Simple Ways To Invest In Real Estate Buying real estate is about more than just finding a place to call
home.
Investing in real estate has become increasingly popular
over the last fifty years and has become a common investment
vehicle.
Although the real estate market has plenty of
opportunities for making big gains, buying and owning real estate is a lot
more complicated than investing in stocks and bonds.
In this
article, we'll go beyond buying a home and introduce you to real estate as
an investment.
Basic Rental Properties
This is an investment as old as the practice of landownership.
A
person will buy a property and rent it out to a tenant.
The owner,
the landlord, is responsible for paying the mortgage, taxes and costs of
maintaining the property.
Ideally, the landlord charges enough
rent to cover all of the aforementioned costs.
A landlord may also
charge more in order to produce a monthly profit, but the most common
strategy is to be patient and only charge enough rent to cover expenses
until the mortgage has been paid, at which time the majority of the rent
becomes profit.
Furthermore, the property may also have
appreciated in value over the course of the mortgage (according to the U.S.
Census Bureau, real estate has consistently increased in value since 1940),
leaving the landlord with a more valuable asset.
There are, of course, blemishes on the face of what seems like an ideal
investment.
You can end up with a bad tenant who damages the
property or, worse still, end up having no tenant at all.
This
leaves you with a negative monthly cash flow, meaning that you might have to
scramble to cover your mortgage payments.
There is also the matter
of finding the right property, you will want to pick an area where vacancy
rates are low (due to demand) and choose a place that people will want to
rent.
Perhaps the biggest difference between a rental property and other
investments is the amount time and work you have to devote to maintaining
your investment.
When you buy a stock, it simply sits in your
brokerage account and (hopefully) increases in value.
If you
invest in a rental property, there are many responsibilities that come along
with being a landlord.
When the furnace stops working in the
middle of the night, it's you who gets the phone call.
If you
don't mind handyman work, this may not bother you; otherwise, a professional
property manager would be glad to take the problem off your hands for a
price, of course.
Real Estate Investment Groups
Real estate investment groups are sort of like small mutual funds for rental
properties.
If you want to own a rental property, but don't want
the hassle of being a landlord, a real estate investment group may be the
solution for you.
A company will buy or build a set of apartment
blocks or condos and then allow investors to buy them through the company
(thus joining the group).
A single investor can own one or
multiple units (self-contained living space), but the company operating the
investment group collectively manages all the units, taking care of
maintenance, advertising vacant units and interviewing tenants.
In
exchange for this management, the company takes a percentage of the monthly
rent.
There are several versions of investment groups, but in the standard
version, the lease is in the investor's name and all of the units pool a
portion of the rent to guard against occasional vacancies, meaning that you
will receive enough to pay the mortgage even if your unit is
empty.
The quality of an investment group depends
entirely on the company offering it.
In theory, it is a safe way
to get into real estate investment, but groups are vulnerable to the same
fees that haunt the mutual fund industry.
Once again, research is
the key.
Real Estate Trading
This is the wild side of real estate investment.
Like the day
traders who are leagues away from a buy-and-hold investor, the real estate
traders are an entirely different breed from the buy-and-rent
landlords.
Real estate traders buy properties with the intention
of holding them for a short period of time (often no more than three to four
months), whereupon they hope to sell them for a profit.
This
technique is also called flipping properties and is based on buying
properties that are either significantly undervalued or are in a very hot
market.
Pure property flippers will not put any money into a house for improvements,
the investment has to have the intrinsic value to turn a profit without
alteration or they won't consider it.
Flipping in this manner is a
short-term cash investment.
If a property flipper gets caught in a
situation where he or she can't unload a property, it can be devastating
because these investors generally don't keep enough ready cash to pay the
mortgage on a property for the long term.
This can lead to
continued losses for a real estate trader who is unable to offload the
property in a bad market.
A second class of property flipper also exists.
These investors
make their money by buying reasonably priced properties and adding value by
renovating them.
This can be a longer-term investment depending on
the extent of the improvements.
The limiting feature of this
investment is that it is time intensive and often only allows investors to
take on one property at a time.
REITs
Real estate has been around since our cave-dwelling ancestors started
chasing strangers out of their space, so it's not surprising that Wall
Street has found a way to turn real estate into a publicly-traded
instrument.
A real estate investment trust (REIT) is created when
a corporation (or trust) uses investors money to purchase and operate income
properties.
REITs are bought and sold on the major exchanges just
like any other stock.
A corporation must pay out 90% of its
taxable profits in the form of dividends to keep its status as an
REIT.
By doing this, REITs avoid paying corporate income tax,
whereas a regular company would be taxed its profits and then have to decide
whether or not to distribute its after-tax profits as dividends.
Much like regular dividend-paying stocks, REITs are a solid investment for
stock market investors that want regular income.
In comparison to
the aforementioned types of real estate investment, REITs allow investors
into non-residential investments (malls, office buildings, etc.) and are
highly liquid, in other words, you won't need a realtor to help you cash out
your investment.
Leverage
With the exception of REITs, investing in real estate gives an investor one
tool that is not available to stock market investors: leverage.
If
you want to buy a stock, you have to pay the full value of the stock at the
time you place the buy order.
Even if you are buying on margin,
the amount you can borrow is still much less than with real
estate.
Most conventional mortgages require 25% down.
However, depending on where you live, there are many types of mortgages that
require as little as 5%.
This means that you can control the whole
property and the equity it holds by only paying a fraction of the total
value.
Of course, your mortgage will eventually pay the total
value of the house at the time you purchased it, but you control it the
minute the papers are signed.
This is what emboldens real estate flippers and landlords alike.
They can take out a second mortgage on their homes and put down payments on
two or three other properties.
Whether they rent these out so that
tenants pay the mortgage or they wait for an opportunity to sell for a
profit, they control these assets despite having only paid for a small part
of the total value.
Conclusion
We have looked at several types of real estate investment.
However, as you might have guessed, we have only scratched the
surface.
Within these examples there are countless variations of
real estate investments.
As with any investment, there is much
potential with real estate, but this does not mean that it is an assured
gain.
As with any investment, make careful choices and weigh out
the costs and benefits of your actions before diving in.
Written by Andrew Beattie. Culled from www.investopedia.com
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