Investing in real estate could be a smart financial decision with proper planning and budgeting. Real estate tends to appreciate in value over time, can act as a hedge against stock market volatility, offers great tax advantages and can provide a stable monthly income.
All things considered, buying property represents one of the most effective ways to build wealth but also one of the slowest. Though, once your investments start to compound, your portfolio will begin to have several income generating assets. You can reinvest the profits you make from selling previous investments and see your wealth truly begin to snowball.
To learn more about the different types of real-estate investments available to you as well as how to determine the right one for you, continue reading this comprehensive guide.
1. Short-term rentals
Short-term rental properties, otherwise known as vacation rentals, can act as one of the best ways to generate significant income from your real estate holdings. Owners can charge higher rates a day than long-term investment properties and they can also potentially use the home themselves when renters do not occupy the property.
Moreover, home-sharing apps such as Airbnb and Vrbo have made vacation rentals much more accessible and easier to market than ever before.
Vacation properties can also represent one of the more expensive types of real-estate investments. They can potentially carry intensive maintenance costs as a result of excessive wear and tear. Further, you will have to clean it after each stay, which could range from every couple of weeks to every day, depending on your guest preferences.
If you do not want to get your hands dirty, you can hire a property manager, but you still need to manage your property manager to ensure the rental remains in good condition. On short-term rentals, property managers typically charge around 25% of rent as compensation, more than long-term rental property managers, discussed next.
You also run the possibility of having your short-term rental remain empty for long periods, especially during the offseason. This could lead to lost income if your budget does not reflect this eventuality.
2. Long-term rentals
Becoming a landlord and owning a long-term rental property (or several) is one of the most common ways to invest in physical real estate. Some people pay cash for their rental properties, while others use leverage to take on more risk with financing and property management. Those who can manage this portfolio appropriately have learned how to make money while you sleep.
Long-term rentals provide more stability for owners than short-term because they usually come with leases lasting for a year or more. They also provide investors with a steady flow of monthly income via tenants’ rent payments.
Acting as a landlord rarely comes as an easy job. You will be on the hook for maintenance, repairs and any problems that arise with the property. Like with short-term rentals, you can hire a property manager, but this can eat into your income.
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You will have to depend on your tenants being reliable and making their rent payments on time. If they don’t, you might have to pursue legal action. Purchasing your first long-term rental property can also require a significant amount of capital upfront, especially if you choose to pay cash for your rental properties, though financing options exist under different terms than a conventional mortgage on an owner-occupied property.
Flipping houses is a great way to get started in real-estate investing if you have cash on hand.
Fixer-uppers provide investors with the ability to purchase properties in neighborhoods that might otherwise be out of their price range because the home is in need of repair. They hold the potential to turn a significant profit, especially for handy individuals who can tackle most of the renovations on their own.
Moreover, if you find an off-market property that looks like it’s in bad shape, you may be able to approach the owner directly and close the sale without a Realtor (and avoid commission fees). If you have interest in accelerating the growth of your real-estate investment portfolio, you might consider pursuing the BRRRR method, a strategy reliant on uncovering hidden gems and rehabbing them.
Flipping a fixer-upper is a big responsibility and will require a lot of time, money and effort. The process is very intensive, and you will be involved in everything from choosing paint colors to making major repairs. Basically, if you are a passive investor, these types of properties are not for you.
Buying an outdated property in the hopes of turning a profit can also quickly go wrong if the house has more damage than you initially expected. You will also likely need to obtain a hard money loan using the property as collateral, as opposed to funding the purchase with a mortgage.
Hard money loans have higher interest rates (between 7% to 12%) and shorter repayment periods (usually 6 to 18 months). Although higher rates are offset by quick turnaround times, if it takes too long to sell the property, you could run the risk of defaulting on the loan and losing the property altogether.
4. Commercial real estate
Investing in commercial real estate carries high risks, but also high rewards. Owning an office or retail space allows you to rent out to businesses with lease terms typically much longer than residential rentals. Plus, rental rates usually come in higher on commercial properties.
Commercial real estate almost always comes with a higher price tag than residential real estate. As a result, you will need to save a large sum of money before moving forward. You will also probably need to hire professional help to run the property as well as to handle emergency maintenance and repairs.
These investments carry higher risk because more people visit them each day, which means more people have chances to get hurt on the property (and sue). They can also more easily damage and vandalize the property on account of higher foot traffic.
If you want to make a passive real-estate investment, then real-estate investment trusts (REITs) can serve as a great option.
REITs are individual companies that own commercial properties such as hotels, apartments, office buildings and retail spaces. These investments usually pay high dividends and get used regularly in retirement funds. They do so because by keeping your REITs in a nontaxable retirement account, you can automatically reinvest your dividends without a tax consequence, allowing your money to grow even further.
Although some REITs are publicly traded on an exchange similar to stocks, others are not. REITs that are not publicly traded are difficult to sell and harder to value. REITs also tend to have high minimum buy-in prices and take longer to generate profits than an active investment.
The bottom line
Buying property represents one of the biggest financial decisions of someone’s life. Investing in real estate can serve as a great way to build your wealth. Before proceeding, make sure you assess your budget, timeline and goals when deciding which type of investment is right for you.
As with any large purchase, make sure you go in prepared and understand the potential repercussions of your investment.
Riley Adams is a CPA and the author of the Young and the Invested website, which focuses on financial independence and investing.