“Real estate is a good investment, especially in the long term,” says top real estate agent and investment properties specialist Collier Swecker, who’s been endorsed by America’s trusted voice on money, Dave Ramsey. “The stock market, where most people have their 401(k)s, ebbs and flows.”
Real estate values fluctuate month to month (and everyone remembers 2008) but steadily increase over time, making it an appreciating asset. Plus, real estate has an intrinsic value as a real, physical asset, unlike stocks which are paper or financial assets.
So why isn’t everyone and their dog out there investing in real estate? Well, there’s a learning curve and it costs a lot of money to get started.
That shouldn’t deter you from the opportunity, but you do need to know what type of real estate investing is right for you, whether it’s:
- House flipping
- Owning rental property
- Putting money into REITs (real estate investment trusts)
Let’s go through the risks and benefits of each avenue, and then you can make smarter decisions about becoming a real estate investor.
1. Take the homeownership plunge
Do you remember the first time you thought about buying your own home? In that moment you were considering becoming a real estate investor.
Most first-time home buyers approach the process with their lifestyle needs at the forefront. These buyers focus on a property’s appearance, finishes, comfort, and convenience first.
However, when you look at your primary residence as an investment, your first priority is purchasing a property that has the best chance of achieving a significant increase in value over time.
“You don’t really make your money in real estate investing on the sale of a property. You make your money on the purchase,” Swecker explains.
It all comes down to asking the right questions about the house you want to buy. “Am I in the right buy? Am I in the right city? Am I in the right town? Am I in the right part of town that actually has room to grow relative to prices increasing?”
Many first-time starter home buyers plan on selling 5 to 10 years down the line, so they can buy a larger home as their family grows or their income increases.
When you buy your first house with an investor mindset, you’re planning on using the profit from its eventual sale to provide a sizable down payment on your new home.
If you play your cards right, that sizable down payment can lead to a mortgage payment on a more expensive home that’s the same or less than the mortgage payment on your starter home. Then, assuming you’ve held onto this home and paid off your mortgage, its sale can fund your retirement.
There are some challenges to homeownership, however.
Keep in mind that while real estate is an appreciating asset, the wear and tear on a property over time actually causes the physical structure to depreciate—especially without proper maintenance.
If you want to split hairs, it’s actually the land your home is built on that appreciates, which is why location has such a big impact on a property’s value.
Experts recommend budgeting at least 1% of your home’s value a year for maintenance. While you may not spend that much, set it aside anyway so you’re financially prepared to pay for big-ticket expenses, such as a new HVAC, roof replacement, or foundation repairs.
Homeownership has other hidden costs that you may not think to budget for if you’ve never owned a home before. First-timers forget that they’ll need to pay property taxes, additional utilities such as snow removal or septic services, and maybe even HOA dues.
Not to mention real estate isn’t a liquid asset. It can take months to sell a home, which means you can’t have access to that invested cash in a hurry.
True, you can access your capital with a home equity loan. However most banks require that the loan amount be a minimum of $10,000, and it can take some time to build up that much equity.
While it’s not completely risk-free, owning your own home does provide long-term financial security. However, you’re not going to get rich through this type of real estate investing.
If you’re looking for an investment that’ll actually produce a profit, there are other real estate options to consider.
2. Get into house flipping
Turn on any home improvement network and you’ll think the whole world is getting rich flipping houses. While house flipping is on the rise, it’s nowhere near as easy—or profitable—as it seems on TV.
In reality, flipping is a high-risk business offering profit margins as low as 10 to 15%. As those flipping shows demonstrate, the remodeling side of flipping can be fun—but it’s the riskiest venture if you don’t know what you’re doing.
“Flips are risky because you don’t gain from long-term natural appreciation,” says Daniela Andreevska, Content Marketing Director at Mashvisor, a real estate analytics tool which helps real estate investors. “Instead, you have to force appreciation on the property [through the remodel] in order to make profit.”
And it’ll cost you more to flip than you might expect.
For starters, house prices are still rising—even for homes being sold “as-is”—which means you’ll probably be paying more for your investment property than you expect.
Refurbishing your flip will likely be pricier than you’re planning on, too. All those remodeling expenses you see listed on house flipping shows don’t reflect the true costs.
The truth is that they’ve likely received their building materials at a discount (or free) in exchange for the free advertising they get for product featured on the show.
Plus, the program’s production budget pays for the professional craftsmen and construction crew who do the remodeling work behind the scenes.
Aside from the money you’ll need to buy the home and pay for the remodel, you need a sizable amount of reserve capital to keep you afloat when things go wrong.
And if home prices don’t rise before you run out of money, you’ll wind up breaking even or selling at a loss.
3. Scoop up rental properties for the long haul
Reality TV makes it seem like flipping is all the rage, but the truth is, owning rental properties is the bigger business in real estate investing. Not only is it less risky than flipping, it’s also a long-term moneymaker.
“With rental properties, you’re making money in two different ways,” says Swecker.
“You’re making money from the natural appreciation of the home, and you’re making money from your renter. And that rental income is paying your mortgage down and paying you back for the equity you put in.”
Unlike many stock market options, rental properties provide a monthly cash flow. And with rental rates on the rise, the income generated from your renters has the potential to cover the mortgage payment, house-related expenses, and still leave you with money you can take to the bank.
Rental property owners can also count on significant tax breaks, thanks in part to the Tax Cuts and Jobs Act that went into effect January 1, 2018. Among other benefits, as a landlord you won’t be required to pay self-employment taxes and the individual tax rates on your rental property income is lower.
However, buying a rental property isn’t cheap.
“The largest expense is the price of the property and most will have to take a mortgage loan in order to buy their first rental property,” says Andreevska. “Most lenders require a down payment of 20% of the property price. For example, according to Mashvisor data, the median property price in Detroit, MI, is $177,000, so the down payment would add up to $35,400. Meanwhile, the median property price in Anaheim, CA is $623,000, which results in a down payment of $124,600.”
Whether it’s a vacation rental or long-term lease you’re looking for, finding the right rental property is key.
For example, if you’re looking to lease your house to long-term renters, it’s best to buy a mid-sized home because more renters will be able to afford it.
On the other hand. If you’re buying in a coastal tourist destination city, a luxury home with a private pristine beach may be the smarter choice.
As the owner of either rental property type, you’ll need to factor in the mortgage, monthly maintenance expenses, and annual expenses like taxes or pest control treatments. It’s also wise to pay 5 to 10% of your rent revenue to hire a professional property management company.
A professional property manager will save you the headache of vetting tenants, collecting rent, and handling complaints, repair requests and other potentially tense communications with your renters.
“You’ll make more money in the long run by taking care of not only the home but also the tenants,” advises Swecker.
4. Offload your responsibility to a Real Estate Investment Trust
House flipping and rental property ownership require at least some amount of sweat equity. If you’d rather have a secure real estate investment income without the hands-on hassle, investing in a Real Estate Investment Trust (REIT) may be your best option.
As a REIT investor, you’re putting your money into a company that owns, operates or finances income-producing real estate, such as commercial office buildings or residential apartment complexes.
With this type of real estate investment, you bear no responsibility (or have any control over) the choice of tenants or the types of properties purchased.
For the most part, you’re safe in trusting the REIT decisionmakers, since the whole purpose of the REIT is to make money.
And when the trust makes money, you make money—without any significant risk of losing your investment (if you’ve invested with a vetted REIT rather than a potentially sketchy private investment group).
“You have the equivalent of a stock in a REIT. They’re publicly traded and the Security Exchange Commission has oversight over them,” advises Swecker. “But the problem with some private real estate investment groups is that you don’t know where your money is going. I’m not against partnerships, I’m against partnering with people you don’t know.”
While REITS are probably the most risk-free way to invest in real estate, they may not be the most profitable. The dividends you’ll likely see from a REIT investment is around 4% (with a high of approximately 7%), which you’ll only receive as quarterly payouts (although there are some that pay monthly).
Are you ready to invest in real estate?
Now that you know your options, deciding if you’re ready to invest in real estate comes down to answering two questions:
- How much money do I have to invest?
- How much risk am I willing to take?
For most REIT investments you’ll only need $500 to $2,500 as a minimum investment to get started. The other three options require a lot more financially.
This professional assessment of your finances will also tell you if you’re financially sound. If you are, you can take on the riskier real estate investment options, like flipping, or if you’re better off starting with a small REIT investment.
Locking a large chunk of your savings into an illiquid asset like real estate can be an intimidating proposition. But if you buy the right property, you’ll get a larger payoff on that investment in the long run.