Thinking about taking the plunge into real estate investing but you don’t know where to begin? You’re not alone. The real estate market is complex and often confusing, leaving many potential investors sidelined. The good news is that there are many different ways to invest in real estate, and they’re often quite lucrative. This article will tell you what you need to know about investment opportunities, as well as how to mitigate risks.
Different Types of Real Estate Investments
Real Estate Wholesaling
Wholesaling real estate is a newer way to make a profit in the real estate world. Real estate wholesalers find the property, assess the return potential, and enter a contract with the sellers. Then, using connections with flippers and other investors, the wholesaler finds a buyer and then keeps the difference.
For example, say a wholesaler enters a contract with someone at $150,000, but finds a buyer willing to pay $175,000. The wholesaler makes a $25,000 profit just for facilitating the sale. The buyer, who is usually an investor, stands to make even more from that property. Real estate wholesaling is more complex than that oversimplified example, but the potential returns are more than worth looking into.
Wholesalers succeed because they can connect investors to profitable houses they wouldn’t otherwise have access to. They do all the leg work of determining the profit potential of a house and understand local economies deeply. If you want to invest but lack the expertise needed to find the best house, look for a real estate wholesaler. This will remove some risks involved in buying rental properties or flipping because the properties have already been thoroughly vetted.
Pros and Cons
- Returns for wholesalers can be very high
- Returns for people who buy from wholesalers can be even higher
- Wholesalers help investors lower their risk of losing money
- Legal restrictions on wholesaling can be tricky to work around if you are inexperienced
As depicted on TLC and other popular home shows, “flipping” consists of buying an outdated house and restoring it for resale. This can be lucrative and doesn’t require much capital. In fact, it’s one of the best ways for the average person to get involved in real estate investing.
The initial costs of flipping aren’t nearly as high as other forms of real estate ventures. However, the cost of renovations can be hard to gauge and are often much higher than anticipated. If you can accurately predict your costs and resale price, flipping can be a great way to multiply your wealth.
Pros and Cons
- Initial costs are low and renovation costs can be spaced out over time
- When done right, your investment can be doubled or tripled
- High carrying costs involved (mortgage, taxes, etc.) that can tally quickly before the flipped home is sold
- Selling a house at a profit is never guaranteed
- For most people, opportunities are limited to where they live
If you aren’t a high net-worth individual, buying a rental property is one of the best ways to start investing. Typically, a single-family rental property can completely pay for itself (mortgage, repairs, and everything) in about six years. Each month, you’ll be bringing in income that will pay the mortgage and expenses, while leaving some profit left over.
Once the mortgage is paid, the profit margins go way up. It’s common to reinvest the initial profits into more properties. Doing this (barring unexpected losses) can turn a small investment into a large source of recurring income.
Becoming a landlord is less of an investment than it is a part-time job for some people. Unless you can afford to hire contractors for maintenance and management of the property, you’ll be doing that work yourself. Still, by owning a few single-family, duplex, or multi-family properties, you can make a good income. For savvy, dedicated investors, the income from rental properties can be enough to replace their jobs, and then some.
Pros and Cons
- Relatively small initial investment (down payment, closing costs, and repair costs)
- Returns are easy to calculate and more predictable than stock returns
- Multiple properties compound the returns quickly
- Income is dependent upon consistently finding good tenants
- Local housing markets can be finicky
- Being a landlord takes time and energy
Real Estate Development Projects
Investing in real estate development happens in one of two ways: equity investing and debt investing. Equity investments in real estate mean you own a portion of the property and will get a share of the revenue. For example, say you become an investor in a new multi-use building in a downtown area. You’ll be paid each month or year based on the size of your equity stake. If the property loses money, however, you lose, too.
With debt investments in real estate, you (and others) loan money to the developer so they can build the property. When the loan comes due, you get back your investment, plus interest. If they can’t pay the loans? You still lose money, but not quite as much.
Real estate development isn’t for everyone. It often requires you to be a high net-worth individual with serious capital to invest. If you lack the funds to be an individual investor in a real estate project, you still have options. You can buy stock in a Real Estate Investment Trust (REIT) that’s involved in every sector of real estate. REITs let people who have a lower net worth get in on the action in the real estate development world.
Pros and Cons
- Returns can be very high
- Debt investments of this nature are typically very stable
- Mostly inaccessible for those without high amounts of capital
Risks and Rewards of Real Estate Investing
Just like any investment, real estate is more complicated and risky than it initially appears. Real estate, unlike other industries, is more local than it is national or global. The housing market in Seattle has little to do with changes in Columbus, Ohio’s industrial real estate market.
This makes it difficult to call any real estate investment “safe” because they’re so tied up in the local economies. Let’s say you pour $250K into a property in a hip, expensive neighborhood fueled by the success of a tech company. It should be a home run, but the company shutters a year later, and you’re stuck with a dud.
Working with a real estate wholesaler to find properties with high potential is a great way to mitigate some of the risks involved with real estate investing. So, too, is investing in a REIT with a large and diverse real estate portfolio.
The potential returns on a real estate investment are quite high. While a 6-8% return is typical of a good year in the stock market, the average return of a REIT is 10.5%. Other investment types have even higher returns (though it’s harder to give concrete numbers). That’s the chief reason that investors are willing to risk large losses — the returns can be exponential.
Diversifying your portfolio through real estate investments is a great idea for many investors. The returns are often higher than the stock market, even though these investments are generally riskier. The good news is, using a real estate wholesaler or investing in a REIT can decrease the risks associated. So, are you ready to get started with your first real estate investment?