Investing in real estate doesn’t just mean buy and rent (landlord-style) or flip houses like you see on HGTV. There is more than one way to invest and make money in real estate from leveraging what you already own to investing on public exchanges similar to how you would trade a stock.
Main Takeaways on investing in real estate:
- Flipping houses comes at a higher risk depending on the condition of the property but can be highly profitable.
- Wholesaling is different from the assignment of the contract, but both are short-term investments for experienced investors.
- House hacking can cover your mortgage while giving you access to a lower interest rate and down payment.
- Becoming a landlord can be a fruitful, active, or passive investment depending on how you manage the rentals.
- REITs have the lowest barrier to entry, as they’ve bought and sold like a stock on the market.
- Crowdfunding and trust deed investing is long-term strategies that create a diverse portfolio.
This post will explore several different options for how to invest in real estate, so you can increase your income starting with a breakdown of the different types of real estate available to investors.
What is Real Estate Investing?
Real estate investing is the buying, selling, renting, managing or owning of real estate for a profit. There are five main categories of real estate.
Residential real estate is any property used for residential purposes and occupied by families or individuals (not businesses). Examples include single-family homes and multi-family homes with one to four units. In addition, condos, townhomes, and duplexes classify as residential real estate.
Commercial real estate is property used for business purposes and occupied by businesses. Some examples include apartment complexes (with five or more units), hotels, restaurants, and office buildings.
Industrial real estate is property used for manufacturing, production, storage, and research. Examples include warehouses and factories.
Land includes vacant lots, agricultural farms, and ranches. Vacant land can be broken down into undeveloped property and property in early development.
Special purpose real estate is a miscellaneous category that includes real estate used by the public such as zoos, stadiums, amusement parks, and many others.
Get Started with Real Estate Investing
Active vs. Passive Investments
When investing in real estate, get started by choosing your strategy in terms of being an active real estate investor or passive real estate investor. Active real estate investing requires significant effort to make money. Active investment strategies include rehabbing houses and wholesaling. Passive real estate investing is when your income is growing with little to no effort on your end– examples include real estate investment trusts and crowdfunding platforms.
Capital Required to Invest
Depending on the amount of capital (or access to capital) you have to begin with will dictate what type of real estate investments are available to you. Contract assignment requires no capital but depends on a deep knowledge of the market and a buyers list whereas investment properties could require a 15% to 25% down payment.
Market Analysis before Investing
Keep up with the real estate market by reading and networking. Join local REIA (Real Estate Investors Association) groups to connect with other investors in your area. There are virtual groups that include people all across the country on Facebook. Get involved in forums on real estate sites such as BiggerPockets. All of these sources combined can give you a good indication of the state of the real estate market.
Ways to Invest in Real Estate
1. House Flipping
Flipping houses is a real estate investment strategy that allows you to have direct control over your investment. You can lower your risk by purchasing fixer-uppers that require cosmetic repairs, or take on a bigger risk with homes that have more serious damage such as foundation issues or mold. You make your money when you purchase a flip, as you should know what it will cost to renovate and re-sell for upon completion.
When searching for a home to flip, keep in mind that most distressed homes sell for cash due to the competition for these properties. Buying properties from investors could garner you a deeper deal than buying off the MLS (you can avoid agent fees of 5-6 percent). Network with local investors via Facebook, and join their buyer’s lists.
Is House Flipping Profitable?
House flipping is an active investment strategy and on the higher end of effort whether you’re doing the work yourself or overseeing the construction. Andy Kolodgie, a cash house buyer in Northern Virginia, says, “It’s important to do your own due diligence. The risk can be very high for someone inexperienced with purchasing a distressed home.” Rehabbing houses enables real estate investors to make money at a large profit, but the risk profile should be analyzed ahead of the purchase.
You can head here to read more on how to get started flipping houses.
Wholesalers in real estate are people or companies who purchase property in need of repair and then sell to another buyer doing a double close transaction. The turnaround time is quick (ideally both closings occur on the same day), which is an advantage if you don’t want a long-term investment.
What is an Assignment of Contract?
Similar to wholesaling is the assignment of contract. When done correctly, the assignment of contract requires no cash in the deal. This type of real estate transaction involves getting a house under contract and assigning the contract to a buyer before the close date.
This is often confused for wholesaling, but the main difference is the initial investor who gets the home under the contract does not double close on the home. The investor profits the end buyer’s offer minus what he/she initially offered.
For example, an investor offers a seller $150k and assigns the contract for $160k. At closing, the investor receives $160k-$150k, totaling $10k in profit.
Is Wholesaling Real Estate Worth It?
The main advantage with wholesaling and assignment of contract is quick income with no capital required as long as you can find a buyer willing to offer at or over what you got the house under contract for. If you can’t find a buyer, you close on the home.
The drawbacks of wholesaling and contract assignment are they require a vetted buyers list and thorough market knowledge. Before you get a property under contract, you should know confidently you have an end-buyer willing to make an offer at your price. Tight number crunching and sometimes a gut feel is necessary— working with an experienced investor in your area who is well versed in these transactions is recommended.
3. House Hacking
House hacking is defined as buying a property as your primary residence and renting out the rooms or units to cover a portion or all of your mortgage. This is a great way to start investing in real estate because it removes your largest monthly expense, rent, while allowing the convenience of living at the property when maintenance issues arise.
Finding the right property to house hack is important financially. A good rule of thumb is the 1% rule, which means you are receiving 1% of the property’s value in rent each month (more expensive homes can dip below 1% and still return profits). Account for maintenance, property management (even if self-managing), and vacancies to lower your risk.
Is House Hacking a Good Idea?
A major advantage of house hacking is it enables access to a lower interest rate and down payment compared to an investment property. This is because the property is your primary residence, so lenders follow more lenient guidelines. Further, your tenants can cover your mortgage, utilities, and even leave you with some extra income (i.e. cash flow).
The drawbacks of house hacking are a loss of privacy when renting out rooms in your home, and taking on the duties of a landlord from managing monthly payments, leases, and turnover, to more maintenance, than you would deal with as a single homeowner.
4. Rental Property
Purchasing a rental property can be an active or passive, long-term investment depending on who manages and maintains the investment property. Becoming a landlord is perfect for investors who want monthly rental income and high returns due to leveraging a mortgage instead of investing all cash.
When looking for rental properties, searching the MLS is a good place to start (Redfin, Zillow, and other real estate marketplaces have access to the MLS). Another option is joining investors’ buyer’s lists, which will give you access to off-market property deals, so you can buy in at a lower price.
Are Rental Properties a Good Investment?
Understanding the numbers and how much a property will rent for (and what the associated costs are with owning a rental) are important for creating fruitful investments. The 1% rule is common among buy-and-hold investors. Work with a local real estate agent specializing in investment properties to learn what the market rent prices are for the properties you’re vetting.
If you are self-managing a rental property, all property management duties including tenant interaction, rent collection, maintenance, and evictions become your responsibility. Further, you’ll be handling or delegating any maintenance concerns and filling vacant rooms.
If you hire a property manager, there’s a system in place to handle all of the work for you, which would make owning a long-term rental a passive investment. However, in return for the work put in by the management company, they will take a cut of your profit.
It’s important to understand the state and local laws, as some regions are more friendly toward tenants than landlords. Research the eviction process and tenants’ rights in your local area– if anything is unclear, schedule a meeting with an attorney to gain a complete understanding.
Increase your rental cash flow by implementing co-living, which involves renting out a property by room instead of unit. This grows your rental income, as you can charge more per room than you could per unit (even after accounting for the additional management). This style of renting is perfect for a metropolitan area because it typically attracts young professionals who are on a budget.
The difficulties of co-living include getting the right type of permits to allow this high-density living. Further, co-living requires more management because you’re dealing with more tenants on shorter leases (2-4 months) and potentially roommate conflicts. It also requires multiple bathrooms (usually no more than 2-3 tenants per bathroom with a shower).
Leasing short-term rentals such as properties available on AirBnb is a real estate investment strategy that allows you to get more value out of a home. Whether you purchase an investment property in a location with high demand or already own a home in a popular destination (it doesn’t necessarily need to be a vacation destination), you can take advantage of investing in a short-term rental.
Short-term rentals are similar to a hotel but are usually more local and more affordable after accounting for the size of the space and amenities. You can market your rental as a whole home, single room, or shared space on AirBnb. Other short-term rental platforms include VRBO and HomeAway.
More management and cleaning is required with short-term rentals and is often hired out to a management company that specializes in STR management due to the frequent turnover. If it’s located in the right area, you can expect 30% rental income, but be sure to check your property’s HOA guidelines to avoid breaking any rules.
5. Hard Money Lender
Investing in real estate for a high rate of return with a secured investment can be achieved by investing through a hard money lender (known as trust deed investing). However, this passive investment strategy is only available to accredited investors.
A hard money lender is a person or company that lends money to flippers, developers, and landlords at a high-interest rate (10 to 15 percent) while securing the money with the underlying asset (i.e. the property). “Good” hard money lenders give 10% yearly returns or about 2.5% quarterly returns to investors.
How Do I Invest in Hard Money Lenders?
To start investing through a hard money lender, you need to find a reputable lender in your area. This can be done via a Google search or networking with local professionals who have likely used them in the past such as home flippers. There are minimum buy-ins, which hover around $25,000-$100,000 with a lock-in period of a year or more.
The drawbacks of trust deed investing are that it is not as simple as investing in a REIT because there is no public brokerage for investing money with hard money lenders. Your investment is also less liquid, as you agree to a lock-in period with the lender.
6. Crowdfunding Platforms
Real estate crowdfunding enables the connection between investors and real estate developers through online platforms. Essentially a large group of individuals are funding real estate development projects in return for debt or equity (depending on the type of investment made) in the project along with monthly or quarterly distributions (if successful).
Crowdfunding has a higher risk profile and should be viewed as a long-term investment. This is because it is much harder to access your equity with crowdfunded real estate. Unlike a REIT, you cannot easily liquidate, and unlike a rental property, you cannot open a home equity line of credit (HELOC).
How Do I Start Crowdfunding in Real Estate?
A popular crowdfunding platform is Fundrise, as it does not require investors to be accredited and has a low initial investment amount of $500 plus a 0.15% annual fee. Note that some crowdfunding platforms do require investors to be accredited (i.e. $200k per year or net worth of $1MM).
7. Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts (REITs) are an effective real estate investing strategy for the passive investor, as you don’t have to physically buy a property. The most common type of investment trusts are equity REITs, which can be thought of like mutual funds, but instead of being made up of hundreds of different companies, equity REITs are composed of hundreds of different properties.
How Do I Invest in REITs?
Most REITs are publicly traded on major exchanges similar to stocks. There are also non-publicly traded REITs, but these require an accredited investor (i.e. someone who makes at least $200k per year or has a net worth of $1MM or more) who has more initial capital to invest. Private REITs are also less liquid than publicly-traded REITs.
Investing in REITs allows you to diversify your portfolio by owning part of a company that owns, operates, or finances commercial real estates such as hospitals, office buildings, hotels, or apartment complexes. Due to being bought and sold like a stock, REITs are highly liquid, which allows you to invest in real estate without being locked in the long term.
REITs are a good way to get started with investing in real estate, as the barrier to entry is low. An investor only needs a brokerage account and enough money to buy at least one share. Before investing in a REIT, research the management– look for a real estate investment trust that has a voted board with an extensive track record.
Are REITs a Good Investment?
A major advantage of REITs aside from liquidity and a diverse portfolio is they yield high dividends. REITs are required to pay out 90% of taxable income to shareholders. However, the dividends offered by REITs are taxed at a higher rate.
The disadvantages of REITs are they typically decrease in value when the Fed increases interest rates. Further, certain property-specific REITs such as hotels tend to do poorly in times of economic downturn, as travel is one of the first luxuries that people eliminate.
Final Thoughts: How to Invest in Real Estate
Real estate investing is a great way to create wealth and diversify your investment portfolio. The key is to understand the market and have a deep knowledge of the investment strategy you choose. Keep in mind that it’s more difficult to start investing in real estate without a network of experienced investors– networking is valuable no matter which way you decide to invest. Start simple and focus on one investment strategy at a time. As you gain more experience, you will be generating income with ease.