Real estate investing involves purchasing, owning, managing, renting, or selling real estate properties as an asset class. The goal of real estate investing is to generate income, profit from price appreciation, and build long-term wealth. There are various strategies investors can use to get started in real estate, each with their own pros, cons, and level of risk.
The main benefits of real estate investing include cash flow from rental income, tax advantages like depreciation, leverage from financing, and potential for forced appreciation strategies. However, it also requires significant capital, can be management intensive, faces liquidity challenges, and has risks like vacancies and maintenance costs.
This guide will provide an overview of the most common real estate investing strategies, including flipping houses, rental properties, REITs, crowdfunded real estate, wholesaling, hard money lending, and more. We’ll explore the pros and cons of each approach to help you determine which strategy may be right for your investment goals and risk tolerance. Whether you’re looking to invest passively or take an active role, real estate can be a powerful component of a diversified investment portfolio when approached strategically.
Pros of Real Estate Investing
Real estate investing offers several advantages that make it an attractive option for generating wealth. Some of the key pros include:
Diversification
Real estate provides portfolio diversification because it tends to perform differently than stocks and bonds. Real estate values typically don’t move in lockstep with other major asset classes, so adding real estate to a portfolio can reduce overall risk.
Leverage
Real estate investors can use leverage to purchase properties. This allows them to buy larger assets by only providing a portion of the total cost. The mortgage loan covers the rest. This gives real estate investors greater upside when property values rise.
Tax Benefits
There are several tax advantages associated with real estate investing:
- Depreciation deductions lower taxable income from rental properties
- 1031 exchanges allow deferring capital gains taxes when selling one property and reinvesting in another
- Mortgage interest can be deducted from income taxes
Appreciation
Real estate values tend to appreciate over time, especially in growing markets. This allows investors to build equity as the property increases in value.
Positive Cash Flow
Owning rental properties can produce positive monthly cash flow after expenses are paid. This provides recurring income for investors.
Control
Real estate investors have more control over their investments compared to stocks or bonds. They can choose to add value through renovations, raise rents, or manage properties directly.
Cons of Real Estate Investing
Real estate investing can be highly profitable, but it also comes with some downsides to consider. Here are some of the main cons or risks associated with real estate investing:
Illiquidity – Real estate is not a liquid investment like stocks or bonds that can be bought and sold easily. It can take weeks or months to sell a property, which makes it difficult to access your capital quickly. This lack of liquidity can be problematic if you face an unexpected expense and need cash.
Leverage Can Magnify Losses – Real estate is commonly purchased with debt through mortgages. While leverage can multiply your gains, it can also magnify your losses if the market turns against you. With just 20% down, a 5% decline in property value would wipe out your entire equity investment.
Management Responsibilities – As a landlord, you take on management duties like finding/screening tenants, collecting rent, maintenance, repairs, accounting, and dealing with legal issues. This can be time-consuming and problematic if you lack experience. Property managers can handle this but take a cut of rental income.
Large Capital Required – Buying investment properties often requires a substantial amount of capital. It’s tough to diversify with less than six figures to invest. Financing can help overcome low capital, but requires good credit, income, and existing home equity.
Vacancy Risk – There is always a risk of vacancies leading to lost income. Tenants may leave unexpectedly or default on rent. Vacancy rates fluctuate based on overall economic conditions. Proper screening and reserves can help mitigate this risk.
Flipping Houses
Flipping houses involves buying a property that needs repairs, fixing it up, and then selling it quickly for a profit. It can be a risky but potentially lucrative real estate investing strategy if done correctly.
The process typically involves:
- Finding a run-down property priced below market value. Look for cosmetic issues that can be fixed inexpensively.
- Estimating repair costs. Inspect the property thoroughly and get contractor quotes. Repair costs can eat into profits quickly.
- Securing financing. Flippers typically use hard money loans or private financing at higher interest rates.
- Making repairs and renovations. Focus on fixes that maximize return on investment. Curb appeal matters.
- Reselling the property quickly. List the property and market it aggressively. The longer it takes to sell, the lower your profit.
Flipping works best in rising housing markets. The goal is to buy low, renovate fast, and sell high. Profit margins usually range 10-20% per flip.
Risks include under-budgeting repairs, undiscovered property defects, market slowdowns, and being unable to sell quickly. Patience and strong knowledge of the local housing market are key.
Flipping is not a passive investment, but successful flippers can profit handsomely from their time and expertise around real estate deals. It offers hands-on investors an alternative path to returns.
Rental Properties
Owning and managing rental properties can be a great way to generate passive income and take advantage of real estate appreciation over time. Rental properties provide ongoing income in the form of rent payments, and if managed properly, the rental income should exceed your expenses like mortgage, taxes, insurance, maintenance, etc. This results in positive monthly cash flow.
Rental properties can also benefit from appreciation, meaning the property increases in value over time. As the property value increases, so does your equity in the property. Appreciation and paying down the mortgage over time allows you to build significant equity that can be tapped later via a cash-out refinance or selling the property.
There are also tax benefits to rental properties. Costs like mortgage interest, property taxes, insurance, maintenance and depreciation can be deducted against the rental income, reducing your taxable income from the property. Depreciation deductions provide a way to shelter income that doesn’t require an actual cash expense.
Successfully investing in rental properties does require hands-on work as a landlord. This includes finding tenants, collecting rent on time, maintaining the property, handling repairs, dealing with evictions if necessary, and more. Some investors hire a property management company to handle these day-to-day rental duties. But there are costs associated with property managers, usually 8-12% of rent.
The key strategies for effectively investing in rental properties include:
- Researching the local rental market to find an in-demand area
- Running the numbers to ensure positive cash flow with a sufficient margin
- Finding good tenants and setting up systematic rent collection
- Maintaining the property well but also budgeting for repairs
- Using a property manager if you don’t want to handle landlord duties
- Exploring tax benefits like depreciation to maximize deductions
Rental properties can provide ongoing income and long-term wealth if managed correctly. But they require hands-on landlording and carry risks like vacancies, tenant issues, and maintenance costs. Overall, rental properties remain one of the more traditional ways to invest in real estate.
REITs
Real estate investment trusts (REITs) allow investors to gain exposure to real estate without having to buy or manage properties directly. REITs are companies that own and operate income-producing real estate such as apartments, shopping malls, offices, hotels, etc. They are structured similarly to mutual funds, but focus exclusively on real estate assets.
Some key advantages of investing in REITs include:
- Diversification – REITs allow you to diversify across different property types (retail, industrial, residential) and geographic regions. This helps spread out risk.
- Liquidity – REIT shares trade on major stock exchanges, providing daily liquidity. You can buy and sell with ease.
- Dividends – REITs must pay out at least 90% of taxable income as dividends to shareholders. This provides steady income.
- Professional management – REITs are operated by experienced real estate professionals who handle acquisitions, financing, maintenance, etc.
- Lower investment minimums – You can invest in REITs with much less money than buying property directly. Minimums are usually the cost of one share.
Some downsides to keep in mind:
- Less control – You don’t have a say in investment or management decisions as you would as a direct owner.
- Interest rate sensitivity – REIT values are impacted by interest rates since their assets are often financed.
- Fees – There are fund management fees, though these are generally low.
Overall, REITs provide a simple, diversified, and liquid way to invest in real estate without being a landlord. They can be a smart addition to an investment portfolio for income and diversification.
Crowdfunded Real Estate
Crowdfunded real estate investing has emerged as a popular way for investors to gain exposure to the real estate market without having to directly purchase or manage properties themselves. This method involves pooling funds from multiple investors to invest in real estate assets like apartment buildings, shopping centers, self-storage facilities, etc.
Some key benefits of crowdfunded real estate investing include:
- Lower Barrier to Entry: Investors can get started with crowdfunded real estate with much lower minimums compared to buying investment properties on their own. Many platforms have minimums of $500-$1000 to invest in a deal. This opens up real estate investing to more people.
- Diversification: Investors get exposure to a portfolio of real estate assets, spreading out risk across different property types, locations, etc. This is far more diversified than owning just one or two rental properties.
- Passive Income Potential: Most crowdfunded real estate investments generate monthly or quarterly dividends from the rental income produced by the properties. This creates a relatively passive income stream for investors.
- Professional Management: The properties are overseen by experienced real estate companies, taking the workload off the investors’ shoulders.
However, there are also risks to be aware of with crowdfunded real estate:
- Illiquidity: These investments are generally illiquid, meaning there is no secondary market to buy/sell them. Investors need to plan to hold them long-term.
- Speculative Nature: As with any real estate, returns are not guaranteed. The properties may decrease in value or not generate as much income as projected.
- Due Diligence Is Key: Vetting the real estate companies and deals is critical before investing to assess the risks involved. Past performance does not guarantee future results.
Overall, crowdfunded real estate can be a smart way to add real estate exposure to an investment portfolio. But like any investment, proper research and due diligence is important before jumping in. Investors should assess their risk tolerance and timeline when considering this approach.
Wholesaling
Wholesaling real estate involves finding distressed properties, getting them under contract, and then assigning those contracts to end buyers for a fee. It requires less capital than other real estate investing strategies since wholesalers don’t actually own or renovate the properties.
The process typically involves these key steps:
- Find a distressed property. Wholesalers seek out motivated sellers with properties priced below market value. Sources include foreclosure listings, public records, driving for dollars, and networking with real estate agents.
- Put under contract. The wholesaler negotiates an agreement to purchase the property. This is usually structured as a short-term contract with an assignment clause allowing them to sell the rights.
- Find an end buyer. The wholesaler markets the deal to cash buyers interested in flipping or renting the property. Buyers may be investors, rehabbers, landlords, or owner-occupants.
- Assign the contract. The original purchase agreement is assigned to the end buyer for an assignment fee. This transfers the right to purchase the property to the new buyer.
- Close and get paid. The end buyer purchases the property directly from the seller at the originally agreed upon price. The wholesaler receives their negotiated assignment fee, typically $5,000 to $20,000 per deal.
Wholesaling can enable faster profits compared to buying, renovating, and reselling or renting out properties. Less capital is required upfront, and wholesalers don’t have to manage renovations or tenants. However, it involves extensive networking and marketing to find deals and buyers. Wholesalers must move quickly and have strong negotiation skills to put properties under contract at big discounts. It’s a volume game requiring persistence to close multiple deals each month. But for those able to source and sell deals efficiently, wholesaling can be quite lucrative.
Hard Money Lending
Hard money lending involves providing capital to other real estate investors at high interest rates, usually for short durations like 6-12 months. It is an alternative financing option for real estate investors who may not qualify for traditional loans and are willing to pay higher rates for quick access to capital.
The hard money lender provides a bridge loan, secured by the real estate asset, to fund the investor’s purchase and rehab costs. The investor must pay back the loan plus interest once they sell or refinance the property. Interest rates typically range from 7% to 15%.
Benefits of hard money lending:
- Earn high returns from interest payments
- Loans are secured by the real estate asset
- Short loan durations provide quicker payback
Risks of hard money lending:
- Higher default risk if the borrower is unable to sell or refinance
- Need to carefully vet and evaluate borrowers
- Real estate market fluctuations can impact collateral value
Hard money lending is less regulated than traditional lending. However, hard money lenders must still follow state laws regarding interest rates and lending practices. Hard money loans are not subject to the same standards and requirements as traditional mortgages.
Overall, hard money lending provides an alternative investment strategy for those with capital to fund real estate investors. It offers high potential returns but also has risks related to the borrowers’ ability to repay the loans. Careful evaluation of deals and borrowers can help mitigate some of the risks.
Conclusion
Real estate investing can be a great way to build wealth over time, but it’s important to understand the pros and cons before getting started. Some of the key pros are the ability to leverage property to build equity, tax advantages like depreciation, and the potential for cash flow through rentals. However, there are also cons like illiquidity, the responsibility of being a landlord, and the high transaction costs involved in buying and selling properties.
The strategies discussed provide different options based on your goals, time commitment, and risk tolerance. Flipping houses involves renovating and quickly reselling for profit but requires hands-on work and local market knowledge. Rental properties can generate monthly cash flow but involve ongoing property management. REITs offer a more passive approach to invest in real estate as a publicly traded security. Crowdfunding opens up real estate investing to more people with smaller amounts of capital. Wholesaling involves finding discounted properties for other investors to purchase. Hard money lending provides short-term bridge financing for real estate investors at higher interest rates.
Whichever strategy you pursue, it’s essential to do thorough due diligence and understand all the costs, risks, and responsibilities involved. Diversifying across different properties, markets, and strategies can help manage risk as well. With the proper education, realistic expectations, and long-term discipline, real estate investing can be a rewarding way to build wealth. The key is approaching it as a business rather than a get-rich-quick scheme.
