Your home is the first thing that comes to mind when considering dealing in real estate. Real estate owners can, of course, choose to invest in many different things besides real estate.
Real estate has become a popular trade method in the last fifty years. Here are some of the best choices for individual buyers and why you should put money into them.
BECAUSE OF THIS
People have long thought real estate was a good business, and they were right. Before 2007, statistics from the past about housing prices made it look like prices could keep going up forever. Almost every year from 1963 to 2007, when the Great Recession began, the average sale price of homes in the U.S. went up. When COVID-19 broke out in the spring of 2020, home prices dropped slightly. But as more vaccines emerged and worries about pandemics disappeared, home prices rose quickly and reached all-time highs by 2022.
The Federal Reserve Bank of St. Louis made this chart that shows the average sales prices from 1963 to the first quarter of 2022, which is the most current data that can be found. The light grey parts show where the U.S. economy is shrinking.
If you buy rental properties, you become a landlord, so consider whether you’ll be happy in that job. You’ll be the landlord, so you’ll have to pay the mortgage, property taxes, and insurance, keep the house in good shape, find renters, and fix any problems.
Being a landlord is a hands-on business unless you hire a property manager to do it all for you. Taking care of the property and the renters may be a job that you have to do 24 hours a day, seven days a week, and it’s only sometimes fun. However, you can reduce the chance of significant problems if you carefully pick your properties and tenants.
The U.S. Bureau of Labor Statistics “Property, Real Estate, and Community Association Managers: What They Do.”
You can charge different amounts of rent depending on where the rental is. But it can be hard to figure out the best rent because if you trust too much, people will not want to live there, and if you charge too little, you’ll lose money. One typical strategy is to capture just enough rent to cover costs until the mortgage is paid off. After that, most of the rent is profit.
If the value of your home goes up, you can sell it for more than you paid or use the equity to get a loan for your next investment. There is no promise that real estate will increase in value, but it usually does.
This is especially true when the real estate market is volatile, like during the COVID-19 pandemic. It’s wild that median home prices in the U.S. increased by 38% from February 2020 to March 2022.
Many people are worried that prices will drop because of the sharp rise.
Real estate flippers and day traders are different from buy-and-hold investors. Flippers buy homes to hold them for three to four months and then sell them for profit.
To flip a house there are two main ways to do it:
1. Fix things and add new ones. In this method, you buy a house that you think will be worth more after some fixes and improvements. Ideally, you finish the work as quickly as possible and then sell it for more than you put into it (including the repairs).
2. Keep and sell again. This way of flipping is different. You don’t buy a house and fix it; you buy it when the market proliferates, hold on to it for a few months, and then sell it for a profit.
You may be unable to sell the property at a price that will make you money with either type of sale. But this can be hard because most flippers need to keep more cash to pay long-term property debts. Even so, if you do it right, flipping can be an excellent way to make money investing in real estate.
When a company or trust is set up to buy, run, and sell properties that make money for investors, that property is called a real estate investment trust (REIT). The same places where stocks, ETFs, and REITs are bought and sold are also where REITs are bought and sold.
For a business to be a REIT, it has to give 90% of its taxable profits to owners as dividends. This keeps REITs from having to pay corporate income tax. On the other hand, a typical company would have to pay tax on its gains, lowering the amount of money it could give its shareholders.
Like regular stocks that pay dividends, REITs suit buyers who want a steady income. They also have the potential to go up in value. Many types of properties are bought by REITs, including malls (about a quarter of all REITs focus on these), medical buildings, mortgages, and office buildings. REITs are better than other real estate purchases because they are easy to sell.
Real estate investment groups, or REIGs, are like small mutual funds for rental homes. If you want to own a rental property but don’t want the work of being a landlord, you should join a real estate investing group.
As an investor, you can buy a group of buildings, usually flats, through a company. This way, you can become a part of the group. An individual trader can own one or more units of separate living space. However, the company that runs the business group controls all the units and ensures they are maintained, advertised, and rented out. For managing the property, the company gets a cut of the rent every month.
There are different kinds of business groups. In this type, the investor holds the lease, and all the units share a part of the rent to cover those times when there are no tenants. This means that even if your team is empty, you will still have enough money to pay.
What kind of business group you get is entirely up to the company that provides it. It is a safe way to invest in real estate, but some groups may charge fees just as bad as those in the mutual fund business. When investing, it’s essential to do your homework.
A real estate limited partnership (RELP) is like a business group for real estate. It’s a business set up to buy and hold a group of homes or sometimes just one property. RELPs, on the other hand, only last for a certain number of years.
In this case, the general partner is a property manager or real estate development company with much experience. Then, buyers from outside the company are asked to help pay for the real estate project in exchange for a small stake in the company. The partners may get payments from time to time from the earnings of the RELP’s properties, but the real payoff comes when the properties are sold (hopefully at a significant profit) and the RELP ends.
Real estate mutual funds invest primarily in REITs and real estate operating companies. They provide the ability to gain diversified exposure to real estate with a relatively small amount of capital. Depending on their strategy and diversification goals, they provide investors with much broader asset selection than can be achieved through buying individual REITs.
Like REITs, these funds are pretty liquid.7 Another significant advantage to retail investors is the analytical and research information provided by the fund. This can include details on acquired assets and management’s perspective on the viability and performance of specific real estate investments as an asset class. More speculative investors can invest in a family of real estate mutual funds, tactically overweighting certain property types or regions to maximize return.
Real estate can improve an investor’s risk-and-return profile by giving them better returns when risk is considered. Generally, the real estate market is not very volatile, especially compared to stocks and bonds.
Real estate is also a good choice compared to more common ways to make money. Generally, this type of asset trades at a higher yield than U.S. Treasury bonds, and it’s especially appealing when Treasury rates are low.
Diversification is another good thing about buying real estate. When stocks go down, real estate usually goes up. This is because real estate has a low correlation with other big asset classes, and sometimes it even has a negative correlation. Adding real estate to a portfolio can make it less volatile and give a higher return for each unit of risk. The better the protection, the more direct the real estate investment. Less direct publicly traded vehicles, like REITs, will show how the stock market is doing.
Direct real estate also has less principal-agent conflict because it is backed by real estate. This means that the investor’s interests depend less on the honesty and skill of managers and borrowers. It’s possible to be protected when you spend in even the most indirect ways. For example, REITs require that at least 90% of their gains be paid in dividends.
The inflation-hedging capability of real estate stems from the positive relationship between gross domestic product (GDP) growth and demand for real estate. As economies expand, the need for real estate drives rents higher, which translates into higher capital values. Therefore, real estate tends to maintain the purchasing power of capital by passing some inflationary pressure onto tenants and by incorporating some inflationary pressure in the form of capital appreciation.
Aside from REITs, real estate trading gives investors one tool that stock market investors don’t have: they can use leverage. Leverage means taking out a loan to pay for something bigger than you have cash on hand. If you don’t buy on margin, you must pay the total stock amount when you place your buy order. The percentage you can borrow is still much lower than when you buy a house, thanks to the mortgage, that magic way to get money.
A 20% down payment is needed for most standard mortgages.
You can get a mortgage with as little as 5% down, though, based on where the property you buy is located. In other words, you can own the whole house and all its equity for a minimal amount. The amount of ownership you have in the place depends on the size of your mortgage, but you decide that as soon as the papers are signed.
This is what gives owners and people who flip houses confidence. Another loan can be taken out against their homes, and they can also make down payments on two or three other places. They have control over these assets, even though they have only paid a small portion of their total value. This is true whether they rent them out so that the renters pay the mortgage or wait for a chance to sell for a profit.
Investing in real estate can be a smart move to help you build wealth and earn a steady income. However, one problem with real estate is that it can take time to turn an asset into cash or cash into an asset.
It only takes seconds to buy or sell stocks or bonds, but it can take months to close on a real estate deal. Sometimes, it takes weeks of work to find the right partner, even with the help of a broker. REITs and real estate mutual funds have better market prices and liquidity. They are more volatile and offer less diversification than direct real estate purchases. This is because they are much more tied to the stock market.
When investing, you must keep your expectations in check and do research before making a choice.