to make any money unless you’re already a millionaire. 

Well, we’re here to tell you anyone from a beginner to a seasoned pro can profit from this industry. Those that are young and have little money can still reap rewards by following our ultimate real estate investment guide.

Watch the video: How to invest in real estate in a post Covid world

What does it mean to invest in real estate?

Robert Kiyosaki defines an asset as anything that puts money in your pocket. A liability is anything that takes money out of your pocket. The big mistake that people make, according to Kiyosaki, is spending their lives buying liabilities instead of assets. He explains that if you want to be rich you should spend your life buying assets. Ofcourse, an accountant would determine Kiyosaki’s definitions of assets and liabilities to be incorrect, but they are useful nonetheless  when considering purchasing real estate. 

Investing in real estate is different from buying your own property – it can produce returns over a long period and is often more optimal than renting. As a method for actively creating more money it is not the best option. Living in a property that you call ‘home’ will increase your opportunity cost elsewhere.

On the other hand, real estate investments are those that actively generate wealth. These can be divided into two categories: 

  1. Direct real estate investments – this is when you buy a property, or a percentage of a property, with the intention of holding or renting to tenants. 
  2. Indirect real estate investments – any other option that involves investing in the real estate market without directly owning a property. You may acquire a stake in a property fund, buy real estate stocks or invest in a development company. You then earn by collecting a share of all profits/dividends.  

Importantly, both options can generate steady monthly returns – hopefully taking that pocket from full to overflowing.

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Is real estate a good investment?

Yes! Real estate is undeniably a solid investment choice for anyone looking to diversify a portfolio. It has rewarded most that have taken the leap. However, as with most investments, there is a right way to do it.

There are simply too many variables to compare real estate with alternative investment options such as stocks. But there are two discernable characteristics of real estate investing that have made it one of the most popular options for investors. 

Firstly, real estate market movements are usually not correlated with equities, bonds, or commodities. They can also be steadier and more consistent. Now it’s not all plain sailing – there are never any guarantees, as we’ll mention later on – but as an option to diversify, it is often seen as one of the most secure.

Secondly, thanks to the use of leverage, returns from an initial investment can be greatly amplified. There is no need to be a real estate ‘tycoon’ to profit from this sector. Yes, investment properties usually require a 20-25% down payment, but the remainder can often be financed. When choosing wisely, returns can often outpace repayments, which keeps that asset working for you.

Watch & learn: Hidden inflation rears its head in housing

Risks & Benefits

RISKS

So you’ve heard about some of the benefits, but any investment is never a slam dunk, and real estate is no different. Here are some of the risks to consider.  

  • Economic risk: The financial collapse of 2007/8 taught many a hard lesson – property prices can certainly go down as well as up. The combination of subprime borrowers and adjustable-rate mortgages meant that too many homeowners were unable to make repayments. As banks had already traded this bad debt, effects cascaded globally. 

The housing crash meant that many lost their homes, mortgage interest rates spiked, house prices dropped far below mortgage values and retirement savings dwindled. The effects were felt for several years. To stabilize the economy in the US, the Federal Reserve cut interest rates to zero. Construction in Spain came to a sharp halt and house prices In Ireland continued to fall until 2013 and they still haven’t recovered. 

This was the most recent reminder that the housing market is not always a ‘sure thing’. Although the market has recovered, for those not prepared to hold for the long-term, things can unravel and go horribly wrong. 

  • Investing in the wrong location: Location, location, location as the saying goes. Choosing the wrong location can be costly. But choosing the right one can pay dividends. Luckily, this risk can be actively avoided by doing a little homework. While the ‘right’ location will mean different things to different people, there are always some common questions to ask yourself.

Is the rental demand in the area high? Will the expected rental cover any expenses? Is the area reliant on one company or organization? Are there any future developments close by that may influence appreciation?  

So remember location – you can’t pick the bricks up and move them if you choose poorly. 

Watch the video: How will urban decline affect real estate?

  • Problematic tenants: Not all tenants will treat your investment property with care and affection. If you are unlucky you may end up difficult tenants. Common problems can include not paying rent, damage to the property, and subletting to other tenants.

The worst-case scenario is that the tenant costs more than the rental income provides. A thorough tenant background check should always be completed, including a credit and criminal history report. 

  • Hidden structural problems: To the untrained eye, a building may look like a dream property, but peer behind the plasterboard and there may be surprises waiting for an unsuspecting investor. 

Not all structural issues can be seen when viewing a property, especially structural damage which typically is the most costly. Therefore, it is always important to obtain a building survey from an accredited building surveyor before parting with any funds. It could be the best $300 you ever spend.

  • Lack of liquidity: Unlike stocks that can be sold quickly for cash, the processes involved with acquiring and selling property are slow. Combine this with the fact that returns are higher over a longer timeframe means that funds placed into real estate are extremely illiquid.  

This can also be viewed as a hidden gem. The best investors are invariably the ones that leave investments alone. Illiquidity ensures that this is much more likely to be the case. 

  • Negative cash flow: While investment properties more commonly produce positive cash flow, certain circumstances can mean that cash flow can turn negative if costs begin to compound. Negative cash flow can result from low occupancy levels, low rental income, high maintenance costs, or high mortgage repayments. 

It is vital that you do your homework at the start to mitigate the risk of negative cash flow.

BENEFITS

Real estate has captured the interest of investors for decades, especially as properties have appreciated exponentially. But alongside the potential for returns, there are some other key reasons why real estate can be beneficial.

  • Cash flow: Real estate can be one of the best investment options when it comes to producing monthly cash flow, or passive income. Investments in physical property will likely mean a monthly payment of rent. Once any monthly costs are removed the remainder is yours to be invested further or simply enjoyed. Even investments in property equity can yield positive cash flow. 
  • Financial security: History has shown us that properties tend to appreciate over a long timeframe. Now short-term fluctuations happen – prices can certainly fall. But a growing population and general shortage of housing have dominated the long-term effect of property prices. When committing to an investment for the long-term, perhaps to be sold for retirement, real estate is hard to beat. 
  • Tax benefits: When purchasing a property directly to buy and rent, any costs incurred can be written off – just like a business. Tax bills can sometimes be greatly reduced by claiming expenses, which means you can keep more of your returns. Expenses can include mortgage interest, maintenance fees, and insurance. Further to expenses, tax can also be offset by depreciation costs, although this may be recaptured when it comes to selling.

While more tax benefits exist with direct property investments, indirect investments such as Real Estate Investment Trusts (REITs) also hold advantages. To avoid corporate tax REITs must distribute all taxable income to shareholders. 

  • Control: Investing in direct real estate places control with you. Stocks are controlled by the success of a company. Bonds are controlled by governments. Here in the land of direct real estate investing – you can be the one calling the shots. You determine the rental charge. You determine how long the asset is held. You decide if improvements should be made to appreciate the value.  

How to invest in real estate

1. Buy rental properties

Buying a property to rent is certainly the most popular option when it comes to investing in real estate, however, the process is not as simple as buying a property and letting it out. There are several decisions an investor needs to make.

Alongside picking a good location, as a landlord, you need to consider whether you would prefer to rent the property over a long period, such as a year, or whether you would prefer to let it over shorter periods. 

Perhaps you would prefer to list the property on Airbnb and capture lucrative short term rentals. Holiday homes are also another avenue to consider. It may be possible to purchase a property that is used by yourself for several months of the year and then let for weekly holiday rentals. 

Whatever the decision, you need to be sure that the investment will become an asset, with cash flow remaining positive. 

Benefits

  • Returns will include passive rental income and capital appreciation.
  • Can amplify returns by using leverage to purchase property.
  • Flexibility for short or long-term tenants.

Risks

  • Negative cash flow if costs outweigh returns.
  • Requires a high upfront capital and funds will become illiquid.

Read the guide: How to buy/invest in a rental property

2. Invest in commercial real estate

Commercial real estate covers the majority of buildings that are not intended for residential use. These include warehouses, offices, retail premises, and multi-family units. 

Commercial opportunities come with a larger price tag and, therefore, requires the highest amount of upfront capital. However, this also means bigger returns. There is a reason why the property moguls like to play in this arena.

The wider range of properties, each with unique variables, means a lot of real estate experience is often required. It is useful to have familiarity with legal frameworks and different rental agreements. Or have a team in place that does. Learn the basics and there could be significant money to be made. 

Benefits

  • Can offer the largest returns of any real estate investment option.
  • Wider range of properties to choose from.

Risks

  • Requires the most upfront capital.
  • Significant levels of real estate knowledge must be applied to avoid complicated legal frameworks and unprofitable rental contracts.

Read the guide: How to invest in commercial real estate

3. Buy land

You don’t always need to purchase bricks and mortar to invest in real estate. Land can be just as valuable – sometimes even more so.

Buying land gives investors a different level of flexibility when compared with buying a property. There is no property to maintain and there is no need to rent the land to tenants. However, that’s not to say that the land could not be rented for commercial purposes if the location is suited. 

Land could be held until a suitable outcome presents itself. The unique element of this option is that outcome is only limited by what developers can imagine utilizing the land for. When selling, note that land is often more valuable when planning permission has been secured.

Benefits

  • Usually less expensive than purchasing a property.
  • Land could be sold for multiple use cases at a later stage.

Risks

  • Will need to be sold to someone that has a vision for development.
  • Planning permission may not be approved.

4. Flip properties

Fancy yourself as a DIYer? Then flipping properties may be the right investment decision for you. The process involves finding a property that requires a little, or a lot, of TLC to bring it back to its former glory. Your aim is to add enough value to the property that you can sell for a profit. 

While a lucrative idea, and one that is seemingly effortless on DIY shows, it is an option that requires a huge amount of effort. To truly turn a house around you need to have a creative vision, a solid network of laborers, and good negotiation skills to ensure a profitable purchase price. You also need to be an excellent problem solver, as issues can crop up on a weekly basis.

Benefits

  • Can result in high returns over a shorter time frame.
  • Property can be purchased using leverage to amplify returns.

Risks

  • Requires a significant amount of time and effort to see a project succeed.
  • Upfront capital is needed for both purchase and renovation work.

5. Stock market investing

While not an obvious option, the stock market can provide a good platform to gain real estate exposure. There are hundreds of stocks that are tied to the performance of the real estate market, which provides a great proxy for those not wishing to invest in properties directly. 

Companies can include those that focus on home builds, mortgage providers, construction, and estate agencies. Alternatively, to diversify a position, mutual funds or exchange-traded funds (ETFs) could be acquired. The iShares U.S. Real Estate ETF contains 83 property-related stocks. 

Most options can be accessed from traditional brokers or pension accounts. 

Benefits

  • Upfront investment can be low.
  • Funds are much more liquid in comparison to direct property purchases.

Risks

  • Stocks can experience volatile market movements.
  • You have no control over the performance of a stock or collection of stocks.

Read the guide: How does the stock market work

6. Foreclosed properties

If a borrower defaults on a home loan the property is usually repossessed by the lender. The property is then sold by the lender for a discounted price to recoup losses. This provides an excellent opportunity for investors. By acquiring a property below the market price it can leave far more room for profits. 

Foreclosed properties require slightly more research to find and while prices can be lower, options will be significantly more limited. Although it could be a dream deal, a property still needs to be in a suitable location and offer solid fundamentals to attract either tenants or resale. 

Benefits

  • Can provide an opportunity to acquire a property for a lower market price
  • Lower market price means returns can be higher

Risks

  • More complex legal process than acquiring a standard rental property
  • Limited options may mean that a property may be unable to be viewed before purchase  

Read the guide: How to find, buy & profit from a foreclosed home

7. Wholesaling

One option worth considering if you have enough funds could be wholesaling. Wholesalers are ‘middlemen’ that profit from a property deal. There are two ways wholesalers can profit from a transaction. 

The first is to buy and sell a house immediately. This involves the wholesaler purchasing a property at an undervalued price and subsequently selling the property for a higher price to a member of their buyer’s network. The two transactions usually occur within a few weeks of each other.

The second option is commonly referred to as a double closing. Unlike buying and selling a house immediately, a double closing involves both transactions completing on the same day. The money transfers from buyer to wholesaler, who remove their cut and subsequently to the seller.   

Benefits

  • The method is a quick way to turn a profit on a property.
  • Funds can remain liquid once transactions are completed.

Risks

  • Requires a network of potential buyers to find deals quickly.
  • A wholesaler must usually purchase a property outright which means more money is at risk, if only for a short time. 

Read the guide: Guide to Wholesale real estate investing

8. Invest in REITs

Real Estate Investment Trusts, or REITs, are a second method for investing in property indirectly. Acquiring equity in a REIT is equivalent to purchasing a share of a property, or a collection of properties. However, the properties are actually owned by one company. 

The REIT could be residential-focused, such as Equity Residential, or commercial-focused, such as Realty Income. The properties are then managed and rented, with over 90% of taxable income paid as dividends to investors. 

REITs can be an excellent way to gain exposure to the real estate market without having the hassle of owning your own property. You also have the freedom to invest as much or as little as you want. 

Benefits

  • Gain quick exposure to the real estate market without owning a property.
  • Can provide monthly cash flow in the form of dividend payments.

Risks

  • REITs are managed by a third party and are, therefore, beyond an individual investor’s control.

Read the guide: How to invest in real estate investment trust

9. Crowdfunding

Thanks to the wonders of technology investors no longer have to reduce ambitions when it comes to real estate investing. Property crowdfunding allows individual investors to pool resources and either buy properties or lend to developers. 

Crowdfunding allows for participation in projects that would otherwise be out of reach for individuals – particularly commercial real estate. Returns are either gained as a share of rental income or as interest paid on a loan. Crowdfunding sites such as CrowdStreet and Equity Multiple open the door to every adult that wishes to wet their feet. 

Benefits

  • Provides a lower barrier to entry for commercial real estate.
  • By gaining access to commercial real estate opportunities, returns can be high.

Risks

  • The terms of a crowdfunding investment deal can be complex, and may not be applicable for the majority of investors.
  • Many deals require investors to be accredited and need funds to be locked in for several years. Early withdrawal may result in a charge.

10. Online Real Estate investing platforms

These platforms connect developers with individuals wishing to invest. However, the difference here is that individuals usually require a high net worth ($1 million +) or a high-income salary (suitable for those earning over $100k annually). 

Investors can either invest in the debt or equity of a project, with the intention of receiving monthly returns for carrying the risk. Many platforms usually require funds to be locked for a set period and, like crowdfunding, sometimes an investor must be accredited. 

Benefits

  • Platforms allow you to invest in real estate from the comfort of your own home.
  • Flexibility to invest in either the debt or equity of a project.

Risks

  • Many online platforms require proof of funds and are only accessible for high net worth individuals. Accreditation as an investor may also be needed.
  • No control over the development of a project.

Closing thoughts

Investing in real estate no longer requires owning bricks and mortar. Nor does it require thousands in the bank to get started. The sector is available to every level of investor, with options for those that have small capital and those that have a little more in the bank. The lack of correlation with equities, steady price history, and passive income opportunities is why it remains an excellent option for diversifying a portfolio.   

Whether choosing a direct or indirect method, often the key to success is homework. If you are picking a property to buy, you need to know it like the back of your hand. If you are investing in a REIT, stock, or development project, do you know what factors will affect success? There is money to be made in real estate. It’s been proven. But it’s only attainable for those that put in the effort.

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