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Real estate can be a very lucrative investment – and it doesn’t have to be hard. Being a real estate investor doesn’t always require a great deal of financial commitment upfront, and you don’t always have to deal with tenants.
Understanding your options to make money in real estate is the first step to exploring this type of investing. We’ll take a look at several real estate investment options.
How Real Estate Investing Works
Real estate investments come in many types, so most investors can find a version that’s right for them.
When you invest in real estate, you own, lease or sell real estate for profit in any of several ways. Most real estate investments gain value over time, and some also provide a steady income stream.
While some types of real estate investments (especially house flipping) can reap profits quickly, most are long-term investments that require a fair amount of patience. Like any investment, real estate investments also come with some risks.
Active vs. Passive investments
As a real estate investor, you can take an active, hands-on role, or you can invest passively. Active investments require a hands-on approach that involves frequent, even daily, attention. With passive investments, you can invest money while someone else handles the work.
Active real estate investors are heavily engaged in all steps of the process, including the acquisition, renovation, property management and sale of the real estate. Types of active real estate investments include:
- Wholesaling: The investor purchases a property and then sells the property rights to someone else.
- Flipping: The investor purchases a property below market value and then immediately sells it for a higher price, sometimes renovating before selling.
- Development: Investors develop or renovate real estate from the beginning (negotiating contracts) to the end (construction and sale).
- Rentals: Investors gain income by renting their properties to tenants.
Passive real estate investors aren’t looking for hands-on involvement. They use their existing assets to generate passive income. Sometimes they hire property managers to handle the active aspects of their investments. Many landlords do this with their rental properties.
Major types of passive investments include:
- Real estate investment trusts (REITs): Investors buy shares in a trust, which handles the active management of its properties.
- Syndication: Multiple investors pool their money to invest in properties they couldn’t afford on their own.
- Rentals with property managers: An investor hands off routine maintenance tasks to a property management company.
Types of Real Estate Investments
Take a look at the details surrounding each of these main types of real estate investment:
Your choice of residential real estate investment depends on how much you have to invest, how quickly you want to see returns and how actively you want to be involved. Residential real estate investors make money when they either sell the property they’ve invested in or through rental income.
Some of the key types of residential real estate investments include:
- Long-term rental properties: The properties can be single-family homes, multifamily homes or larger apartment buildings. You can be actively involved in managing the property, or you can hire a property management company.
- House hacking: The homeowner lives in a unit on the property while collecting rent on the other units.
- Flipping houses: You buy a fixer-upper, usually below market value, then make the needed repairs and sell the home. The amount of capital you’ll need can make this investment risky, although the payoff can be substantial.
- Live-in flips: Investors who are handy at construction sometimes live in the homes they plan to flip for a short time while rehabbing them on their own.
- Wholesaling: A wholesaler never owns the home. They act as an unofficial broker for the home. The wholesaler finds a property that’s usually distressed, enters into a contract with the owner, finds a buyer and pockets the difference between the purchase price and sale price.
- Accessory dwelling units (ADUs): ADUs are extra living spaces on your property that you rent out. They may be basement apartments, converted garages or “tiny homes” erected in your yard. They allow homeowners to bring in rental income without a large investment.
- Vacation rentals: Income is generated by renting these short-term rental properties to visitors. While property management companies can handle vacation rentals, they can also be extremely hands-on investments.
PROS of Residential Real Estate Investments👍
Because residential real estate typically appreciates over time, you should make a tidy profit when you sell.
Collecting rent is an excellent form of passive income.
Many investors can reap tax deductions through residential real estate investments.
CONS of Residential Real Estate Investments👎
The initial investment can be significant, adding up to hundreds of thousands of dollars.
Managing rental property (especially short-term rentals) is extremely hands on, demanding a lot of time and effort from investors.
If you need a large amount of liquid cash fast, you may not be able to sell your property quickly enough.
Investors in commercial real estate typically own retail stores, office buildings, mixed-use properties and industrial properties, such as warehouses or storage units. Tenants typically commit to multiyear leases, which helps keep the cash flow stable. As with residential real estate, owners of commercial real estate make money when they sell their property at a profit.
PROS of Commercial Real Estate Investments👍
Commercial real estate investments are typically more lucrative than residential investments over the long run.
Commercial real estate investments may generate cash flow more quickly than residential investments.
Relationships with tenants tend to be professional, making property upkeep easier and less risky.
CONS of Commercial Real Estate Investments👎
Because commercial buildings are open to the public, upkeep must meet higher standards, which can be costly.
Commercial real estate investments carry a higher level of risk, as evidenced during the nationwide Covid-19 lockdowns due to the pandemic, when many office buildings were left empty as employers turned to a work-from-home model.
Commercial tenants may be more demanding, creating a greater drain on your time.
Real Estate Investment Trusts (REITs)
REITs are companies that purchase, manage and sell properties using investors’ money. They also provide a steady income to investors with the hope of significant appreciation.
REITs tend to invest in large properties, such as malls, office buildings and health care facilities. Some REITs are publicly traded, including on the New York Stock Exchange.
Investors take a very passive position with these investments, which are more liquid than most real estate investments because you can buy and sell shares of the trust fairly easily and quickly.
PROS of REITs👍
Because REITs are so passive, all an investor has to do is invest money and collect dividends.
Most REITs are set up to deliver a steady stream of income to investors.
Because REITs are highly liquid, they’re a great choice to diversify your investment portfolio.
CONS of REITs👎
The tax treatment of REIT income isn’t attractive, with REIT dividends taxed higher than other types of dividends.
Some investors may dislike the lack of control that comes with this type of investment.
Real Estate Investment Groups (REIGs)
A REIG buys or builds an apartment building or a group of buildings and handles the management. An investor can invest passively in a single unit or several units.
The REIG collects and uses some of the rental income to handle management expenses. The rest goes to investors. All members of the REIG pitch in to cover any vacancies in the buildings.
REIGs tend to be a stable, safe way to enjoy passive rental income. However, as with other types of mutual funds, it’s important to keep an eye on the fine print because some REIGs charge exorbitant fees.
PROS of REIGs👍
REIGs have a low bar to entry, making them appealing as starter investment opportunities for new investors seeking to learn the market.
Many investors like the team effort aspect of REIGs.
Because investors pool their resources, they have some protection against income-sapping events such as vacancies and significant repairs.
CONS of REIGs👎
Some REIGs charge excessive fees, cutting into potential profits.
Unlike REITs, REIGs are not liquid investments. Investors can’t get funds out of them easily if they need the money for an emergency.
The flip side of the team aspect is the clashes that could potentially arise between investors.
Real Estate Limited Partnership (RELP)
Similar to a REIG, a real estate limited partnership buys and holds one or more properties. RELPs typically invest in larger residential properties or commercial real estate, such as office buildings or retail developments.
A real estate development firm develops, constructs and/or maintains the property, and the RELP provides the financing.
RELPs exist for a limited time. While investors may receive some limited payouts over the duration of the project, they primarily see their return when the real estate development is sold. At that point, the RELP is dissolved.
PROS of RELPs👍
RELPs require little work on the part of investors, who also have limited liability.
RELPs are designed to provide tax savings to investors.
The potential for high returns can be very strong.
CONS of RELPs👎
RELP investments have little liquidity, making them a bad choice for investors who may need immediate access to their funds.
The projects funded through RELPs come with no guarantees. While the rewards are high, the risks may be high as well.
Real Estate Mutual Funds
Real estate mutual funds are similar in structure to traditional mutual funds that invest in stocks and bonds. However, these specialized mutual funds invest in real estate operating companies and REITs – although they aren’t REITs themselves.
Investors can take advantage of a more diversified real estate portfolio through real estate mutual funds, which typically don’t require much capital to get started.
Because the mutual fund managers perform a great deal of research and analysis as they gather assets, these investments are often less speculative than REITs or REIGs.
They’re also more liquid than most real estate investments because investors are buying shares of a fund, not actual properties.
PROS of Real Estate Mutual Funds👍
The diversification provided by real estate mutual funds makes them a less risky investment.
Investors can remain hands off.
A relatively small amount of capital is required to get started with real estate mutual fund investing.
CONS of Real Estate Mutual Funds👎
Real estate mutual funds don’t have the large payoff associated with riskier investments, and it can take some time to see returns.
Because they’re mutual funds, these investments can be affected by a volatile stock market.
Real estate crowdfunding is a fairly new type of real estate investment. It relies on online real estate platforms that bring together investors who, in most cases, don’t have the capital to make major real estate investments on their own.
However, investors must often prove they have sufficient assets and income to join many real estate crowdfunding opportunities.
PROS of Crowdfunding👍
Crowdfunding allows easy diversification of an investment portfolio without requiring a lot of capital upfront.
It connects small investors to allow the pooling of assets.
Crowdfunding is a passive investment that doesn’t demand hands-on involvement.
CONS of Crowdfunding👎
Investors must pay tax on any dividends they receive.
Because of the income and asset requirements, crowdfunding doesn’t provide the low bar to entry it may seem to offer.
Many crowdfunding sites charge investors service and management fees.
Investing in raw land is attractive to many real estate investors because it requires less capital than investments in developed properties.
Investors may lease their land out for agriculture, but typically, they wait for an opportunity to sell the land to a developer at a higher price.
PROS of Investing in Raw Land👍
The cost of raw land is lower, making it easier to acquire than developed properties.
Little to no maintenance is required while holding raw land investments.
Opportunities abound for raw land investors. They can lease out the land, sell it for a profit or develop it.
CONS of Investing in Raw Land👎
Unlike other real estate investments, there are few tax advantages to buying and holding raw land.
Waiting for land to appreciate can take a significant amount of time.
Zoning restrictions may limit what you can do with the land.
Frequently Asked Questions
We’ve got a summary of some of the most common questions about investing in real estate.
What is the best type of real estate investment?
The best type of real estate investment will depend on the investor’s budget and tolerance for risk, local market conditions, potential ROI and desired timeline.
Real estate investors must decide whether they want to actively participate in the ownership and maintenance of properties or take a passive approach and invest in REITs, real estate mutual funds or crowdfunding platforms.
All real estate investments require plenty of research and patience. When looking for deals, prospective investors shouldn’t rule out any options before doing their research.
Where can I find real estate investment properties?
Many real estate investors find properties through the real estate property multiple listing service (MLS). Working with an experienced real estate agent can provide access to potential investments. And looking for properties that are for sale by owner (FSBO) can also be a good starting point.
Can I start real estate investing with no money?
Several types of real estate investments require little money upfront, notably real estate mutual funds and crowdfunding.
Some investors look for 0% loans to fund their investments, while others take out a home equity line of credit (HELOC) on their primary residence to generate capital.
If you’re interested in owning residential rentals, you can also buy a multifamily property and live in one unit while earning rental income on the other units.
What is a good return on investment in real estate?
Generally, returns of 5% – 10% are considered a solid return on real estate investments. Of course, anything over 10% is considered excellent. Investors should remember that they may have to be patient to see their ROI.
Playing the Long Game
Real estate investment can be a good way to create wealth and generate income. However, real estate investors, especially new investors, should keep in mind that riches rarely come quickly in real estate. You must be prepared to play the long game.