You probably know that real estate investing can be highly lucrative. Just think about all the wealthy people you’ve met or heard about. You’ll realize that many of them have made enormous gains on property investments.
This post is for people who recognize that real estate investments can make them rich but don’t know where to begin. For those of you who fall into this category, here are five ways to invest in real estate.
How to invest in real estate
Let’s do a deep dive into each of the five real estate investing methods listed below:
Invest in residential rental property
Invest in commercial property
Online real estate investing platforms
Invest in residential rental property
Investing in residential rental property is an excellent option. Rents are rising, and so are property prices. Take a look at this data from the St. Louis Fed:
Consumer Price Index for All Urban Consumers: Rent of Primary Residence in U.S. City Average
You can see that residential property rents have risen steadily over the years. In fact, in recent times, the rate of increase in rents has accelerated. According to a report in Bloomberg, rentals for single-family homes grew an average of 7.8 percent in 2021. That’s an all-time high. In December 2021, the year-over-year jump was a whopping 12 percent.
Higher rental income isn’t the only benefit that landlords enjoy. House prices are rising too.
Here’s another graph from the St. Louis Fed:
All-transactions House Price Index for the United States
Again, you can see the upward trend. House prices have been increasing for decades. Valuations recorded a 14 percent jump in the year to January 2022.
And this momentum in the increase of housing prices is likely to continue. At the end of 2020, the country had a housing supply deficit of 3.8 million units. Freddie Mac, the government-sponsored enterprise tasked with providing “liquidity, stability, and affordability to the U.S. housing market,” estimates that the housing stock deficit went up by 52 percent between 2018 and 2020.
The conditions seem ideal for residential real estate investments. The best part is that you don’t need to put up all the money upfront when you are purchasing a house. You can invest, say, 20 percent and borrow the rest. The rental income will help you pay the mortgage, and the money that remains is your income. Of course you also need to pay for repairs and upkeep.
How can you make sure your purchase will be a good investment? You’ll need to do your homework to identify a profitable rental property. But to make a start, you can use the 1 percent rule.
|The 1 percent rule says that your monthly rent should be at least 1 percent of the amount you have paid for the property.
Invest in commercial property
Commercial property investments include the purchase of industrial properties, factories, offices, and retail real estate. Interestingly, the term “commercial real estate” can also include some types of residential property. In industry parlance, single-family homes and residences with up to four units fall under the residential property category. But multifamily properties with five or more units are considered commercial real estate.
So, how is commercial property different from residential property?
There are several dissimilarities:
- Type of tenant: Residential properties are leased to individuals, while with commercial properties you’ll usually be dealing with businesses.
- Different hours of operation: Commercial properties follow business hours. However, residential units could require 24/7 involvement from the landlord.
- Managing a commercial property is more complicated: If you invest in commercial property, you’ll probably need to hire a property management company to take care of the requirements of your tenants. While this can make life easier for the landlord, it could mean paying 5 to 10 percent of your rent revenues as fees to the management company.
There’s another major difference between residential investment properties and commercial investment properties. In fact, from an investor’s standpoint, it could be a game-changer.
Picture a real estate investment opportunity that provides you a return without any of the hassles usually associated with property investments like repairs and maintenance. Even the payment of real estate taxes is taken care of by the tenant. This is precisely what a triple net lease offers.
In a triple net lease (NNN), the tenant pays the maintenance charges, real estate taxes, building insurance, and other property expenses. There are two main reasons why lessees agree to these terms. The first is that in an NNN, rents are typically lower. Secondly, lessees have far greater control over the property. This allows them to make the changes needed to keep up their brand image. Companies like Walgreens, Starbucks, and 7-Eleven usually opt for triple net leases.
How to invest in real estate–raising the money
In this section, we’ll address what is probably the most crucial issue about investing in real estate.
How will you raise funds to buy the commercial or residential property you have identified? Here is a quick list of your options:
- Banks: Banks can be an excellent choice for real estate investors. Banks like Chase, Bank of America, and First Internet Bank have special offers for property investors. On the downside, some of these financial institutions require lots of documentation. And their approval process can be painfully slow.
- Commercial lenders: If you find banks slow and their procedures too complex, a commercial lender can be a good option for financing an investment property.
What’s the difference between a bank and a commercial lender? Firstly, commercial lenders are classified as non-banks–they don’t offer all banking services. As far as borrowing from them is concerned, you would likely have to pay a higher rate than you would to a bank. But their loan approval process is usually faster.
- SBA loans: The U.S. Small Business Administration (SBA) is a government agency supporting small business owners. Their 7(a) loan program is possibly the lowest cost option for real estate investors.
But there’s an essential condition that you have to meet.
If your primary business is real estate investment, the SBA 7(a) loan program is not available to you. 7(a) loans are targeted at owner-occupiers who buy property to use for their own companies. However, SBA rules permit you to rent out a maximum of 40 percent (new construction) or 49 percent (existing buildings) of the property you purchase.
Now let’s address how to invest in real estate from another angle. Say you don’t have much of an investible surplus. And you’d rather not get into the nitty-gritty of managing properties and taking calls from your tenants at all hours.
Real Estate Investment Trusts (REITs) offer an excellent option for real estate investors who want to adopt a hands-off strategy.
What’s a REIT?
According to the trade association Nareit, REITs are companies that:
- Invest at least 75 percent of their total assets in real estate
- Pay out at least 90 percent of their taxable income as dividends
- Have a minimum of 100 shareholders
Essentially they are companies that use the funds you invest to buy real estate on your behalf. You can purchase many publicly traded REITs using a trading platform. In that case, buying a share of an REIT is like buying a stock.
Many REITs specialize in a specific segment of the real estate industry. There are industrial REITs, infrastructure REITs, data center REITS, and self storage REITs.
Here’s a list of some of the top REITs in the country:
Some of the top REITs
|American Tower Corp
|Crown Castle Intl Corp
|Digital Realty Trust
|Simon Property Group
There’s another big advantage with REIT investments. REITs are permitted to deduct the dividend they pay to their shareholders from their taxable income. Consequently, many REITs distribute 100 percent of their taxable income. By doing this, they don’t pay any corporate tax.
Millions of Americans have taken the REIT route to property investments. According to the Nareit website, an astounding 145 million Americans live in households that have invested in REITs through their 401(k) and other investment funds.
Online real estate investing platforms
Many people stay away from the property market because they don’t have enough capital to invest. Fortunately, there’s an easy way out. You can begin your real estate investment journey with…wait for it…as little as $10!
Of course, you’ll need to invest significantly more than that to make meaningful returns.
Fundrise is an investment platform that offers people a low-cost method to enter the real estate market. It takes just minutes to set up an account. And you can invest practically any amount you want. As we mentioned, the minimum is $10.
It wasn’t always so easy to put money into properties. Until a few years ago, only accredited investors could participate on online real estate platforms.
|What’s an accredited investor? According to the U.S. Securities and Exchange Commission, an accredited investor is a person who has earned at least $200,000 ($300,000 together with a spouse) in each of the last two years. If you don’t meet this condition, you need to have a net worth of at least $1 million (excluding the value of your primary residence) to qualify.
But with the passing of the JOBS Act in 2012, real estate crowdfunding platforms began permitting small investments. That’s been a boon for less affluent people who want to enter the real estate market.
Fundrise isn’t the only company that provides opportunities for retail investors. You can use several other real estate crowdfunding platforms to diversify into property investments.
House flipping can involve getting your hands dirty. Think of it as a direct, hands-on approach for people who want to enter the property market.
What is house flipping? Simply put, it involves buying a property that needs work, carrying out repairs and improvements, and selling it for a higher price.
It sounds simple, but it isn’t.
You’ll need to take the help of several professionals:
- A real estate broker can help you identify a property to buy. And you’ll need help to sell it, too.
- An insurance agent will guide you on the best policy to buy.
- A contractor will carry out the repair work on the property.
House flipping can involve many moving parts. You need to buy at the right price, renovate the property as quickly and at the least possible cost, and sell at a price that gives you an adequate profit.
Details from ATTOM, a provider of property and real estate data, reveal that the average time taken to complete a flipping transaction in the third quarter of 2021 was 147 days.
And how much did fix-and-flippers make? ATTOM says that the gross profit on a typical transaction was $68,847.
Gross profit on a typical flipping transaction
|Gross flipping profit
The actual profit that flippers make is much less than $68,847, as repair costs could be high. Industry experts estimate that rehab costs and other expenses are usually 20 percent to 33 percent of the property’s resale value.
The bottom line
Real estate offers investors an excellent way to build long-term wealth. You can consider buying a commercial or residential property if you have adequate funds. Direct investment provides many benefits. The rental income could be enough to pay off your mortgage, and there’s a good chance your property will appreciate in value.
There are also real estate investment opportunities for people who don’t want to get directly involved in the property market. REITs and online real estate investing platforms offer an excellent option if you have limited funds and want a low-cost and efficient way to take advantage of the property market’s potential.