5 Types of Real Estate Investments
Once you have determined that real estate investing is right for you, the next step is to determine which type of real estate investment is right for you.
In real estate investing there are basically five types of investments to choose from:
- Residential Investments
- Commercial Investments
- Real Estate Funds
In this post, we will explore the similarities, differences, advantages, and disadvantages of each investment type.
Residential Real Estate Investments
There are actually several possibilities when it comes to investing in residential real estate. You can invest in single family residences or in multi-family units. In either case, you can either invest to flip the property, or you can hold the property and rent it out.
Single Family Residences
Single family residences are homes intended for a single family (as opposed to duplexes, triplexes, apartments, etc.). When one invests in a SFR, the intent is usually to either flip it or rent it out to tenants. Flipping just means that someone intends to purchase the home, fix it and/or update it, then sell it again right away.
Flipping is obviously a short term strategy, and it requires quite a bit of knowledge about home valuations and repair costs. Lots of people lose money flipping houses, but if you know what you are doing, it can be profitable.
The other option is to buy a SFR, fix it up, then rent it out. This long term strategy is great if you won't need your capital back any time soon. In a buy and hold strategy, the investor is looking to make money on the capital appreciation (i.e. home prices going up) as well as on the cash flow from renters.
Multi-family investing is similar to single family residence investing. Multi-family units include duplexes, quadplexes, small apartments, or even large apartment complexes, although investing in large complexes begins to function more like commercial investing.
Just as SFR investors either buy the property to flip or fix and rent out, multi-family investors can also buy the property to flip or rent, although most multi-family investors intend to hold and rent the properties. Multi-family properties have the advantage of constant cash flow. If a single family residence loses its tenant, the owner receives no cash flow until they find another tenant. In multi-family investments, if one tenant moves out, there are usually others still occupying other units. The general disadvantage to multi-family investing is that the property values do not increase as much as SFR values do. You will likely have a higher appreciation rate investing in single family homes.
Commercial real estate is a rather broad category. It can include anything from laundromats to grocery stores, to strip malls, to high rise buildings, and any number of other types of businesses and structures. Commercial real estate investing nearly always entails buying property with the idea of collecting rent from tenants.
Without going into too much detail here, suffice it to say that commercial real estate investing is quite different from residential investing. For example, commercial investing utilizes different lease structures than residential investing. Commercial investing also often means one has to understand basic functions of certain industries. For example, if you were to purchase a building that you intend to rent out as a restaurant, you have to know what types of amenities restaurants require (i.e. grease traps, fire suppression systems, etc.). Medical buildings, on the other hand, require a whole other set of amenities.
Commercial investing usually requires more capital than residential investing. For this reason, commercial investors tend to have deeper pockets and/or access to more capital.
REITs or Real Estate Investment Trusts are great passive investment vehicles that offer a way to invest in real estate without having to be so involved with the properties themselves. When one invests in residential or commercial real estate, one is usually quite involved in the operation of the business. Even if you hire a management company to manage properties for you, you still have to make important real estate decisions for your properties.
A Real Estate Investment Trust is like a stock. It is a fund in which you buy shares. The fund owns properties, and you simply own a slice of each one via your shares. A REIT generally owns many properties. REITs can specialize in certain types of properties, such as malls or apartment complexes. So, if you want to invest in commercial real estate without actually buying property yourself, you can buy shares of a REIT. The REIT shares trade on an exchange, and you can buy and sell them anytime you want.
The advantage of REIT investing is that you can get in and out of your investment quickly. And, you don't have to sell all of your investment just to realize part of your returns. For example, if you buy an investment house, and at some point in the future you need part of your capital for something else, you have to sell the whole house (obviously). Let's say your investment house is worth $400,000, but you only need $100,000 for some special project. You would have to sell the house and find something else to do with the other $300,000. In a REIT, you could just sell $100,000 worth of shares.
Real Estate Funds
Real estate funds are similar to REITs in that they offer a passive way of investing in real estate by simply purchasing shares in a fund. The difference is that a real estate fund does not actually own any real estate like a REIT does.
A real estate fund simply tracks an index. What is an index? In short, an index is a mathematical representation of a broad basket of securities. The Dow Jones Industrials is an index that tracks the stocks of 30 companies. A real estate fund index tracks the prices of REITs or even companies that provide various real estate services. As with a REIT, investing in a real estate index fund just means you are buying shares of a security on an exchange. Again, you can get in and out of the shares when you want, and you are generally able to be more nimble with your cash. The fund might specialize in certain types of real estate securities, but it will not own any actual real estate.
Finally, there is land. As a real estate investment, land can be purchased with the idea of selling it later for a profit (price appreciation), or it can be purchased with the idea of developing it.
If you have a knack for seeing where things are heading in a community, buying land can be very profitable. Land investing is quite different from the other real estate investments in that you are always speculating on future events. Still, as the saying goes, they aren't making any more of it, and as such, land is often a great investment in areas where development is up and coming.
Summing it All Up
Real estate investing is a great way to employ part of your capital. Once you have determined that investing in real estate is right for you, your next decision is what type of real estate investment to make. Whether you decide to purchase residential real estate, commercial real estate, REITs, real estate funds, or land, real estate investing offers a variety of ways for you to take advantage of rising property values.