A real estate position is in the portfolio of many investors. However, diversifying your portfolio and protecting yourself from stock market volatility can be accomplished by adding additional real estate investments. Let’s take a look at your real estate investing options, their advantages and disadvantages, and how to get started.
a list of the five steps required to begin investing in real estate, arranged alphabetically.
Source: The Motley Fool What options do I have for investing?
The most well-liked approaches to real estate investing are as follows:
Let’s take a deeper look at REITs, real estate investment trusts, flipping houses, limited partnerships, and mutual funds for rental properties.
The most hands-on option on this list is renting out properties. You acquire residential property and lease it to tenants. The majority of rental properties are rented out for 12 months, but companies like Airbnb (NASDAQ: ABNB) are also gaining popularity.
You are the landlord because you own the property. Maintenance, cleaning in between tenants, major repairs, and paying property taxes are all your responsibility. You might be responsible for paying for utilities and appliance replacement, depending on the terms of the lease.
The rental income you get from tenants and price appreciation if you sell the property for more than you paid for it make you money with rental properties.
You can also take advantage of tax deductions. If your modified adjusted gross income is less than $100,000, you can deduct up to $25,000 of losses from your rental properties from your normal income under passive activity loss rules. Even if you’re still making money, the property could still show an accounting loss due to depreciation, which is a noncash expense, and interest, which you pay no matter what.
There may be a requirement for a down payment of up to 25% when purchasing rental property. However, if you charge enough rent to cover your mortgage, your tenant will cover the remainder as well as any price appreciation.
Real estate investment trusts (REITs) are an easy way to start investing in real estate if you don’t want to deal with the hassle of managing a rental property or can’t afford the 25% down payment. REITs are trusts that own and manage rental properties and trade on the stock market. Anything can be theirs: Malls, industrial real estate, medical office space, and office or apartment buildings are just a few examples.
Due to the requirement that they distribute at least 90% of their net income to investors, REITs typically have high dividend payments. The REIT will not be required to pay corporate taxes if it meets this requirement.
Additionally, a REIT has the advantage of liquidity because they trade on stock exchanges, whereas selling a rental property could take months and require a lot of paperwork.
Groups of real estate investors Owning a real estate investment group (REIG) is one way to maintain the profit potential of private rental properties while potentially gaining more upside than a REIT that trades at a premium.
REIGs acquire and manage properties before selling off portions to investors. A REIG will acquire something like an apartment complex, and investors will be able to purchase units there.
The property is managed and a portion of the rent is retained by the operating company. This indicates that the business finds new tenants and handles all maintenance. If some of the units are vacant, the investors will frequently pool some of the rent to continue paying down debt and fulfill other obligations.
The most difficult and riskiest of these options is flipping houses, but it can also be the most profitable. Buy, wait, and sell or buy, repair, and sell are the two most common methods for flipping houses. In either case, the most important things are to keep renovation costs low and limit your initial investment with a low down payment.
With a 20% down payment, or $50,000, let’s say you buy a house for $250,000. You do another $50,000 of redesigns and afterward list the house for $400,000. After paying off the $200,000 loan with the $400,000, you make a profit of $100,000 on a $100,000 investment. If you can get it, it is a fantastic return.
The issue is that you typically are unable. Although housing markets aren’t known for being volatile, being overly leveraged—which is what you have to be—kills you in the game of flipping houses. It may sound simple to keep renovation costs to a minimum, but if you lack direct construction experience, it may be nearly impossible.
Materials costs are skyrocketing, there are a lack of workers everywhere, and almost no cheap houses are available by 2021. For house flippers, it’s the worst part of the cycle: The market could change at any time because everything is expensive.
If you decide to flip houses, be smart and figure out how to wait until the market gets too hot before doing so. Although it may appear counterintuitive, it will ultimately save you money.
REIGs include real estate limited partnerships (RELPs), which are a type of REIG. The limited partners (investors) and general partners (managers) of RELPs are similar to those of hedge funds. The real estate company that assumes all responsibility is the general partner.
RELPs are a real estate investment that takes less action. The general partner typically establishes the partnership and solicits investors to become limited partners. After that, investors receive a K-1 to file with their taxes to report income, but they have little influence over operations.
If you can find a reliable general partner, RELPs can be very profitable. However, you’re depending absolutely on that broad accomplice who must, absent a lot of oversight, deal with the property and dependably report financials back to you.
With a third person sitting nearby, two people exchange handshakes.
Image Credit: Getty Images Real estate mutual funds Real estate funds invest in REITs and REOCs. Similar to REITs, REOCs grow much more quickly because they are not required to pay dividends.
The simplest means of investing in real estate are exchange-traded funds (ETFs) or real estate mutual funds. While you collect dividends, you let a manager or even an index choose the best real estate investment.
Even if you only invest in stocks, real estate funds can provide you with diversification while maintaining your familiar liquidity profile.
Why should you make real estate investments?
Real estate investing has its advantages and disadvantages:
Cons: You can control your investment if you invest in physical property. You could also have an investment that you don’t have to manage at all. In an Extraordinary Downturn kind of occasion, costs can fall and bring down your whole portfolio.
can provide a steady source of monthly income. Even small price drops can wipe out your entire investment due to the amount of leverage required.
can lower your overall volatility by diversifying and experiencing fewer price changes in general. Flipping houses or owning rental properties on your own can become a full-time job and take up a lot of free time.
can result in wealth over the long term through the use of leverage. Initial investments may be challenging due to high costs. You need to save enough money for the down payment and to cover shortfalls in cash flow when jobs become available.
How to start investing in real estate If you decide to make an investment in real estate, the following five steps will help you get started:
Spend less: Of all the asset classes, real estate has some of the most expensive barriers to entry. You should have a lot of savings and pay off your high-interest debt before you start.
Select a method: Any of the aforementioned tactics has the potential to work. You can start by doing online research on your options if you decide to buy funds or REITs. You will need to select a market if you want to purchase real estate.
Establish a team: When you first start out, you might want to work with an agent. Off-book opportunities that haven’t been listed yet will be sent to you by great agents. At some point, you might require a property manager and an accountant to handle your finances. If you succeed, you may eventually require investors as well.
Analyze deals: Any investment, whether in residential or commercial real estate, should be thoroughly researched. For instance, when it comes to rental properties, you’ll need to figure out how much you might have to pay in rent in the future, what expenses you might have to cover, and how much you might get for selling the property.
Get the deal done: The last step is to fire the gun. You can either close on your property or buy it using your brokerage account.
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The conclusion Real estate investing can initially appear intimidating. People don’t always have the time or skills to flip houses or manage tenants. The good news is that there are options for investors of all levels, each tailored to different objectives, skill levels, and time constraints. The most crucial step is to begin immediately and allow your investment to begin compounding.