Real Estate Investing in the US 2021

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What You Should Know

  • Investing in real estate requires thorough research as some investment methods have high capital requirements and risks
  • You can either profit from real estate investing through capital gains or rental income. This is the source of real estate cash flows.
  • There are many different investing methods: REITs, REIGs, rentals, flipping, and online real estate platforms
  • Different real estate investing methods have very different risks, minimum capital requirements, and levels of liquidity
  • Real estate assets can be added to a stock portfolio to diversify your investments

Benefits of Investing in Real Estate

Real estate investing is a different type of investment than stocks or bonds. Real estate investors can leverage their money by making a down payment on a property at a fraction of the cost and benefiting from price increases on the total value of the property. Minimum down payments range from 3% to 20%, but you will have to “buy” the rest of your home equity over the next several years through monthly mortgage payments. By paying the bare minimum to have financial control over real estate assets, you can leverage your money by 20x with a 5% down payment.

By investing in real estate and waiting for property values to increase, you get capital gains. However, you can also profit from the cash flows that real estate investments generate. The most prominent example of this is rental income. Many property owners will rent out their properties and their tenants will effectively be paying for the mortgage and expenses. Real estate investors can also deduct expenses incurred during the ownership, operation, and management of a property.

The last major and often overlooked benefit to investing in real estate is the diversification benefits. Real estate prices often fluctuate with a low correlation to other assets like stocks and bonds. Many investors use real estate to diversify their portfolios and generate leveraged returns. Even for small investors, there are many real estate investment instruments that let people with low net worths invest in the real estate market.

How to Invest in Real Estate

While most people see real estate investment as buying a property, you can get involved in real estate through different funds and trusts as you would with stocks. The process for investing in real estate varies depending on the asset type you choose, but the most complex investment strategies involve owning property yourself. If you decide to purchase property, rent out units, or flip properties, then you will have to get familiar with real estate transactions and guidelines. Many legal and financial considerations make transacting real estate property very complicated. If you’re first getting started, you’ll likely want to invest in a way where the properties are managed for you.

Types of Real Estate Investments

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are one of the easiest ways to invest in real estate. They are public corporations that use the outside investment to operate income-generating properties similarly to REIGs or provide real estate financing for home buyers. REITs are traded on major exchanges and are subject to stricter regulations. There are two major types of REITs. The most common type, equity REITs, buy equity in different property types and operate them to generate rental income. Mortgage REITs (mReits) generate income by financing other investors’ home purchases with mortgages and originating mortgage-backed securities. Equity REITs rely on rent, which is a stable source of income, so they are a much simpler investment. All REITs are subject to certain financial restrictions. They are required to distribute 90% of taxable profits as dividends, 75% of their assets must be invested in real estate, and 75% of their gross income must be real estate-related.

Risks and Vulnerabilities

Of the many ways to expose your money to the real estate market, REITs are the lowest risk investment you can make. Since REITs are traded on major exchanges, your only exposure is the amount you invest and you can withdraw your money whenever you want. The extent to which REITs are exposed to risk depends on how they operate, but REITs are subject to stricter requirements and limitations. This reduces investor risk but also restricts the real estate investment decisions that REIT managers can make, which could lead to lower returns. Different REITs also carry different amounts of risk. Some REITs are not traded on major stock exchanges and are much harder to value, so inexperienced investors should stick to publicly-traded REITs.

Minimum Capital Requirement

REITs have no minimum capital requirements except the amount required to purchase a share. REIT share prices are generally very low and any retail investor can get involved with as much or as little money as they want. While other real estate investment opportunities require large down payments or capital to invest in property, which is a large asset, REIT funds are collected through countless public investors (a minimum of 100). Some REIT shares can be bought for just a couple of dollars.

Liquidity

Since REITs are traded on major exchanges, they are the most liquid real estate investment. If your REIT is not traded on a major exchange, you may have trouble liquidating your share, but most major REIT shares can be liquidated instantly.

Retirement Funds

Many investors choose to hold REITs in their retirement accounts because of the high dividend yields. When held in a 401(k), IRA, or Roth IRA account, capital gains and dividends can be tax-free or tax deferred depending on your account type. This is advantageous compared to directly investing in property because capital gains are taxed and rental income is subject to income tax.

Real Estate Mutual Funds

Real estate mutual funds invest in public real estate companies like REITs, but do not invest in real estate properties themselves. These funds are managed by professional investors that value the many real estate companies on the market and pick the ones they find promising. Retail investors then buy shares of the mutual fund and share in the profits. Real Estate Mutual Funds often provide more diversification benefits because they can invest in multiple REITs and real estate companies. However, Real Estate Mutual Funds are often less liquid, have higher taxes, and charge higher fees than REITs. If you want similar diversification benefits without the higher management fees charged by mutual funds, REIT ETFs are passively managed and are a combination of many different REITs.

Real Estate Investment Groups (REIGs)

Real Estate Investment Groups (REIGs) allow individuals to invest in real estate without having to maintain or manage the properties they own. REIGs often operate as partnerships that purchase multiple properties to resell units to individual investors. Each investor is considered a private shareholder in the company and therefore, becomes part of the REIG. While you purchase the full property, the management, maintenance, marketing, and tenant arrangements are usually done by the company. While it is common for REIGs to make many of the active decisions, some require that investors actively participate in management decisions. The companies charge part of the rent as payment for operating the properties.

Risks and Vulnerabilities

REIGs are less risky than buying properties yourself. The first way REIGs avoid risk is by diversifying their investments. REIGs invest in several properties at once and engage in different types of real estate investing (flipping, property financing, etc.). This reduces exposure to any single property failing. Since the property is managed by the REIG, your involvement in daily operations is largely reduced and tenant risk is absorbed by the REIG. You are also protected from vacancies to a certain extent because REIGs will typically set aside money that is paid to an investor if their unit is vacant. REIGs have fewer restrictions on what they can do compared to REITs, so the success of any REIG is entirely dependent on its management. By investing in a REIG, you are trusting the people who run it to manage properties on your behalf.

Minimum Capital Requirement

REIGs are meant for high-net worth-individuals who want to invest in real estate but do not want to spend the time and effort managing them. REIGs let investors buy multiple properties within the REIG and need large amounts of total capital to effectively diversify. Unlike directly investing in real estate, you will not have to obtain mortgage financing because the pooled funds in the REIG pay for properties. If you do not make a contribution large enough to purchase a property, the remainder will be paid for by other real estate investors.

Liquidity

Liquidity for a REIG depends on its management. Liquidity is usually lower than REITs, but you can get access to your capital without having to sell a property. Your REIG agreement should outline how and when withdrawals can be made, but it is a private company investing in a fairly illiquid asset, so expect restricted withdrawals. You may lose part of your investment or profits may be delayed.

Rental Properties

With a rental property, you manage and maintain the home. You’re responsible for keeping the house in good condition and dealing with tenants. Renting out property can be a job in itself, but the financial benefits are substantial.

Risks and Vulnerabilities

To rent out homes, you have to own property for your tenants to live in. You bear the full risk of owning real estate and there’s also tenant risk. You need to manage leases, make sure your tenants make payments on time, and repair tenant damage to the property. While rent payments should cover the expenses needed to operate the property and mortgage payments, failing to find a tenant will stop your property from generating cash flows. Renting out properties is generally a riskier form of real estate investment especially considering you’re exposing yourself to many different liabilities.

Minimum Capital Requirement

Most people who own rental properties have mortgages and use rent payments to cover the monthly mortgage payments. Unfortunately, most mortgages require a substantial down payment. This is a large financial barrier because each new property you want to rent out will require another down payment. You will need capital to back these investments, so rental properties are not easily accessible to most retail investors. Even if you own the property beforehand, you will need a large amount of capital for up-front maintenance and to cover vacancies. It’s also good practice to have a substantial amount of money saved for emergencies and other financial obligations.

Liquidity

Rental properties are as liquid as any other real estate property. Liquidity depends on how active your local real estate market is and how in-demand the property type is. Good rental properties should be located in high-density areas with high real estate demand. This helps you guarantee that you can find tenants, but it also improves the property’s liquidity. Compared to other real estate assets, rental properties are fairly illiquid, but if you pick the right location, this should not be an issue should you choose to sell.

Room Rentals

Instead of renting out an entire property, you can choose to rent out sections or rooms of your home and earn some income on the side. You can make short-term arrangements through websites like Airbnb to avoid dealing with long-term tenants and lease agreements. Airbnb provides some protection against potential damages, so you can mitigate part of the tenant risk. Unfortunately, renting out a room carries many of the same responsibilities as renting out a property. You are still responsible for the room’s maintenance and room rentals carry unique risks. Fortunately, since you already own the property, you won’t have to worry about making a down payment, vacancy issues, or selling the property (unless you want to sell your home). Room rentals are a good way to become a landlord without taking on too much responsibility.

Flipping Investment Properties

Flipping investment properties is profitable, but risky. Only people well-versed in real estate with key knowledge about all aspects of real estate flipping should consider this method of investing. “Flipping” investment properties refer to when real estate experts seek undervalued properties on the market. They then buy the property, repair the house as needed, then resell the property at a net profit within a period of usually less than six months. Real estate investors look for value in properties, then factor in all related costs to financially plan out the entire process. If you’re planning on flipping investment properties, you should already know your exact profit before buying the property.

Risks and Vulnerabilities

Flipping investment properties is the riskiest way to invest in real estate. If the calculations of your net profit are incorrect, you could end up losing money even without unforeseen issues. Predicting future selling prices at a profit means that you have to be smarter than the current real estate market. The real estate market is constantly changing and accurate valuations may not be reflected when the time comes for you to sell the property. Both the timing and values of flipping investment properties make it risky no matter how much real estate experience you have.

Minimum Capital Requirement

You will need a significant amount of capital to flip investment properties. To get ownership of the property, you need a mortgage and as an active real estate investor, you will probably need to make a large down payment. For each property you want to be flipping simultaneously, you will need a down payment that could be as large as 20% of the purchase price. Until you sell the property, your capital will be tied up in these investments. You will also need to factor in the cost of any needed repairs. With your capital tied up, you will need to be able to finance necessary repairs out of pocket. You should also keep an emergency reserve if there is a lack of liquidity. Generally, flipping real estate requires that you have much more liquid capital on hand because of the added risk.

Liquidity

There is a large amount of risk associated with liquidity. While the property itself is as liquid as any other property within the area, the importance of being able to sell the property is much higher when flipping properties. Generally, you won’t be able to rent out a property in the middle of being flipped because of the ongoing renovations and tenants could undo your work. This means you’ll be making monthly mortgage payments without any incoming cash flows. Many real estate investors fail to account for this and run out of cash due to paying off the mortgage. If you do plan on flipping a property, make sure the local real estate market is active and that you will be able to sell the property when the time comes. If a property is severely discounted and you think it is undervalued, there is probably a reason and one of those reasons could be a lack of liquidity.

Foreclosed Homes

Experienced real estate investors also have the option of flipping foreclosed homes. These homes can be sold as-is upon foreclosure, so you will likely have to pay high renovation costs. However, foreclosed homes are sold at a large discount, so they represent the largest opportunity to make real estate profits, which also means your risk increases. It may also be more difficult to get mortgage financing because foreclosed homes are inherently riskier and major lenders will avoid financing homes in need of major repairs.

Micro Flipping

Micro flipping is similar to regularly flipping investment properties, but you can own the home for as little as a couple days. Micro flipping is when real estate investors find a property that is undervalued compared to the surrounding real estate market. The profit margins on this kind of investment strategy are much lower but since you own the properties for a shorter period, you can micro flip many more properties. The key to succeed with micro flipping is to have a robust network of buyers and sellers. Just like with regular flipping, if you are unable to find a seller for a property, you could be forced to sell it at a loss or hold it. Micro flipping is an advanced and very risky strategy that only veteran flippers should consider.

Online Real Estate Investing Platforms

Recently, online real estate investing platforms have gained popularity among investors as a way to easily get involved in real estate investing. These platforms give borrowers a way of reaching many potential investors.

Risks and Vulnerabilities

Online platform investing is extremely risky and many websites are restricted to accredited investors, which are individuals with annual incomes greater than $200,000 ($300,000 with a spouse) in each of the past two years or net worths of at least $1,000,000 (excluding a primary residence). However, crowdfunding has recently become more popular as a way to give the same real estate investment opportunities to retail investors. Unfortunately, your exposure is the same and all investors should be wary of the high risk. To minimize risk, investors should look for multiple high-quality investments to diversify their portfolios.

Minimum Capital Requirement

While you will usually not need to put up as much as you would for a down payment, investing through online real estate platforms will usually require some minimum investment. This can range from a few hundred dollars to tens of thousands for higher-end websites. This makes online platforms less accessible than REITs, but better than directly investing in real estate. You will usually be charged high management fees depending on your platform and chosen investment, but your maximum returns are much higher to compensate you for the added risk.

Liquidity

While you will usually not need to put up as much as you would for a down payment, investing through online real estate platforms will usually require some minimum investment. This can range from a few hundred dollars to tens of thousands for higher-end websites. This makes online platforms less accessible than REITs, but better than directly investing in real estate. You will usually be charged high management fees depending on your platform and chosen investment, but your maximum returns are much higher to compensate you for the added risk.

Real Estate Investing for Beginners

If you are a new investor or you want to diversify into the real estate market, REITs are the best option. In nearly every situation, REITs connect you with the real estate market without exposing you to high-risk or illiquid assets. Most REITs are traded on large stock exchanges, so the price you pay is close to the market value of the share. This means that even if you cannot effectively value real estate projects, you can rest assured that you are making a low-risk investment. REITs also provide regular dividends and are well-diversified further lowering their investment risk. There is virtually no minimum capital requirement because you buy as many shares as you like with some REITs costing a couple of dollars. As a beginner, picking REITs can help you learn about the real estate market and pick quality investment opportunities without being punished for bad decisions.

If you want to directly invest in property, you should still take small steps. Depending on which investment method you want to try, you should try low-risk and low-commitment options to first learn more about it before investing your life savings into high-risk investments. You should also have a full understanding of how much you can afford and how you expect to earn money:

  1. Capital Gains: Capital gains refer to profits when you buy an asset and sell it for more than you paid. The overarching real estate market grows over time, but individual properties can increase or decrease in price. If you hope to earn a profit with capital gains alone, you should first have an in-depth understanding of the local real estate market. Flipping properties is the most effective way to profit off of capital gains.
  2. Rent: Renting out a property or room helps you repay your investment over time, but it requires more active involvement and includes higher costs. You are responsible for maintaining properties and managing leases. A good way to start is to rent out a room of your primary residence to get accustomed to managing short-term tenants.
  3. Private Groups and Funds: You can directly invest in real estate through REIGs or RE mutual funds. While you don’t manage the property yourself, REIGs and funds invest your money into specific properties that are operated for rental income. This is generally lower risk than investing in property yourself, but as a new investor, you should have a thorough understanding of how the REIG/fund operates and the properties they own.

If you would prefer owning the property, you should use a separate legal entity like a limited liability company (LLC) or limited partnership to limit your exposure. Regardless of how knowledgeable you are about the real estate market, you will always carry a large amount of risk when owning property. Investing through a separate entity protects your personal assets in case your investment doesn’t work out.

How to Invest in Real Estate With No Money

If you have low capital, there are multiple ways for you to get involved in the real estate market.

  • REITs: REITs are traded on public exchanges and each share represents a very small portion of the total company that invests in real estate assets. A single share of a REIT can cost as low as a couple of dollars and can generate high dividends.
  • Online Real Estate Investing Platforms: Online platforms have been getting cheaper in recent years and the minimum investment can be as low as $10 without needing to be an accredited investor. Websites with lower minimum investments may host riskier investments or could charge higher management fees. Investments on these websites are already very risky, so exercise caution when evaluating these projects.

Investing in Real Estate vs Stocks

You may be looking into real estate investments because you’ve heard about booming real estate markets or you might want to diversify your portfolio. In either case, considering real estate investments expands your options and could lower your portfolio risk. Any experienced stock investor understands the powerful effects of diversification, but many stock investors don’t realize that many stocks are highly correlated, which reduces the effectiveness of diversification. Luckily, real estate is an entirely different market and while it is correlated with the general economy, real estate investments are much less correlated with stocks than other stocks while still offering competitive returns.

You should treat real estate as another investment opportunity and compare it with the pros and cons of investing in different stocks. Value each real estate investment for its merits and compare it with your risk tolerance.

Returns: Over the past 17 years, the Vanguard Real Estate ETF Total Return (VNQ) has beaten the S&P 500 ETF (SPY) in terms of returns by 77.7 percentage points. The total return of SPY over this period has been 234.5%, which is very good, but real estate has generated higher returns. This doesn’t mean that real estate will always beat stocks as there have been many periods where real estate is outperformed by the stock market. However, any notion that real estate doesn’t generate as high of returns as stocks is false.

Risk: Your risk exposure varies largely between types of real estate investments and the investments themselves as well. It’s difficult to compare real estate investment risk with stock risk because both cover a very large range of potential risks.

Liquidity: The largest downside of investing in real estate is that certain types of investments are very illiquid. It may take multiple years to withdraw your investment and in some cases, you may only be able to sell an asset early if you’re willing to take a loss. Especially if you purchase the property yourself, you could be stuck with a declining asset without a guarantee that you’ll be able to sell it. However, many real estate assets are very liquid such as publicly traded REITs, which can be bought and sold instantly.

Real estate assets are very different from stocks. Comparing real estate and stocks is nearly impossible because the nature of these two types of assets is completely different. While stocks are fairly straightforward even with the different types of shares, different types of real estate assets vary significantly from each other. The best way to compare your many options is to evaluate each type of real estate investment individually and decide what’s best for you.

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