How to Add Real Estate to Your Portfolio
When you think about real estate investing, the first thing that probably comes to mind is your home. However, real estate investors have lots of other options when it comes to choosing investments, and they're not all physical properties. Real estate has become an increasingly popular investment vehicle over the last 50 years or so. Here's a look at some of the leading ways for individual investors to invest in Real Estate.
With Rental Properties
If you invest in rental properties, you become a landlord—so you need to consider if you'll be comfortable in that role. As the landlord, you'll be responsible for things like paying the mortgage, property taxes, and insurance, maintaining the property, finding tenants, and dealing with any problems. Unless you hire a property manager to handle the details, being a landlord is a hands-on investment. Depending on your situation, taking care of the property and the tenants can be a 24/7 job—and one that's not always pleasant. If you choose your properties and tenants carefully, however, you can lower the risk of having major problems.
One way landlords make money is by collecting rent. How much rent you can charge depends on where the rental is located. Still, it can be difficult to determine the best rent because if you charge too much you'll chase tenants away, and if you charge too little you'll leave money on the table. A common strategy is to charge enough rent to cover expenses until the mortgage has been paid, at which time the majority of the rent becomes profit.
The other primary way that landlords make money is through appreciation. If your property appreciates in value, you may be able to sell it at a profit (when the time comes) or borrow against the equity to make your next investment.
By Flipping Houses
Like the day traders who are leagues away from buy-and-hold investors, real estate flippers are an entirely different breed from buy-and-rent landlords. Flippers buy properties with the intention of holding them for a short period—often no more than three to four months—and quickly selling them for a profit.
The are two primary approaches to flipping a property:
- Repair and update. With this approach, you buy a property that you think will increase in value with certain repairs and updates. Ideally, you complete the work as quickly as possible and then sell at a price that exceeds your total investment (including the renovations).
- Hold and resell. This type of flipping works differently. Instead of buying a property and fixing it up, you buy in a rapidly rising market, hold for a few months, and then sell at a profit.
With either type of flipping, you run the risk that you won't be able to unload the property at a price that will turn a profit. This can present a challenge because flippers don’t generally keep enough ready cash to pay mortgages on properties for the long term. Still, flipping can be a lucrative way to invest in real estate if it's done the right way.
Buying Into REITs
A real estate investment trust (REIT) is created when a corporation (or trust) is formed to use investors’ money to purchase, operate, and sell income-producing properties. REITs are bought and sold on major exchanges, just like stocks and exchange-traded funds (ETFs). To qualify as a REIT, the entity must payout 90% of its taxable profits in the form of dividends to shareholders. By doing this, REITs avoid paying corporate income tax, whereas a regular company would be taxed on its profits, thus eating into the returns it could distribute to its shareholders.
Much like regular dividend-paying stocks, REITs are appropriate for investors who want regular income, though they offer the opportunity for appreciation, too. REITs invest in a variety of properties such as malls (about a quarter of all REITs specialize in these), healthcare facilities, mortgages, and office buildings. In comparison to other types of real estate investments, REITs have the benefit of being highly liquid.
Joining Real Estate Investment Groups
Real estate investment groups (REIGs) are sort of like small mutual funds for rental properties. If you want to own a rental property but don’t want the hassle of being a landlord, a real estate investment group may be the solution for you. A company will buy or build a set of buildings, often apartments, then allow investors to buy them through the company, thus joining the group. A single investor can own one or multiple units of self-contained living space. But the company that operates the investment group manages all the units and takes care of maintenance, advertising, and finding tenants. In exchange for this management, the company takes a percentage of the monthly rent.
There are several versions of investment groups. In the standard version, the lease is in the investor’s name, and all of the units pool a portion of the rent to guard against occasional vacancies. This means you will receive enough to pay the mortgage even if your unit is empty. The quality of an investment group depends entirely on the company that offers it. In theory, it is a safe way to get into real estate investment, but groups may charge the kind of high fees that haunt the mutual fund industry. As with all investments, research is key.