9 Kinds of Actual Property Investments In contrast
Interested in investing in real estate but feeling overwhelmed about where to begin?
Any new investment is intimidating at first when you’re still struggling to learn the vocabulary, challenges, risks, and rewards. But real estate offers some compelling benefits for investors willing to learn the ropes, from asset diversification to passive income to real estate investing tax benefits.
And you have plenty of real estate investment options to choose from. From a fast one-time payout to ongoing income, hands-on work to complete passivity, you can pick the right investment option based on your personal goals.
Here are nine popular options to help you start building your real estate empire – or at least add real estate to your portfolio.
1. Flipping Houses
Reality TV shows like “Flip This House” popularized house flipping back in the mid-2000s, and flipping’s appeal managed to survive the housing crisis and Great Recession.
It’s not hard to see why. When done correctly, investors can earn returns in the several hundred percent range in just a few months.
Of course, many new investors don’t do it right and end up losing money. Even those who do earn a strong return are often surprised at the amount of work required to achieve it. Flipping houses involves an investment of time and labor, not just money.
If you don’t feel like messing around with a hard money loan and rushed renovation, one other option is doing a live-in flip. You move into a home that needs updating, improve it over the course of a year or two, then sell it and pay only capital gains tax on the profit. Or you can avoid capital gains entirely if you qualify for a Section 121 exclusion.
There aren’t many investing strategies that let you walk away with tens of thousands of dollars after just a few months. Flipping houses is one of them, but it comes with its own risks. So make sure you get the numbers right, particularly repair costs, carrying costs, and the after-repair value. Also, make sure you’re comfortable with managing and negotiating with contractors before trying your hand at your first flip.
2. Long-Term Rental Properties
Not everyone is cut out to be a landlord and deal with all the unexpected challenges landlords face. Still, rental properties can provide ongoing passive income and a slew of tax benefits for enterprising investors willing to take on the headaches.
There are three paths to buying your first rental property.
The BRRRR Strategy
One option is buying a property that needs renovation, but instead of selling it upon completion, you keep it as a rental. The BRRRR stands for buy, renovate, rent, refinance, repeat, and it’s a great way to finance 100% of your property purchases.
It works like this: You put down 20% or so with a purchase-rehab loan, make the renovations to create equity in the home, then rent it. With all that equity, you can pull cash out when you refinance for a long-term mortgage. Enough cash to refund your original down payment if you created enough equity.
This works because the refinance loan amount is based on the after-repair value of the property, rather than your original purchase price and repair costs.
That frees you up to repeat the process indefinitely using the same cash. And with each property, you add more passive income with no cash out of pocket.
Like flipping houses, new investors often get into trouble by underestimating costs, particularly renovation and carrying costs. Much of their success comes down to their ability to find good contractors who won’t raise costs on them mid-renovation. HomeAdvisor is a great place to find reputable contractors in your area. They put all contractors on their platform through a screening process to make sure you’re going to be hiring the best company for your needs.
Turnkey Rental Properties
Not so thrilled with the idea of hiring contractors and overseeing renovation projects?
A turnkey rental property comes either already rented out or in rent-ready shape. Expect to pay more, of course, since you’re not buying a handyman special. That said, you also avoid the headaches associated with renovating a property.
Over the last few years, it’s become much easier to buy turnkey rental properties anywhere in the country. Not only has virtual tour technology become better, but peer-to-peer selling platforms like Roofstock have popped up to add transparency to the process.
Roofstock includes a wealth of data, both about the property and the neighborhood. They include home inspection reports, title history reports, cap rate and cash-on-cash return analyses, neighborhood- and property-level appreciation history, local school data, and more. Most impressively, they offer two buyer guarantees, including a 30-day money-back guarantee and a 45-day leasing guarantee for vacant properties.
The ease of turnkey investing comes with its own risks. Take special care in calculating cash flow, as these easy-to-invest-in properties invite stiff competition.
While there are many ways to house hack, the classic strategy involves buying a small multifamily property, moving into one unit, and renting out the other unit or units. The idea is simple: Your neighbors pay your mortgage for you.
It’s a great way to ease your way into rental investing, not least because you can get a low-interest mortgage with a small down payment. Properties with two, three, or four units are still classified as residential by the mortgage industry, so you can take out a standard homebuyer’s mortgage. That could mean a down payment as low as 3.5% for an FHA loan, 3% for a Fannie Mae HomeReady loan, or 0% for a VA loan.
Contrast that against the standard 20% for an investment property loan, plus a higher interest rate to boot, and you can see why house hacking proves so attractive — to say nothing of the whole “my neighbors pay my mortgage” perk.
3. Short-Term Vacation Rentals
No one says you have to lease out your rental properties to long-term tenants. Sites like Airbnb and HomeAway let you rent them out short-term to vacationers or even mid-term to corporate guests.
Vacation rentals come with their own trade-offs, of course. Yes, you can charge more on a per-night basis, but your occupancy rates are lower. And while you won’t have the same headaches with nonpaying tenants and evictions, you’ll have other headaches, like cleaning the unit between guests, furnishing the unit, and paying for utilities.
Before investing in a vacation rental property or deciding to use an existing rental to host tourists, make sure you gather accurate numbers for expenses like vacancy rate, management fee, cleaning costs, and seasonal rents and occupancy rates. Include utility costs, and be conservative in all estimates.
It can be an effective business model if you approach it as a business and not a passive investment.
Often, aspiring real estate investors start by wholesaling properties rather than buying properties themselves. To wholesale, you find a great deal on a property and put it under contract for, say, $100,000. The property is worth $120,000 in its current condition, but instead of buying it, you sell the contract to another investor for $110,000.
You earn a profit without ever having to take the title to the property, and the buyer gets the property for a discount below its market value. It’s a win-win.
If it sounds like easy money, it’s not. Finding outstanding deals on properties takes a lot of work, and it also takes work to build a network of investor-buyers. Wholesalers must also accept a degree of risk that they’ll fail to find a buyer, leaving them stuck with a contract they never intended to close.
But for all that, it’s a great way to learn how to find deals and earn money before you’re financially ready to buy properties yourself.
5. Public Real Estate Investment Trusts
A real estate investment trust, or REIT, is a type of security traded on public stock markets. The REIT fund uses its capital to invest in real estate, either directly by buying properties or indirectly by lending mortgages against real property — these are known as mortgage REITs or mREITs.
One common advantage to REITs compared to traditional stock funds is high dividend yields. By law, REITs must disburse at least 90% of their profits to shareholders in the form of dividends, making for high-yield investments.
The downside of that high dividend yield is that REITs often have trouble putting together capital to grow their portfolio since they have to immediately pay out so much of their profit to shareholders. But if you’re looking for a completely passive way to diversify your stock portfolio to include real estate, there’s no easier option than buying REITs in your brokerage account, IRA, or 401(k).
Pro tip: If you don’t have a brokerage account or IRA set up, you can open an account with You Invest by J.P. Morgan. They are offering up to $625 when you open and fund your new account.
6. Real Estate-Related Stock Funds
Certain industries include a high exposure to real estate, such as commercial construction companies, homebuilders, home improvement retailers, and even the hotel industry. That means you can indirectly invest in real estate by buying shares in companies that make their living from the real estate sector.
You could invest by picking individual stocks or by buying industry-specific mutual funds or exchange-traded funds. Just be aware these companies’ stocks aren’t driven solely by real estate markets and could rise or fall based on reasons as varied as poor management, high building material costs, or even a CEO sex scandal.
While it’s the least direct way of diversifying into real estate investments, it’s completely passive, and you can do it with the click of a button.
7. Crowdfunding Websites & Private REITs
Not all real estate crowdfunding websites operate on the same model.
In one model, the crowdfunding website provides financing for short-term purchase-rehab loans – the kind of loans flippers and BRRRR investors use. To come up with the cash to fund those loans, the crowdfunding website sources money from the public. As the capital investor, you can look over the loans currently being funded, evaluate the property and borrower, and invest money toward the loan. One example of this model is GroundFloor, which allows participation by nonaccredited investors.
The other common model for crowdfunding websites operates like a REIT, but one not publicly traded on stock exchanges. In these cases, the crowdfunding website privately buys and manages income-producing properties using money raised from individual investors like you. A good example includes DiversyFund, which has an average annualized return of 17.6% since its inception. This crowdfunding site accepts money from nonaccredited investors and investments as low as $500.
Note that many crowdfunding websites only accept funds from accredited investors, set high minimum investment amounts, or both.
8. Private Equity Funds & Opportunity Zone Funds
Accredited investors with plenty of money to invest have more options than the rest of us. Among those options are private equity funds.
These funds allow wealthy investors to pool their money for larger-scale investments such as commercial buildings. A fund manager oversees the day-to-day operations – for a hefty fee, of course – leaving the fund’s investors to sit back, relax, and enjoy the returns.
One specific type of private equity fund particularly relevant to real estate is an opportunity zone fund. These funds buy and improve real estate in qualified opportunity zones designated by the state and certified by the Treasury Department.
Qualified opportunity zones are typically low-income areas where the state aims to spur economic growth and investment. The carrot for investors: deferred and reduced taxes on profits. See this IRS summary for details.
These tax benefits make a tempting offer for wealthy accredited investors looking for creative ways to trim their tax bill. But be prepared for higher risk when investing in distressed neighborhoods.
9. Private Notes
One way to invest in real estate indirectly and passively is by lending money directly to real estate investors for a property purchase.
Most often, that means lending to friends, family members, and other people you know personally and trust with your money. That trust is key because if they default on you, you have little recourse other than suing them. Most private note lenders don’t get a lien against the property, and even when they do, it’s no trivial matter to foreclose on a property.
But typically, private note investors charge high interest rates. And when they personally know the real estate investor and their (hopefully excellent) track record, that often translates to low risk, high returns. Just be careful when mixing your personal life and financial investments. You’re risking your personal relationships, not just your money.
You have no shortage of options when you’re ready to add real estate to your investment portfolio.
Before deciding which real estate investing strategy to take, get very clear on your personal goals. Flipping is great for generating cash with a quick turnaround, but it’s a one-time payout that’s taxed as regular income, and it’s far from passive. In contrast, lending money in the form of a private note to your real estate investor friend is completely passive but leaves you with no control or assurances other than your personal trust in the borrower.
Real estate is a notoriously illiquid investment, so make sure you understand the time commitment for your funds before investing. Plan out your ideal exit strategy, then create a contingency plan in case you need to switch to Plan B.
As a source of high returns, ongoing income, and tax benefits, real estate makes a winning case for inclusion in your portfolio. But as with any investment, do your homework and understand the risks before shelling out your hard-earned cash.