Many people find real estate investment difficult. But real estate can be a lucrative and dependable way to create a substantial income stream, both short and long term. Real estate investment adds to your portfolio with unique advantages like portfolio diversification and tax benefits. We will discuss with you investing in real estate and how you can best get started.
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Table of Contents
What is real estate investing?
Real estate investing is the earning of money by means of ownership, purchase, sale, or lease of land and any structure on it. There are four (4) categories: residential, commercial, industrial, and land.
Types of Real Estate Investing
Residential real estate: Residential real estate is composed of single-family homes, multi-family homes, condominiums, and townhouses. These real estate properties may be rented or owned by the occupants. But, homes bigger than four units are categorized as commercial property. Residential real estate houses, vacation properties, apartment buildings, and all places where people live (ex. primary residence). To begin as an investor, you can best venture initially on this type of real estate.
Commercial real estate (CRE): Commercial real estate refers to properties used for business. The classification of commercial real estate is retail space (ex. restaurants), office space (ex. Business offices), or multi-family homes (ex. Large apartment buildings). CRE includes office spaces, retail stores, or buildings used for business purposes.
As compared to residential real estate, CRE is more expensive and you will manage more properties. If you want to try out CRE, you can best get started by buying shares in real estate investment trusts (REITs). In addition, Equity REITs are real estate companies that buy commercial properties and have them rented and turned to a profit.
Industrial real estate: These properties are used for industrial business. Examples of industrial real estate are storage or shipping warehouses, power plants, and factories. Industrial real estate refers to warehouses, storage units, and large “special purpose” structures that produce sales (ex. car washes).
Land: This type of real estate usually refers to undeveloped property without any structures on it. Due to its nature, earning money from land is limited. Using land for agriculture or selling/developing are some ways for owners to best earn money.
What does investing in real estate do?
Here are some benefits of investing in real estate which will help you earn more money:
Cash Flow – Cash flow refers to the net income from any real estate investment after the payments on the mortgage and operating expenses are made. Real estate investing boosts your ability to have the best cash flow.
Tax Breaks and Deductions – Tax breaks and deductions can save money and time for real estate investors. Basically, you can deduct allowable expenses for operating, owning, and managing a property.
Appreciation – Another way for real estate investors to make money is via rental income, profits gained via property-dependent business, and appreciation. The value of real estate generally increases over time. With a great investment, you can optimize timing to sell and gain profit. Rental income may also increase over time.
Build Equity and Wealth – You build equity as you consistently pay down your mortgage. Equity, by definition, is an asset that is part of your net worth. By building equity, you can purchase more properties and boost cash flow, income stream, and wealth.
Portfolio Diversification – Investing in real estate allows the potential for diversification. By adding real estate to a portfolio of diversified assets, you can have decreased volatility which gives higher returns per unit of risk.
Real Estate Leverage – Leverage refers to using different financial instruments or borrowed capital to boost the potential return of an investment. Example. A 30% down payment on a mortgage allows you to get 100% of the property.
Competitive Risk-Adjusted Returns – Real estate returns are different according to factors like asset class, location, and management.
Inflation Hedge – Simply put, as the economy expands, the demand for real estate causes rents to shoot up. This brings about higher capital values. Thus, real estate tends to keep the buying power of capital by passing inflationary pressure on tenants via capital appreciation.
Real Estate Investment Trusts (REITS) – If you are not fully ready to dive into real estate, you can try out REITs. To be discussed below.
These benefits are awesome but remember — there are disadvantages, too. One major drawback is the lack of liquidity. Nevertheless, investing in real estate is a unique type of asset that is easily understandable and boosts your investor portfolio. It allows tax breaks, cash flow, equity building, competitive risk-adjusted returns, and an inflation hedge.
How do I start investing in real estate?
Before investing, first, decide the amount of your down payment. Do not invest money that you cannot afford to lose. Commercial property investors need around $50,000 to get started. But there are less expensive ways to invest in real estate.
Real estate investment can also take a lot of time. You need to fix the property and regularly maintain it. Some real estate investors outsource maintenance.
There are many ways of investing in real estate — with different amounts of funds and different degrees of capital, time, risk, investment horizons, and return potential. Some may earn both income and appreciation. And some may only earn income.
There are two strategies for real estate investment: active and passive investments. And here are important ways to invest in real estate while optimizing strategies varying from intense, high-effort to hands-off, low-effort.
Active Real Estate Investing
Active real estate investing requires knowledge of real estate plus hands-on management or task delegation. Active investors can be part-time or full-time real estate investors — which depends on how many investment properties and the nature of investments. Since they basically invest in properties with one or few owners, they shoulder some responsibility in making the property investment a success. As such, active real estate investors need to truly understand how to invest in real estate plus financial and negotiation skills to boost the cap rate and total return on investment
House flipping is the most hands-on and active way to invest in real estate. With the house flip, the investor will buy a property, will make renovations and changes with the goal of increasing the real estate market value. He then sells the property at the best price.
House flipping is a type of short term investment since as long as the investor owns the property without leasing it to tenants, more expenses are incurred. Thus, their return potential is decreased when the property is sold. Investors may renovate or repair the house to boost its sale price. Or he may sell it without the repairs especially if its value in the market shoots up due to outside factors.
Although house flipping may be exciting, the investor needs deep knowledge in finance and real estate to make sure that the home is improved within time and budget constraints — of course to ensure income when the property is sold.
Therefore, the success or failure of a house flip depends fully on the investor. Enough cash is needed for a down payment and/or exemplary credit score (ex. pay off credit cards) to have a home loan to purchase the property before another flipper buys it. House flipping is a high-pressure and high-risk real estate investment. But if you are knowledgeable, go give it a try.
Wholesaling is another strategy for property-flipping. Wholesaling occurs when the investor purchases a property that they believe has a low real estate market value and then sells the contract immediately to another investor at a higher amount to gain profit. Wholesalers usually look for properties that need renovation and then sell them to house-flippers who can renovate it to improve the value of the property — of course to sell it at the best price.
Wholesaling can be risky and needs financial acumen and real estate expertise. Study this option first before investing so you can earn money in real estate instead of losing money.
Hands-on management is required for rental properties, but the investment horizon can be long term. Rental property can be any type (residential, commercial, or industrial). On a monthly basis, property owners earn regular cash flow via rental payments from tenants. As such, rental property can give reliable and steady income for investors.
But again, it needs diligence and delegation of tasks to ensure seamless operations. Based on the number and size of rental properties, becoming a property manager can be a part-time or full-time job.
Short Term Rentals
Short term rental properties give an option for residents to rent out their houses nightly as an alternative to hotels. Short term rentals are almost the same as rental properties but these are mainly for residential properties and usually for short term periods only.
They are usually backed by Airbnb and VRBO, allowing you to rent out your complete home (or just a portion). By renting the property at night, residents can earn money both regularly or irregularly, which is dependent on the demand of the real estate market. The furnishing and maintenance of the home is the task of property owners.
Passive Real Estate investing (The Hands-Off Way)
If you do not have extensive real estate and financial know-how and skills, this may work for you. Passive real estate investing is for everyone. You just need to provide capital and let professionals invest in real estate on your behalf. Just like bonds and stocks, you are responsible only for your own investment and not the total fund.
Basically, passive real estate investment gives greater investment opportunity for passive income as compared to most active real estate investments which usually need more hands-on management.
Private Equity Fund
A private equity fund is a type of investment wherein accredited investors pool their funds into a single fund to invest in the private market. These are mainly limited liability partnerships with an assigned manager or management group. Investors need not be directly and regularly involved since the manager looks into the investments.
But investors still need financial and real estate understanding to assess potential returns and risks for each investment since the investment minimums are quite high. Private equity funds are limited to accredited investors and institutional investors who enjoy high net worth.
Real Estate Mutual Funds
Another type is the real estate mutual fund — an investment vehicle that operates as a company, pooling its client’s funds and investing on their behalf. These investors own shares of a mutual fund — they need not own the assets directly. The fund itself owns the investments that it manages and purchases. Investors have returned via dividends during ownership and appreciation upon the sale of the shares of the fund.
Real estate funds basically invest in investment programs that own real estate (ex. REIs or real estate stocks) — however they can also directly invest in real estate assets.
As compared to other funds, mutual funds usually invest in publicly traded assets — which are highly liquid. These funds are passive investments that need only capital from investors. Many also have low investment minimums. The net asset value of the shares may be highly correlated to the stock market movement — since they are linked to publicly traded assets. Therefore, mutual funds are volatile real estate investments.
Real estate investment trusts (REITs) refer to a company that makes equity or debt investments towards commercial real estate. Basically, REITs provide income-producing real estate portfolios to investors. Then, the shares of the REIT are bought by the investors who then earn income from the debt and equity investments via dividends. It is like the mutual fund — REITs provide opportunities for ordinary investors to have public access to real estate investments.
Currently, REITs are classified based on investor access via three ways: private REITs, publicly-traded REITs, and public non-traded REITs.
Private REITs are not SEC-registered and are not publicly traded in the stock market. They are quite the same as private equity funds — usually limited to accredited investors (high net worth) and minimums are quite high. And they are usually illiquid.
Publicly-traded REITs are SEC-registered and are traded on the stock market. The publicly-traded REITs are very liquid with no minimum investment other than the value of the share. As such, investors may buy a property and sell it easily. Despite offering generous access due to the correlation to public markets, public REITs are also a very volatile real estate investment strategy.
Note: A real estate investment group (REIG) is an entities that invest in real estate. They may buy, sell, renovate or finance properties. But REIG either does not qualify for REIT status.
Online Real Estate Investment Platforms
Online real estate investment platforms invest in real estate investment that is quite hard to find or reach individually. Real estate platforms open the door for investors to invest in individual assets or a diverse portfolio — some only to debt investments; others to both debt and equity investments. Some to a specific city or region; some across the country.
What type of investment is real estate?
As compared to bonds and stocks (“traditional assets”) — real estate investing an “alternative asset.” It can be expensive and hard to access. But times have changed and it can now be accessed by anyone. Real estate investing means lending money for real estate. Thus, it is considered a fixed-income investment. Just like a bond, you gain your investment returns by lending money to get interest income in exchange.
What does it mean to be a real estate investor?
Becoming a real estate investor can be rewarding. A real estate investor is someone who either actively or passively invests in real estate. Active investors may purchase property, make improvements and/or repairs and sell it for profit.
Basically, you should strategically select a location — try not to focus solely on the price. Experienced real estate investors know that it is best to invest in an out-of-state location that gives the best investment opportunities to boost your business.
Investing in real estate can be risky but if you know the market quite well, you can benefit from this venture.
How does a real estate investor work?
It has been proven that successful investing in real estate can bring wealth. Purchase or secure title to land. Foster and develop the improved agricultural capacity of the property. Build housing that can be rented out. Improve and beautify your investment property so you can ask for higher rent and enjoy higher rental income.
A real estate investor should know these basics: the investment requires large sums of money: a down payment, closing costs, money to repair and update the property, property taxes, insurance, mortgage payments, property maintenance. Illiquidity of property.
But with diligence and hard work, you can reap benefits. Here are some of the points you need to work on to be a successful real estate investor:
1. Choose Your Market & Time The Investment Wisely
2. Buy Low
3. Tap into the Hidden Market
4. Understand Your Costs Up Front
5. Understand The Market
6. Manage Your Risks
7. Go for Best in Class
8. Maximize Value of Real Estate
9. Know the Rules and Regulations
10. Consider Non-Traditional Real Estate Investments
What is the difference between a real estate agent and a real estate investor?
Both the real estate agent and real estate investor utilize real estate to generate revenue. But there are differences between these two based on the following points:
Real estate investors need not possess a license. But real estate agents are required to hold a license of the specific state where they will do business.
Real estate agents can earn around 1-5% of commission for every sale. Investors usually decide the amount they want to earn.
The integrity of the Brand
Real estate agents depend on the integrity of their names or brand in marketing. Real estate investors do not have to do this.
Agents are usually hired by real estate brokers — which is not applicable to investors. Investors are independent people who lead towards profitable deals.
What is a real estate investor's salary?
On average, the real estate investor salary is between $70,000 and $124,000. But these salaries vary and depend a lot on the type of investments, how many deals are closed annually, the time committed to the work, and many other factors.
How to Make Money Investing in Real Estate
There are three ways to make money in real estate: interest from loans, appreciation, and rent.
Interest from Loans (“Debt”): Real estate loan is when investors lend funds to real estate developers and gain profit from interest payments on the loan principal. The investor can enjoy regular cash flow from debt investing. There are different types of debt in the capital stack of loans which depend on the number of lenders.
A loan is classified as passive investment utilized by REITs, private equity companies, and real estate investment platforms.
Appreciation: Referring to ownership of equity, owning real estate allows the investor to earn money from the sale of the equity. Appreciation (increase in property value over time) refers to the potential profit that the investor can gain upon the sale. A sale gives one single and huge return. Equity ownership can be active or passive which depends on the investment’s position in the capital stack.
Rent: Owners can lease the property to gain income via rental payments. Rental income also gives a steady income flow, similar to debt investments. They can keep all profit or share earnings with a property management firm — that depends on the property owner if he wants to manage independently or via hired property manager. Rental payments are promising for passive income based on the type of investment.
What Are the Tax Implications of Real Estate Investing?
Real estate taxes can differ according to the investor. Some of the factors that affect taxes are the investment vehicle, work income, holding vehicle, and others. Upfront, it may look complicated but if done excellently, some real estate investments may allow valuable savings in tax. Discuss your options with a financial adviser.
There are two classifications for returns earned from real estate investments: income or appreciation. Basically, income tax relates to income gained from real estate; appreciation is subject to capital gains tax.
Several of the active and passive investments can earn income. Rental payments are earned via active investments (ex. Rental properties — either short term investment or traditional). The taxation of that income is dependent on various factors but basically, income earned by the rental property is taxable annually. It is also subject to ordinary income tax rates.
The property owner (active investor) may get deductible expenses incurred the whole year through maintenance and repair of the property (ex. Insurance, property taxes, maintenance costs) — which lowers the total amount of taxable income. Costs of depreciation including costs for improvement may be claimed to lessen tax liability. However, rental property owners may face income taxes on depreciation recapture during property sale on top of capital gains taxes.
Many passive investments may also earn income — usually via passive income. This income can be allotted in many ways according to the investment structure. If investors have real estate investments via stock ownership (ex. REITs or mutual funds), then they can gain income payments via dividends.
The investment structure poses great tax implications for investors since passive real estate investments are not directly owned by the investor. For instance, with a partnership, income earned is taxed on the individual investor’s tax return — not on the partnership. In the same way, the income of REIT and mutual fund investors is taxable at the level of investor — not on the fund level.
Capital Gains Taxes
When the investor sells an equity investment (whether active or passive investment), appreciation is realized. Upon selling of the investment, any earned returns earned by appreciation are what we call capital gains and are subject to capital gains tax. The tax rate of an equity investment is affected by the ownership duration.
Returns that are earned on investments bought and sold in less than a year are classified as short-term capital gains. While those held for a minimum of one year are classified as long-term capital gains.
Short Term-Capital Gains
Short term capital gains are part of your annual income — taxed with ordinary tax rates. By buying and selling an active investment (ex. Rental property) within a year, the earnings are short term capital gains. For passive investments, buying and selling shares of REIT, or leaving a partnership in a year, the appreciation is also under short term capital gains taxes.
Long Term-Capital Gains
Long term capital gains tax is different. There will be a tax on adjusted profits but usually at a lower rate. For instance, if after a minimum of one year of ownership, you sell an equity real estate investment, any profit is subject to long-term income taxes.
Remember — investing in real estate is beneficial in the long term. Real estate investing gives a lot of potential for significant returns and diversification.
It provides cash flow when managed wisely and gives long term appreciation. Real estate investments have risks and rewards. Each type of real estate investing involves various levels of resources.
To best get started in investing, follow these:
- Pay via cash (not credit cards). Improve your credit score.
- Keep your property local.
- Prepare for risks.
- Begin your initial investment small.
- Hire an agent.
Best Tip: Know if making money in real estate investments is for you — discuss with a professional.
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