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How to Invest in Real Estate

How to Invest in Real Estate
Chris Muller
Updated August 11, 2021
8 Min Read

Real estate is one of the asset categories covering the largest number of investment vehicles. Property investment strategies range from passive to active, and they generate returns in the form of profit, appreciation, and rental income. In this guide, we look at various real estate investment options to help you diversify your portfolio, produce positive cash flow, and build wealth.

Buying a Rental Property

Buying a property and renting it out for ongoing income is a popular form of real estate investment. Contrary to popular belief, this investment strategy is not ideal if you want to earn passive income. Rental property investments require active management, which can be time-consuming and tedious.

By investing in a rental property, you can potentially generate returns in two ways, namely appreciation and an ongoing return in the form of rental income.

Factors contributing to property appreciation include:

  • Regular home improvements and maintenance
  • The increase in your property equity as you pay down your mortgage
  • Favorable trends in the housing market

Rental property investment can generate a positive cash flow if the monthly payments you receive from tenants exceed the monthly maintenance costs.

Evaluating Potential Rental Property Investments

Selecting the right rental property is critical to ensure that you meet your investment objectives. For example, if you are looking to buy a residential rental property, limit your search to neighborhoods meeting the following criteria:

  • High employment among residents
  • Low crime rate
  • Proximity to reputable schools
  • Consistent appreciation in property value

Ideally, the monthly income the property generates should exceed all monthly expenses, including your mortgage payment, maintenance, property management fees, taxes, and insurance.

The 1%-rule is a simple tool you can use to determine a property's viability. According to this guideline, a property's monthly rent should be equal to or greater than one percent of its total purchase price. In other words, if a living unit costs $100,000, it should rent for at least $1,000 per month.

While useful, the 1%-rule is not ironclad, and you should consider all variables when evaluating a potential investment. For example, a property meeting this threshold is not a worthy option if it needs a new roof or has extensive structural damage.

Crowdfunding Real Estate Platforms

Real estate crowdfunding involves pooling funds from multiple investors to raise capital and fund projects.

Crowdfunding offers benefits to investors and sponsors. As an investor, you gain exposure to real estate without the high capital requirement. A single investment can cover several real estate types and locations, providing optimal diversification.

Crowdfunding occurs via real estate investment platforms like RealtyMogul and allows sponsors such as property developers to fund projects through a community, saving time and fees. Sponsors can also access funding at relatively low interest rates through crowdfunding.

Each real estate crowdfunding platform has unique participation and minimum investment requirements. Some online platforms offer a minimum investment of $500, which is ideal if you are a beginner investor looking for an easy way to start building your real estate portfolio.

Eligibility requirements to participate in a real estate crowdfunding platform can be high. For example, some platforms are only available to accredited investors. Steep investment minimums of $25,000 or more are also standard among high-end platforms.

A crowdfunding investment can tie your money up for five years or longer, depending on the platform. However, some platforms allow anytime share redemption requests in exchange for a fee.

When researching real estate crowdfunding platforms, consider the following:

  • The amount you can invest
  • Your ideal time horizon
  • The property investment types on offer
  • The platform's niche and investing strategy
  • Relevant fee structures and policies
  • The yields and liquidity the platform offers
  • The platform's history and funding success rate

You can potentially earn competitive returns through real estate crowdfunding. If you don't have the credit score or funding to buy a property, this investment vehicle is worth considering.

Real Estate Investment Groups (REIGs)

Real estate investment groups (REIGs) are entities such as partnerships, LLCs, and corporations with multiple real estate investors as partners or shareholders. The primary operation of these groups involves pooling and deploying investor capital to buy real estate.

Like individual investors, REIGs invest in property to generate long-term appreciation, cash flow, or profits through frequent flips. However, the real estate transactions of REIGs are generally significantly more substantive and sophisticated than those of individuals.

By pooling resources, REIGs can make significant initial investments, providing shareholders with larger returns they can't achieve alone. For example, an REIG can purchase vacant land and develop apartment buildings, office complexes, and shopping centers.

An REIG formation typically occurs when a group of lead syndicators needs funding for a large-scale real estate project. The lead syndicators are the active partners who carry out operations such as finding property investments, creating business plans, and managing renovations.

When additional funding is necessary for a project, the lead syndicators will create a legal entity and invite individuals to participate in the project as passive investors. An REIG with substantive real estate projects can have hundreds of passive investors.

As a passive REIG investor, you have a share in the entity and its underlying property and returns. With this strategy, you have the opportunity to generate ongoing and passive cash flow every month.

Investing in an REIG is a long-term strategy with a planning horizon ranging from five to 10 years or longer. Because you'll tie up your money for this period, you should only invest with money you set aside for long-term investment purposes.

House Flipping

Flipping a house is the process of buying an undervalued property, renovating it, and selling it for a profit. The return from a successful flip can have two components—namely, appreciation due to an upward market trend and the capital improvements you make to a property.

In other words, the flipping process doesn't have to include a renovation project. You can also buy a house and wait for its fair market value to increase before selling.

However, one of your objectives should be to complete the sale as quickly as possible, reducing expenses such as taxes, insurance, loan interests, and utilities. A renovation ensures that the property is market-ready, making it easier to sell.

Use the 70% Rule

Buying at the right price is integral to mitigating your risk and maximizing your return on the sale. The 70% rule provides a guideline you should follow to ensure that you don't pay too much for a property you intend to flip.

According to the 70% rule, a property's purchase price should be 70% or less of its after-repair value (ARV) minus the renovation costs. ARV is the fair market value of a home after renovation.

For example, suppose a property’s ARV is $200,000, and you have to spend $35,000 on renovations. Let’s apply the 70% rule to determine the highest offer you should make:

$200,000 x 70% = $140,000

$140,000 - $35,000 = $105,000

Extensive research and knowledge of the local property market are necessary to determine a property's ARV accurately.

In our above example, if other similar properties in the neighborhood sell at prices ranging between $180,000 and $300,000, you should have no problem selling at $200,000. However, if the neighborhood has a property price ceiling of $150,000, it reduces the property's ARV.

Real Estate Investment Trusts (REIT)

A real estate investment trust (REIT) is a trust, corporation, or association with a similar model to that of a mutual fund. However, instead of stocks and bonds, a REIT pools money from investors to invest in real estate and mortgages.

Most REITs trade publicly on a stock exchange, and you can buy and sell them like stocks. REITs can also be private companies, but their shares are generally only for sale to accredited investors with a net worth exceeding $1 million.

The three types of REITs include:

  • Equity REITs that invest in real estate
  • Mortgage REITs that invest in commercial and residential mortgages
  • Hybrid REITs that invest in both properties and mortgages

Equity REITs are the most common, and they typically specialize in a specific property category, such as medical buildings or apartment complexes. If you are a beginner investor, consider buying equity REITS, as they are easier to evaluate and manage than mortgage REITs.

The Internal Revenue Service requires REITs to distribute most of their taxable profits as dividends to shareholders.

REITs generally have low investment minimums of a few hundred dollars. If you have limited capital, buying REIT stocks is ideal for gaining diversified exposure to the real estate market. These shares also offer a hedge against inflation.

REIT investments are liquid, which means you can quickly sell your shares whenever you want without going through the property selling process. To buy REITs, you have to sign up with a brokerage firm as you would when buying other securities on a stock exchange.

Short-Term and Vacation Rentals

If you already own a second property, such as a vacation home, or your primary residence has an empty living space with a separate entrance, you can use it to generate regular real estate income.

Short-term rentals involve renting out living space on a daily or monthly basis. For example, if you own property near an interstate halfway between two cities, you can provide travelers with overnight accommodation.

You can also offer month-long housing to people who are in the process of relocating to your area and are still in the process of finding a new home.

Property in a coastal town or area with tourist attractions can generate relatively high returns as vacation rentals. You can list your property on third-party online marketplaces for vacation rentals to find renters.

Short-term rentals are an active form of real estate investing and can be a full-time business. Before renovating a unit as a short-term or vacation rental, check the relevant laws and regulations in your area to ensure that you meet all requirements.

You should also draw up a business plan to ensure financial sustainability over the long run. If the property is in a low-traffic area, you may have to spend more on marketing. The demand for accommodation in your area may also be seasonal, which affects potential returns. 

Real Estate Limited Partnership (RELP)

A real estate limited partnership (RELP) is similar to a real estate investment group (REIG) in that it's an entity consisting of multiple investors who pool their resources to invest in real estate. However, unlike an REIG, RELPs dissolve after the sale of the properties in its portfolio.

A RELP's structure consists of:

  • A general partner who actively manages the entity's investment
  • Limited partners who are passive investors

The general partner is usually a legal entity operating as a real estate developer or property manager and is responsible for:

  • Establishing the partnership
  • Obtaining financing
  • Facilitating transactions
  • Managing investments

In exchange for the partner's efforts, they receive equity and fees such as acquisition fees, construction management fees, and disposition fees.

The limited partners contribute investment capital, but they are silent partners with no involvement in the investment operations. Profit distribution takes place according to the partnership agreement terms. RELPs are pass-through entities, which means they don't pay taxes.

Joining a RELP as a partner allows you to invest in more substantive deals and generate sizable returns. You can also enjoy tax benefits and a passive income.

Summary

After reading this guide on investing in real estate, you hopefully now have enough information to decide on a real estate investment strategy that fits your financial objectives.

As far as safe investments are concerned, nothing beats real estate. Nobody can pull a disappearing act with a property, and real estate offers a hedge against inflation and stock market volatility.

The returns from a property investment include monthly passive income and increase equity from value appreciation. Costs such as maintenance, mortgage interest, and management fees are also tax-deductible.

If you are looking to build a sustainable investment portfolio, real estate is the first asset category to consider. With the various investment vehicles available, you can select a passive or active investment strategy, and you can get a foot in the door, even if you have limited capital.

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