9 Ways to Invest in Real Estate — Even if You’re No Mogul
There are a lot of reasons to be scared away from investing in real estate.
Maybe you think it’s something only super wealthy people can do. Or maybe you think you’ll have to become a landlord and deal with tenant emergencies 24/7.
But there are lots of ways to invest in real estate. You don’t need to be mega rich. You don’t need to become a landlord. You don’t even need to own physical property.
Let’s talk about how to invest in real estate, regardless of your goals and budget.
Should You Invest in Real Estate? Here Are the Pros and Cons
Real estate investing is a lot more accessible than you think, even if you’re a beginning investor. But like any investment, it has advantages and disadvantages. Here are a few to consider. Keep in mind that some of these won’t apply if you become a real estate investor without buying physical property.
Pros of Real Estate Investing
- Real estate values appreciate over time. Real estate values have ups and downs. But as a general rule, they tend to increase over time, though typical year-over-year increases will vary widely by location.
- It’s unlikely that the value of your investment would drop to zero. When you invest in stocks, you could lose everything if the company folds. Because real estate is a tangible asset, it’s highly unlikely that the value of your investment would ever drop to zero.
- Owning real estate helps you diversify. Owning real estate is a good way to diversify your portfolio, especially because real estate values aren’t strongly correlated with the stock market.
- You may qualify for tax benefits. If you buy a primary residence, you can deduct your mortgage interest. You can’t deduct mortgage interest on an investment property, but you can deduct expenses.
- You can earn passive income. Yes, passive income can be a lazy way to make money. But the benefits don’t stop there. Unlike self-employment income or a salary, passive income isn’t subject to payroll taxes.
Cons of Real Estate Investing
- It’s not liquid. Stocks are easy to sell via a stock exchange, but real estate could take weeks, months, even years to sell, depending on market conditions.
- The upfront costs are high. If you’re buying property, you’ll either need to pay cash or take out a mortgage. Expect to pay a down payment of at least 15% to 25% if you’re buying an investment property.
- It requires a lot of homework. You need to thoroughly research the location, as well as have a property inspection to be sure you’re making a good investment.
How to Invest in Real Estate: 9 Ways to Get Started
Now it’s time for the fun part where we talk how to invest in real estate. As promised, we’ll discuss options for those who want to own property, as well ways to invest in real estate without actually buying a piece of real estate.
Our first nine options are for aspiring real estate investors who DO want to buy property.
1. Buy a Home
The simplest way to invest in real estate is by buying a home. There’s no guarantee your home’s value will increase, but historically speaking, buying a home has paid off.
Countless studies show that homeowners have more than 40 times the wealth of renters. (Of course, there’s a chicken-and-egg thing here because wealthier people are the ones who can afford to buy homes.)
Forget the idea that you need a 20% down payment. There are plenty of options for making a smaller down payment, including:
- FHA loans: 3.5% down payment if your credit score is 580 or higher.
- VA loans: 0% down payment, but you may pay a 2.15% funding fee.
- USDA loans: 0% down payment if your credit score is 640 or higher.
The biggest benefit of investing in homeownership is that you build equity. Yes, a lot of your mortgage payment goes toward interest at the beginning, but gradually more and more goes toward eating away at principal.
2. Become a Landlord
Becoming a landlord could be right for you if you’re not daunted by the idea of difficult tenants and midnight phone calls when a pipe just burst.
Becoming a landlord isn’t just about collecting rent each month. You’ll need to screen potential tenants and work with an attorney to draft a lease agreement.
In addition to mortgage, property taxes and home insurance, your landlord budget needs to include a separate landlord insurance policy, routine maintenance costs and a reserve for emergency repairs. Keep in mind: People tend to be rougher on property they don’t own.
Also be prepared for periods of vacancy and the possibility that your tenant can’t pay rent if they fall on tough times.
Landlords who actively manage properties can deduct up to $25,000 of rental losses for taxes if their income is under $100,000, or a reduced amount if their income is between $100,000 and $150,000.
3. Flipping Houses
If you watch HGTV, you may think you know a lot about house flipping.
But guess what? Any experienced house flipper will tell you that the TV version is a lot different from the reality. House flipping is less about extreme home makeovers and more about research and number crunching.
Just finding the right house involves a lot of work and competition. Plus, getting financing isn’t easy. About 56% of flippers paid cash for their purchases last year, according to the ATTOM Data Solutions 2019 House Flipping Report.
In addition to what you pay for the home itself, materials and labor, taxes, insurance and other expenses often add up to anywhere from 20% to 33% of the property’s after-repair value, according to Todd Teta, Chief Product Officer of ATTOM Data Solutions.
But major repairs aren’t always necessary. Some house flippers simply buy a property in an area where real estate prices are appreciating. They hang on for a few months, then sell it for a profit without changing a thing.
4. House Hacking
If you want to become a homeowner and a landlord with a single purchase, house hacking is an option. You buy a multifamily property and then use the rental income you bring in to pay your mortgage and other expenses.
You get a free place to live while building equity, but of course, you need to be prepared for maintenance and repairs. Plus, you’d better like your tenants, since they’ll be your neighbors.
House hacking can be a good way to invest in real estate without a big down payment. If you’re financing a property with four units or less, you can qualify for an FHA loan with 3.5% down. In some cases, you can even use your expected rental income to help you qualify for the loan.
Another version of house hacking: Buy a single-family home as your primary residence and rent out part of the space. That’s what Kristine Dowhan of St. Petersburg, Florida, did when she bought her dream home and used Airbnb to pay her mortgage.
5. Buy a Vacation Property
Investing in a vacation rental may not look appealing in the Covid-19 era, given the extra safety precautions required and the fact that people are traveling less.
But in the long term, buying a vacation rental could pay off. Short-term rentals fetch higher rates than long-term rentals, though the rates you can charge may vary widely by the season. Vacation properties are often located in areas where real estate values have higher than average appreciation rates, making them a good long-term investment.
If you opt to have the property professionally managed, you can expect management fees of about 25% of the income the property generates.
If you own your primary residence and rent it out for 15 days or less, you don’t have to report the income to the IRS.
The next three options are for real estate investors who DON’T want to buy a property.
6. Invest in a REIT
A real estate investment trust, or REIT, is a company that invests in income-producing properties like apartment complexes, hotels, shopping centers, office buildings, medical facilities, warehouses and more. REITs then sell shares of those real estate investments to outside investors.
There are three main types of REITs:
- Equity REITs own actual property. They make money primarily by leasing the space. This is the most common type of REIT.
- Mortgage REITs don’t own actual properties. They invest in the debt that backs real property, i.e., mortgages. Mortgage REITS may directly finance mortgages, purchase existing mortgages or both.
- Hybrid REITs own both physical property and mortgages.
REITs often specialize in a certain type of property. For example, you can buy hotel REITs or office REITs or health care REITs.
REITs are required by law to distribute 90% of their taxable income to their shareholders. That means shareholders usually earn above average dividends, which makes REITs a good source of passive income.
But because REITs earn money from real estate income and real estate income is relatively stable, they don’t tend to have as much growth potential as regular stocks.
7. Invest in a Real Estate Mutual Fund or ETF
Because REITs tend to focus on a specific type of property, they usually don’t allow you to diversify your real estate investments.
For a broader mix of investments, you could buy a real estate mutual fund or ETF (exchange-traded fund). Both types of real estate funds bundle lots of REITs together into a single investment, giving you more diversification.
One key difference between the two: You buy mutual fund shares directly from the investment company, while ETF shares are traded in stock market exchanges.
8. Buy Real Estate-Related Stocks
REITs, real estate mutual funds and ETFs let you invest in real estate properties without owning physical property. But even if you aren’t investing in property, you can indirectly invest in real estate by buying stock in companies that flourish in a hot real estate market.
- Online real estate companies, like Zillow and Redfin
- Real estate brokerage firms
- Home improvement stores
9. Crowdfunding Platforms
If you’ve ever encountered a viral Kickstarter campaign, you know how crowdfunding works. Basically, multiple investors chip in to fund someone’s big idea, like developing a new product or launching a business.
When you invest in real estate crowdfunding, you’re usually investing in a single project. That makes it a high-risk, high-reward investment. A lot of these opportunities are only available to accredited investors, or those who either have at least $200,000 in annual income ($300,000 if married), or those with a net worth of $1 million, excluding their home.
But some online platforms allow ordinary investors to invest in crowdfunded real estate.
Sites like Fundrise are crowdfunding platforms that are open to non-accredited investors and allow you to get started for as little as $500.
Should I Invest in Real Estate?
Just know that as with any investment, real estate works best when you’re in it for the long term. That positions you to take advantage of the appreciation that usually happens over time, even if there are short-term dips. You’ll also avoid sinking too much money on closing costs and other fees.
The best way to invest in real estate is to do so slowly. Don’t plan to buy multiple investment properties at once or move a large chunk of your investments into real estate. Start small.
But if you invest in real estate the smart way, you’ll be in a good position to build wealth.
As Mark Twain once said: “Buy land. They’re not making it anymore.”
Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].com.