Real Estate Investments
When you think about real estate investing, the first thing that probably comes to mind is your home. Of course, 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 a popular investment vehicle over the last 50 years or so. Here’s a look at some of the leading options for individual investors, along with the reasons to invest.
- Real estate is considered to be its own asset class and one that should be at least a part of a well-diversified portfolio. One of the key ways investors can make money in real estate is to become a landlord of a rental property. Flippers try to buy undervalued real estate, fix it up, and sell it for a profit.
- Real estate investment trusts (REITs) provide indirect real estate exposure without the need to own, operate, or finance 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.
If you have a different activity or want to enjoy life hassle free, you can hire a property manager to handle the details, as 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.
Flippers buy properties with the intention of holding them for a short period—often no more than a few months—and quickly selling them for a profit.
The are some primary approaches to flipping:
- Add value
Adding value can be done through 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).
Some Flippers decide to 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.
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. Usually REITs are bought and sold on major exchanges, just like stocks and exchange-traded funds (ETFs). REITs are appropriate for investors who want regular income, mainly because of tax applications, though they offer the opportunity for appreciation, too. REITs invest in a variety of properties such as malls, healthcare facilities, mortgages, and office buildings. In comparison to other types of real estate investments, REITs have the benefit of being highly liquidl
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.
Real Estate Limited Partnerships
A real estate limited partnership (RELP) is similar to a real estate investment group. It is an entity formed to buy and hold a portfolio of properties, or sometimes just one property. However, RELPs exist for a finite number of years.
An experienced property manager or real estate development firm serves as the general partner. Outside investors are then sought to provide financing for the real estate project, in exchange for a share of ownership as limited partners. The partners may receive periodic distributions from income generated by the RELP’s properties, but the real payoff comes when the properties are sold—with luck, at a sizable profit—and the RELP dissolves down the road.
Real Estate Mutual Funds
Real estate mutual funds invest primarily in REITs and real estate operating companies. They provide the ability to gain diversified exposure to real estate with a relatively small amount of capital. Depending on their strategy and diversification goals, they provide investors with much broader asset selection than can be achieved through buying individual REITs. Like REITs, these funds are pretty liquid. Another significant advantage to retail investors is the analytical and research information provided by the fund. This can include details on acquired assets and management’s perspective on the viability and performance of specific real estate investments and as an asset class. More speculative investors can invest in a family of real estate mutual funds, tactically overweighting certain property types or regions to maximize return.
Why Invest in Real Estate?
Real estate can enhance the risk-and-return profile of an investor’s portfolio, offering competitive risk-adjusted returns. In general, the real estate market is one of low volatility, especially compared to equities and bonds. Real estate is also attractive when compared with more traditional sources of income return, and somehow safer as you still have a phisical product in your hands. Because it is backed by brick and mortar, direct real estate also carries less principal-agent conflict, or the extent to which the interest of the investor is dependent on the integrity and competence of managers and debtors. Even the more indirect forms of investment carry some protection. REITs, for example, mandate that a minimum percentage of profits (90%) be paid out as dividends.
Diversification and Protection – Another benefit of investing in real estate is its diversification potential. Real estate has a low and, in some cases, negative, correlation with other major asset classes—meaning, when stocks are down, real estate is often up. This means the addition of real estate to a portfolio can lower its volatility and provide a higher return per unit of risk. The more direct the real estate investment, the better the hedge: Less direct, publicly traded vehicles, such as REITs, are going to reflect the overall stock market’s performance.
How Can I Add Real Estate to My Portfolio?
Aside from buying properties directly, ordinary investors can purchase REITs or funds that invest in REITs. REITs are pooled investments that own and/or manage properties or which own their mortgages.