At first glance, the benefits of investing in real estate seem ideal – buy the right property, and you can enjoy regular cash flow, low volatility and a variety of tax incentives.
Of course, like every investment, real estate comes with risk. Owning property involves upkeep, labor and a certain level of uncertainty in the housing market.
Not sure if real estate investing is right for you? You’re already on the right track – by weighing the risks and benefits, it’s easier to make smart, confident investment decisions.
How To Get Into Real Estate Investing
Learning how to get into real estate investing can seem a bit overwhelming at first, but don’t worry – you don’t have to rush out and buy an apartment building today. There are plenty of ways to get involved.
The best way to get started in real estate depends on your available cash, time and skills. If you have the money for a down payment, you can buy a property to rent or flip. If capital is an issue, you might buy shares in a real estate investment fund.
Don’t have the money to buy a property? A real estate investment trust (REIT) is an easy way to invest.
A REIT is a company that owns and operates a portfolio of income-producing properties. You can buy shares in the REIT of your choice – when it makes money, you earn dividends. To get involved, you can go through a broker to invest in real estate mutual funds (REIT mutual funds) or REIT exchange-traded funds (ETFs).
Residential properties are zoned as living spaces. This category includes single-family homes, townhomes and multiunit homes.
The most common way to make money from a residential unit is to buy a rental property and charge tenants to live in it. Do it right and you can cover your expenses and still create a steady cash flow. With time and cost-effective upgrades, the property is likely to appreciate. At that point, you can sell it for a profit.
Vacation and short-term rental properties
These properties are furnished, fully stocked homes or apartments that you rent out on a short-term basis – the kind of thing you’d see on Airbnb or Vrbo. You can usually charge more per night than you’d earn with a long-term lease, so the income potential is higher.
Commercial properties are zoned for business purposes. This category includes shopping malls, office buildings, hospitals and hotels. If you own a commercial property, you can make money by leasing space to businesses.
Turn on HGTV, and you’re almost certain to run across a house-flipping show. It’s a popular trend – you buy a fixer-upper, upgrade it and sell it at a higher price. Flipping can be profitable if you have capital, construction skills and access to reasonably priced labor.
10 Benefits of Real Estate Investing
As long as you choose properties thoughtfully, real estate can be a profitable – and stable – part of your investment portfolio. Compared to other types of investments, real estate comes with a few significant benefits.
1. Generates cash flow
When you rent out a property, it can start generating cash flow immediately. Thanks to the lease agreement, the income is usually steady and predictable. This is true whether you’re investing in land, commercial buildings or residential properties.
In the beginning, you can expect to reinvest a significant percentage of that cash back into the property to pay for the mortgage, taxes, insurance, maintenance and repairs. As you pay off the property and build equity, you’ll free up more cash for income or other investments.
2. Creates passive income
The right investing strategy can generate passive income – in other words, your properties will make money with little to no labor on your part.
The trick? Designing a system that operates without your active involvement. Here are some options to consider:
- Buying rental properties and hiring a property manager to handle tenant screening, rent collection and maintenance
- Investing in REITs
- Buying foreclosures or tax-sale properties and selling them for a higher price
- Flipping homes and hiring out renovations to contractors
3. Provides tax advantages
Investing in real estate opens up a world of tax benefits.
- Deductions: You can deduct any expenses that are directly related to owning, running and managing your properties. This includes interest on your mortgage, property taxes, insurance and maintenance costs.
- Capital gains: When you sell your property, it’s taxed as a capital gain rather than income. The capital gains tax rate is much lower than the income tax rate, so you’ll save money.
- Opportunity zone perks: If you buy a property in one of the zones the IRS designated a low-income opportunity zone or if you invest in an opportunity fund, you can defer the taxes on capital gains. After 10 years, this investment becomes tax free.
4. Protects against inflation
If you’re concerned about inflation, real estate can be a safeguard. That’s because as inflation increases, so does your property value. That way, you can charge more in rent, sell the property for a larger profit or borrow against the extra equity if your property value increases.
5. Diversifies investment portfolios
Do you have an existing portfolio of stocks, securities and bonds? Real estate is a great way to diversify your strategy.
Real estate creates another way to earn money, but it can also help you create a more resilient portfolio. After all, properties often react differently to changes in the market than other types of assets. If something goes wrong in another area – a volatile stock market, for example – your real estate holdings can help reduce overall losses.
6. Increases leverage
Leverage – using borrowed money to invest and increase your returns – is one of the biggest benefits of real estate investing.
You only need to pay 10% – 20% out of pocket for the down payment, but you get access to the entire property right away. Then, you can leverage it for other purposes, such as earning an income or using it as collateral for a loan.
As the property value increases, you may be able to take out a home equity loan or use cash-out refinancing to take money out of the property. That capital can be leveraged for another investment (like buying another investment property) while keeping your expenses low.
7. Can appreciate over time
A property can increase in value over time – a process called appreciation. A variety of factors play a part: renovations, interest rates, location and the state of the local housing market, just to name a few.
Once your property has appreciated, the potential returns are higher. You might be able to charge more in rent, for example, or sell the home for more than you paid.
Appreciation isn’t guaranteed, but you can improve prospects by making upgrades, increasing efficiency or adding extra space.
8. Helps build wealth
As you pay down the mortgage, you build equity, which is the difference between the property value and the amount owed. The more equity you have, the larger your net worth. If you need capital to leverage for other wealth-building investments, it’s relatively easy to borrow against the equity to access cash.
9. Provides potential vacation or future retirement home
Don’t wait to buy a vacation property or retirement home – buy the property in a desirable location now and use the rental income to pay off the home. By the time you’re ready to retire, you’ll own it outright (or at least have a smaller mortgage).
Investing in a vacation home is a similar process, but you can start using the property right away. List the home for rent on vacation rental sites to earn an income. When you want to visit, simply block off the dates.
10. Can give fulfillment
Investing in real estate isn’t all about the money – it can also improve your life. A large real estate portfolio is a business in itself, giving you the freedom to be your own boss.
If you have strong ties to a city or neighborhood, buying and upgrading properties is a wonderful way to improve the community. In the process, you’ll create housing opportunities and attract new businesses to the area.
All this activity provides a boost to the economy. New tenants and companies increase foot traffic to other local businesses, and upgraded properties attract other investors.
Risks of Real Estate Investing
Real estate investing isn’t without risk. Some challenges you may face include:
- Problem tenants: Tenants may cause expensive damage or refuse to pay rent. This can happen even with tenants who are a good risk initially but suddenly lose income.
- Market shifts: The real estate market can be unpredictable. Financial recessions or natural disasters can make it difficult to rent or sell your property.
- Increased liability: If you own a rental property, you’re at risk of being sued if something goes wrong. To reduce your personal liability, you’ll need to buy insurance.
- Low liquidity: It takes time to sell real estate or borrow against a property. If you need a business that lets you access capital quickly, real estate may not be right for you.
- Higher initial investment: A down payment for an investment property can easily cost 10% – 25% of the property’s value upfront or $10,000 to $25,000 for every $100,000 worth of property that you plan to buy. That’s more than you usually need compared to investing in stocks, bonds or other investments.
- Structural problems: Issues with the foundation, roof, electrical wiring or plumbing system may require expensive repairs.
How can you minimize the risks of real estate investing?
There’s no way to eliminate risk completely when you invest in property, but you can take steps to minimize it.
- Research the market carefully
- Pick the best places to invest in real estate, such as desirable cities or up-and-coming neighborhoods
- Conduct a detailed inspection before the sale
- Use a real estate attorney to vet the contract
- Order a title search to ensure there are no liens or other people who have a legal claim to the property
- Purchase liability insurance
- Comparison-shop to get the best mortgage terms
Real Estate Investing vs. Other Investments
Real estate can be a valuable part of a diversified portfolio. As you plan a strategy, it’s helpful to understand how properties stack up to other asset classes.
In general, a home or land investment tends to be less volatile than stocks. However, stocks have higher liquidity, so they’re easier to sell when you need cash.
But, when it comes to leverage, it’s hard to beat real estate. It typically offers more leverage than many other traditional investments, including mutual funds.
Risk is an important consideration for investors. Real estate is riskier than bonds and CDs, but it also has a higher potential yield. It’s also probably less risky than cryptocurrency and NFTs, largely because property is tangible and able to create cash flow.
Is Investing in Real Estate Worth It?
Investing in real estate is usually worthwhile, especially when you take the time to monitor the market and pick a profitable property. Before you buy, take time to get your finances in order. Since lenders do the underwriting, solid income and a good credit score can help you save money on interest.
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