Buying and owning real estate is an investment strategy that can be both satisfying and lucrative. Unlike stock and bond investors, prospective real estate owners can use leverage to buy a property by paying a portion of the total cost upfront, then paying off the balance, plus interest, over time.
What makes a good real estate investment? A good investment has a high chance of success, or return on your investment. If your investment involves a high level of risk, that risk should be balanced out by a high possible reward. Even if you choose investments with a high probability of success, though, that isn't a guarantee. You shouldn't put money into real estate—or any other investment—if you cannot afford to lose that money.
Though a traditional mortgage generally requires a 20% to 25% down payment, in some cases, a 5% down payment is all it takes to purchase an entire property. This ability to control the asset the moment papers are signed emboldens both real estate flippers and landlords, who can, in turn, take out second mortgages on their homes in order to make down payments on additional properties. Here are five key ways investors can make money on real estate.
1. Rental Properties
Owning rental properties can be a great opportunity for individuals who have do-it-yourself (DIY) renovation skills and the patience to manage tenants. However, this strategy does require substantial capital to finance upfront maintenance costs and to cover vacant months.
Pros:
-Provides regular income and properties can appreciate
-Maximizes capital through leverage
-Many tax-deductible associated expenses
Cons:
-Managing tenants can be tedious
-Potentially damage property from tenants
-Reduced income from potential vacancies
According to U.S. Census Bureau data, the sales prices of new homes (a rough indicator for real estate values) consistently increased in value from the 1960s to 2007, before dipping during the financial crisis. Subsequently, sales prices resumed their ascent, even surpassing pre-crisis levels. The long-term effects of the coronavirus pandemic on real estate values remain to be seen.
2. Real Estate Investment Groups (REIGs)
Real estate investment groups (REIGs) are ideal for people who want to own rental real estate without the hassles of running it. Investing in REIGs requires a capital cushion and access to financing.
REIGs are like small mutual funds that invest in rental properties. In a typical real estate investment group, a company buys or builds a set of apartment blocks or condos, then allows investors to purchase them through the company, thereby joining the group.
A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all of the units, handling maintenance, advertising vacancies, and interviewing tenants. In exchange for conducting these management tasks, the company takes a percentage of the monthly rent.
A standard real estate investment group lease is in the investor’s name, and all of the units pool a portion of the rent to guard against occasional vacancies. To this end, you'll receive some income even if your unit is empty. As long as the vacancy rate for the pooled units doesn’t spike too high, there should be enough to cover costs.
3. House Flipping
House flipping is for people with significant experience in real estate valuation, marketing, and renovation. House flipping requires capital and the ability to do, or oversee, repairs as needed.
This is the proverbial "wild side" of real estate investing. Just as day trading is different from buy-and-hold investors, real estate flippers are distinct from buy-and-rent landlords. Case in point—real estate flippers often look to profitably sell the undervalued properties they buy in less than six months.
Pure property flippers often don't invest in improving properties. Therefore, the investment must already have the intrinsic value needed to turn a profit without any alterations, or they'll eliminate the property from contention.
Flippers who are unable to swiftly unload a property may find themselves in trouble because they typically don’t keep enough uncommitted cash on hand to pay the mortgage on a property over the long term. This can lead to continued, snowballing losses.
There is another kind of flipper who makes money by buying reasonably priced properties and adding value by renovating them. This can be a longer-term investment, wherein investors can only afford to take on one or two properties at a time.
4. Real Estate Investment Trusts (REITs)
A real estate investment trust (REIT) is best for investors who want portfolio exposure to real estate without a traditional real estate transaction.
A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, like any other stock.
A corporation must payout 90% of its taxable profits in the form of dividends in order to maintain its REIT status. By doing this, REITs avoid paying corporate income tax, whereas a regular company would be taxed on its profits and then have to decide whether or not to distribute its after-tax profits as dividends.
Like regular dividend-paying stocks, REITs are a solid investment for stock market investors who desire regular income. In comparison to the aforementioned types of real estate investment, REITs afford investors entry into nonresidential investments, such as malls or office buildings, that are generally not feasible for individual investors to purchase directly.
More importantly, REITs are highly liquid because they are exchange-traded trusts. In other words, you won’t need a real estate agent and a title transfer to help you cash out your investment. In practice, REITs are a more formalized version of a real estate investment group.
Finally, when looking at REITs, investors should distinguish between equity REITs that own buildings and mortgage REITs that provide financing for real estate and dabble in mortgage-backed securities (MBS). Both offer exposure to real estate, but the nature of the exposure is different. An equity REIT is more traditional in that it represents ownership in real estate, whereas the mortgage REITs focus on the income from real estate mortgage financing.
5. Online Real Estate Platforms
Real estate investing platforms are for those who want to join others in investing in a bigger commercial or residential deal. The investment is made via online real estate platforms, which are also known as real estate crowdfunding. This still requires investing capital, although less than what's required to purchase properties outright.
Online platforms connect investors who are looking to finance projects with real estate developers. In some cases, you can diversify your investments with not much money.