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Curious about investing in real estate? You’re in good company. By the end of 2018, investors accounted for 11.3% of home sales in the U.S. housing market, a 20-year high, according to June 2019 data released from CoreLogic, an Irvine, California, company that has analyzed housing industry statistics since 1999.
What’s more, small investors of the “mom and pop” variety—meaning they’ve bought 10 homes or less over the past two decades—have increased their share of homebuying, particularly targeting starter homes, this data shows. With 43.1 million renter households in the United States, real estate investors continue to be vital to the housing market.
Real estate is generally seen as a solid long-term investment because, despite fluctuations in the short term, it’s historically less volatile than other options like stocks over time. However, real estate is also less liquid and costs more money upfront.
If you’ve thought that terms like fix and flips, owner-occupied rentals, and REITs sound like a foreign language—or if you’re eager to dip your toes in the investment pool but unsure where to start—consider this a primer on most common types of real estate investments so you can learn more about this popular method of potential income.
1. Fix and Flips
Of all types of real estate investments, this likely comes to mind first, thanks to home design TV shows where people buy a distressed property and renovate it for a profit. According to ATTOM Data Solutions, which curates a comprehensive nationwide property database, 207,957 single-family homes and condos nationwide were flipped in 2018.
“You’ve got to know what you’re doing. And if you’re a total novice, it’s just one of those things that it’s good to know that you might do this first one gratis, just to learn.”
You can make a significant amount of money within a few months, based on your renovations and the state of the housing market. Although ATTOM notes that the average return on investment for flipping continues to decline to an almost 8-year low, there’s still a profit margin. Homes flipped in Q1 2019 sold for an average of $60,000 more than what the home flipper paid to buy them, for an average gross return on investment of 38.7 percent, this data shows.
This is one of the most cash-intensive areas of real estate, according to the National Real Estate Investors Association (National REIA), a nonprofit trade association based in Cincinnati, Ohio, that represents about 40,000 individual investors nationwide. That $60,000 average from ATTOM Data Solutions does not include the cost of rehab and renovations, which you can expect to run you between 20%-33% of the home’s value after repairs if you’re a veteran flipper. For a more detailed rundown on flipping ROI, check out HomeLight’s guide: “How Much Can You Make Flipping Houses?”
Fixer-uppers often take twice as long and cost twice as much as expected. Lenders often ask for a higher down payment (such as 20 to 25 percent) for an investment property. Plus, as the market flattens, that affects your profits. “We had guys making $100,000 to $200,000 a pop frequently, and now a lot of times they’re doing all this work and taking all this risk, and it’s like $40,000 to $60,000 [profit]. And these are guys that have done a hundred homes,” Dannecker said.
Who it’s right for:
Someone who knows the local housing market well and is connected with a reliable, hardworking crew. According to Forbes, that includes an appraiser, a knowledgeable title and settlement company, and skilled contractors. Although a skilled real estate agent can assess whether a home is undervalued enough to turn a profit, a contractor can inspect it closely to find, say, a crack in the foundation or a roof problem that will determine whether the investment is worth your while.
2. Long-term Rentals
Any residential building with four units or less counts as a long-term rental property—and what NREIA calls “the backbone of our nation’s housing.” Statistics show that two-thirds of American renters do not live in apartments but in housing that investors generally supply: single-family homes, duplexes, quads, and mobile homes.
Owning one rental property makes for easier management (maintaining one yard for landscaping, one set of plumbing, and so on), plus you can collect rents from multiple tenants in one location. You also can depreciate the building’s value on your taxes over time, meaning you can write off as expenses any wear and tear from age, plus the cost of improvements such as appliances and carpeting, says the podcast Listen Money Matters.
The drawbacks are the headaches that come with being a landlord. It takes time to find the right tenants, a process you have to repeat every time they move, notes the financial education website Money Crashers, which has been featured on MSNBC’s Your Business and Good Morning America. You’re also responsible for the maintenance, painting, and any repairs. In addition, being a landlord increases your chances of being involved in a lawsuit because of the liability involved with rental property, the National REIA notes in its 2019-2020 report: Real Estate ROI: Opportunities in Investing.
Who it’s right for:
People who understand the rental market. If you can rent the property for at least 1 percent of the cost it took to acquire it—including the expected expenses—then it’s a solid investment.
3. Owner-occupied Rentals
This is similar to a long-term rental, except you live on the property, too. If you have a handyman or plumber or electrician that you trust whom you can call upon whenever there’s an issue, an owner-occupied rental such as a duplex or triplex that you share with tenants can be a good way to pay for your mortgage as well as earn additional income. The number of owner-occupied housing units nationwide has started to grow again from a stagnant period in the 2010s, increasing from 77.66 million in 2017 to 79.36 million in 2018, according to the market and consumer data provider Statista.
Because you live on the property, you can buy these units with a minimal down payment, such as 3.5 percent with an FHA loan or even 5 percent with conventional programs. In addition, you’ll get a lower interest rate on your mortgage because the property is also your primary residence, not just a business transaction, which factors into the risk-based pricing lenders use, adds NerdWallet.
Again, it depends on how much you want to be a landlord and how cozy you want to be with your tenants. Even if you don’t have a property manager, you’ll likely have to work with specialized contractors to ensure any repairs are up to code. It’s also wise to know an accountant who can educate you on the tax code relevant to investment property.
Who it’s right for:
Dannecker has seen investors from their 20s and 30s to their senior years in this situation. “It’s a great starting position or a nice, simple streamlined investor position,” he said. If you have a relative who needs extra care or some mild supervision but still values independence, this sort of living situation also can work well.
4. Vacation rentals
Vacation rentals, including booking sites such as Airbnb, HomeAway, or TripAdvisor, are a growing business. The revenue forecast in the vacation rentals market in 2018 alone in the United States was $13.05 billion. The National Association of Realtors notes that 45 percent of investors in 2018 purchased a vacation or short-term rental property, compared to 49 percent of homebuyers who purchased the home as a retreat.
You can fund your travel or a chunk of your mortgage by renting out your property, especially if you’re in an area with seasonal residents. In San Diego, for instance, many people want to visit for the summer but will rent out their furnished property in the winter, Dannecker said. He also has worked with clients in Coronado who will rent their home furnished for, say, $30,000 in July while they’re on an adventure that’s not as expensive, such as camping. “They do it every year because it’s thirty grand for one month.”
There’s a lot of competition in the vacation rental industry, with more than 23,000 vacation rental companies in the United States. In addition to trusting that whoever rents your property will take care of it well, you’re also entering the hospitality business, which involves considering how many bath towels, pillows, and sheets to provide, among making sure your home is clean and tidy.
One survey of about 700 hosts in this industry notes regular maintenance, including getting the carpets cleaned at least twice per year (41 percent), getting the windows washed inside and out twice per year (almost 50 percent), and deep-cleaning the barbecue grill twice a year (42 percent).
Who it’s right for:
Someone who wants supplemental income to pay for their travels or that vacation property. “That’s not necessarily an investment. It’s a way for the owners to have a second home and offset their costs,” Dannecker says.
5. Crowdfunding, or online investment platforms
Similar to services like Kickstarter, online crowdfunding for real estate enables users to pool funds to buy and develop housing. Companies like Fundrise, Small Change, and ArborCrowd give investors a piece of a development deal for as little investment as $500. These also can spring up through local building projects, such as a developer seeking crowdfunding for, say, six townhomes or a thirty-unit apartment building.
“Many syndications, if they don’t already have groups of investors that are offering money, can crowdsource … It’s another way to attract money to a project that they believe in,” Dannecker said. “They can be really good investments.”
You can get a high return on an investment without the large down payment that buying other investment property might require. If you have $100,000 and get back 10% a year, you’re earning $20,000 two years later, Dannecker said. “I did one last year in Arizona, and I made a 60% return in 13 months.”
Crowdfunding websites for real estate have properties in different locations and diverse portfolios, so you can choose the projects in which to place your money, Investopedia says. You also don’t have to deal with managing property.
Real estate developers who use crowdfunding carry a higher risk of default than peer-to-peer and direct real estate investment funding, according to Investopedia. So do your research and vet the company to make sure it has a good track record, just like you would with any stock in the stock market. What’s its performance? Who are the leaders of this firm? You want to work with a company that demonstrates staying power.
Who it’s right for:
Someone who has the extra cash to invest but not the time or desire to be as hands-on as a landlord or a property flipper.
6. Real Estate Investment Trusts (REITs)
A real estate investment fund or REIT (pronounced “reet”) invests directly in real estate, typically in commercial buildings, but is bought and sold like stocks. An investor may already have REITs in a retirement fund or a stock account. These funds are rated like other stocks, and you can research them readily through TD Ameritrade, Charles Schwab, and other brokers.
REITs give investors an opportunity to defer capital gains taxes on other investment properties by investing in new properties. For instance, the 2017 Tax Cuts and Jobs Act included a new federal incentive called Opportunity Zones, where any corporation or individual with capital gains can reap tax benefits by investing in distressed communities. If you have capital gains income from another investment property, “you can buy in federally distinguished areas where they want to inject money into those areas … and you can basically wipe off a lot of the taxes you have to pay,” Dannecker said.
Some REITs lack liquidity, or how easily assets can be converted to cash, and may have upfront fees of as much as 15 percent, according to the Pensacola, Florida, law firm Levin Papantonio, which handles securities litigation. It’s important to talk with a tax attorney or accountant before such an investment to determine a particular REIT’s impact on your tax liability.
Who it’s right for:
Someone comfortable dealing with a stockbroker or financial planner, who generally recommend certain REITs and manage your portfolio.
How to get started
Investing in real estate isn’t a “set it and forget it” proposition. Educating yourself on not only the types of real estate investments but legalities, insurance, and other particulars is important when deciding whether you want to take the plunge.
The National REIA has local chapters nationwide that provide opportunities for aspiring investors to network, as well as an online learning platform, National REIAU. The platform offers a range of classes, some free, and helps students build toward becoming a Professional Housing Provider, a designation that indicates a certain level of education.
Bear in mind these other tips:
Treat investing as a business:
The National REIA says that to become successful as a real estate investor takes real work—and at least three to five years. Don’t treat it like a hobby and devote scattered time to it.
Jeffrey Watson, the National REIA’s general legal counsel, said investors should pick no more than two or three areas in which to practice and do those repeatedly. Those who suffer from “shiny object syndrome” and pursue one different thing after another rarely reap the rewards.
Ask yourself solid questions:
How much time will you put into this investment? How much capital are you willing to risk? What rate of return do you want? That’s not just a percentage. Do you want your investments to give you regular monthly income?
You also can speak to an investor-friendly real estate agent who can calculate different scenarios for you with down payments on various properties, interest rates, mortgage rates, taxes, maintenance, and other variables, so you can understand what your total costs and obligation would be. “Many novice investors come to us, and if I say, ‘It’s only $800,000. It’s a great deal,’ they don’t know what that means. The big question that they’re asking is: ‘What does that mean for my monthly payment? How much money do I need to put down?’” Dannecker said. “A good agent is going to be able to paint that picture.”
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