They say there’s nothing new under the sun, and yet real estate continues to provide new investment opportunities. As the world changes, so too do real estate. So, jump in now to make a buck, but make sure to double back to see what new developments have occurred since you’ve first gotten involved. Here’s just a sample of ways you can invest in real estate.
Getting Started in Real Estate Investment
To begin with, if you’re going to invest in real estate you need a particular legal structure to do so. That’s so that if you get sued or go bankrupt you have something to walk away from rather than ending up personally sunk. Two popular options are limited liability companies (LLC) or limited partnerships (LP). You can actually use a different LLC for every property you invest in. This practice is known as “asset separation”.
Investing in Raw Land
Raw land can serve many functions. It can be used as a farm or a ranch, or it can also be held with the hopes of being purchased by developers or eager investors. It’s often easy to scoop up raw land because sellers are eager to part ways with such properties.
Raw land is just any vacant piece of land you can get your hands on. The hope is that the land you buy is in an area on the verge of a growth explosion! But just because the land is empty doesn’t mean it’s not without its downsides. You need to pay taxes, it doesn’t generate passive income (unless it’s farmland or used for grazing), you need to navigate zoning and environmental issues, and you may have to deal with utilities.
Buying a farm isn’t feasible for most people, but you can buy a real estate investment trust (REIT) that’s farm based. These REITs acquire farmland that they lease to farmers. They provide diversification for your investment portfolio because they farms tend to be spread apart rather than concentrated in one area. And since REITs are traded on stock exchanges, you get greater liquidity than if you invested in an actual farm.
Investing in a ranch has benefits outside of the income it generates. If your ranch is a business, then you qualify for many income tax deductions. Property taxes on ranches vary from state to state. In some places you don’t pay taxes on your land’s market value but on its production value, meaning the amount of agricultural goods that the land can generate. And that’s a big difference! It behooves you to make use of various corporate structures when it comes to how you present your ranch for tax purposes. This will demonstrate that your ranch is more than a hobby; it’s a legitimate business enterprise.
Commercial Property Real Estate Investment
Investing in commercial real estate is more challenging and costly than investing in residential real estate. In part this is because the information necessary to determine what makes a good investment isn’t as readily accessible. When you rent commercial property, you will need a comprehensive lease agreement. You should expect a down payment of at least 25% to 50%. In addition to having good credit, you may also need a lease already in place from someone who will be an occupant in your property. Lastly, the value of your property will be determined by the type of businesses housed in your building and how much revenue they generate.
The overwhelming majority of office buildings are leased rather than owned. Why? Because office space is seen as just another piece of a successful business plan rather than an end in and of itself. Oftentimes a consideration for what makes a good office space is how effectively the space can factor into an advertising plan. Additionally, leasing rather than owning a building gives the business some much needed flexibility. This way, if need be, the business can move to a new location with greater ease.
The location within the office building plays a part in determining the cost of rent. Higher floors, corners, and spaces adjacent to elevators all have different rates. Occupants will often make special requests as part of their leases such as control over signage, influence over who gets to buy neighboring space, and even the opportunity to purchase the building outright. Given the length of leases, it’s sometimes the case that the rent charged may be greater or less than what the market allows, so it’s not uncommon to re-negotiate the rental rates when renewing the lease.
One risk of investing in office buildings is that occupants may go bankrupt, especially during economic downtimes. If this is the case, then it may also be difficult to get the space filled. For this reason, a common strategy is having multiple tenants in an office building rather than just one.
Industrial real estate covers everything from warehouses to car washes. It’s anything that generates revenue from customers who use the facility. Oftentimes, industrial properties will also include additional revenue streams such as vending machines. Thanks to longer leases, industrial buildings generate larger returns. There’s also less worry because turnover rates are low.
These days warehouses are experiencing a resurgence thanks to e-commerce businesses that promise next day or even same day delivery. Warehouses are particularly in high demand near urban areas, which has led to many previously underutilized spaces suddenly getting bought and sold. Some warehouses may not be capable of supporting the technological needs of e-commerce businesses, which often make use of sophisticated equipment to distribute their goods. Given, however, that land near urban areas is scarce, companies may nonetheless resort to purchasing older warehouses and just retrofitting them with modern technology.
Retail real estate is in the midst of a sea change. Online retailers have significantly disrupted the retail market, with many businesses shutting down a considerable number of storefronts if not going bankrupt altogether. This has led to more vacancies and stagnating growth.
A physical store may be down but they’re not out. Shops are being kept afloat by those who need a quick fix through retail therapy, individuals who value on-site returns and repairs, people who are slow or unwilling to participate in online shopping, and consumers who still need to buy things like food, clothing, and toilet paper right away.
So, remember, the strongest brands may still make gains, small stores can experience growth, retail may change in a positive way as opposed to disappearing altogether, and there’s more to stores than just their face value. Plus, there’s always REITs to invest in.
Know the tourism trade where your hotel is. Also, keep in mind the state of the economy at the time of your investment. A poor economy depresses vacations. Also, survey the role of vacation and short-term rentals in the area; they’ll be your competition. Your hotel, however, may not depend on vacations. It may be in an area populated by corporate parks that business people often frequent.
Once your location is picked out, survey the occupancy rate for other hotels in the area. 60 to 65% is a good figure. If you want further detail, and you will, check out the tourism bureaus, economic developers, and the Chamber of Commerce. This may seem like a lot of work, but it’s an investment into a hotel we’re talking about. This is load is exactly what one should expect!
You’ll likely need someone to run your hotel, so you’ll have to pay great attention to your management. Study your agreement carefully so that you’re certain it includes what’s needed to manage and increase the occupancy and value of your hotel. A popular brand will charge a premium for the hotel’s management. Make sure you have the freedom to make renovations, change management, and implement your own advertising. Remember that you can also make an additional revenue stream through vending machines and small concession stands.
Residential Property Real Estate Investment
Residential properties are properties that people pay you to live in. This may be a home, apartment building, townhouse, or vacation home.
If you’re treating a single-family home as an investment rather than a purchase, then you would simply hold onto the property until its value increases. You can rent it out during this time as well.
A duplex is a single building that’s divided into two homes. Duplexes often come with all the amenities of a single family home. They’re just more affordable because the cost is split between two families. These pulses are also downsides, although not necessarily. Occupants will have to get used to living and sharing with their neighbors.
To begin with, you need to figure out how much you could potentially make from rent, storage, and parking vs the cost of repairs, maintenance, etc. Next, subtract your monthly mortgage payment from your net operating income (NOI). Your net income is your take home pay after all the taxes and expenses have been factored in. You also need to know your capitalization rate (cap rate), which is the measure of how soon you should expect a return on your investment.
To get your cap rate you take your NOI and multiply it by 12 (the number of months in a year), and then divide the product by your total mortgage amount. A higher cap rate is not necessarily ideal because it may mean a greater risk, although that may also mean a greater return. Conversely, a lower cap rate means less risk but also less return. A good cap rate is between 5% and 10%. Anything lower may not be worth it and anything greater may be too risky. Duplexes, triplexes, and four-plexes are each good starting points for a first time multi-family home investor. They’re less risky and tend to be more affordable.
Once you have a building in mind, look at what similar properties are charging for rent in the area. Remember, 50% of your income will go toward expenses (and not the mortgage), so you want to be in an area where the rent you can charge will generate enough of a return to maintain and grow your investment. Study who’s selling the place as well since a bank owned property is likely to go for less than a property that’s for-sale-by-owner.
One clear advantage of investing in a vacation property is that you can use it as a second home when not renting it out to guests. And, of course, your home can appreciate in value, which is always a perk. Tax deductions on rental homes can be complex if you decide to live there part-time yourself. For this reason, consulting with an accountant or real estate attorney is advised.
If you manage to get a property in a top tourist destination then you’ll be able to maintain high occupancy rates at a high cost. To further reduce your risk, you can choose a property that can be both a short and long-term rental. While a vacation property requires some maintenance, it’s not so demanding that it will eat up all of your time. You can also hire a property manager. Some factors to consider when choosing your space include local short-term rental legislation and how well other vacation properties fare.
To begin with, investing in an apartment building requires money for a downpayment, upkeep, and likely a management company. The latter is the route you likely need to go because of everything it takes to run an apartment. Finding and screening tenants, all the paperwork, maintaining the building, etc. It’s a lot of work!
When looking for an apartment building, expand the scope of your search to include more than just a rectangular multi-story building. Many types of buildings can be apartment complexes! A fixed up Victorian home, a multi-family colonial estate, etc. Don’t put limits on your imagination!
Once your apartment complex has been found, you’ll have to do the necessary due diligence. Study the location, the number of units, amenities, the condition of the property, etc. Then figure out the cost of all the repairs and maintenance. You’ll have to study the socioeconomic conditions of the area in which your building is found to determine occupancy and turnover rates.
Properties with five or more units don’t qualify for government loans, so be prepared to be rigorously studied when approaching a private or commercial lender. They’ll ask that you have interest and cash reserves. They’ll favor your application if your property has good market potential and a high occupancy rate, which you’ll favor as well since they are hallmarks of a good investment! Lenders will also be positively influenced by the income potential of your property.
Mixed-Use Property Investing
Mixed-use developments are buildings that fuse both residential and non-residential properties. A common variant is a building that has commercial properties on the ground floor and residential properties above. Some benefits of mixed-use properties include affordability, the close proximity of homes, access to amenities, and, in theory, stronger neighborhoods. Ideally, the different types of real estate complement one another.
From the perspective of the investor, mixed-use developments provide multiple revenue streams. An experienced property manager is the most likely route to go since each type of property demands a variant in management duties. Oftentimes the commercial aspects of the mixed-use development will be enticing to potential occupants. It’s very convenient to live above a supermarket! The diversity of tenants makes the property a more resilient investment. General walkability is also enticing to potential residents. Oftentimes, mixed-use properties will incorporate green spaces, which is attractive to active residents and potential families.
Invest in Home construction
When investing in new construction, you will be buying a property directly from the person who developed it. So, you’ll want to investigate the developers other projects to know what you’re getting into. One of the benefits of investing in new construction is that you can find a property that’s appropriately priced, in a great location, and comes with state of the art fixtures and amenities. Plus, everything will be under warranty since it’s brand new!
Just because the property is appropriately priced, though, doesn’t mean that the property will be affordable. An additional potential set-back of investing in new construction is if the property exists in an incomplete neighborhood, perhaps even surrounded by other homes at various points of construction. Additionally, since the home is brand new, it hasn’t been stress tested, so there is an additional degree of uncertainty to consider.
If you’re going to be investing in new construction, it may behoove you to work with an agent who specializes in new construction that may even already have a relationship with the developer. When negotiating the price, you may be able to get the builder to cover the closing or make some upgrades free of cost. The builder may already be working with a lender, but that lender may not be the best lender for you. So, shop around (although do consider working with the builder’s lender).
In the case of a community that’s only partially complete, investigate what the future plans are for the development. Also, don’t forget to investigate the home itself. Just because it’s brand new doesn’t mean it’s free from flaws. If you want to be strategic, try to make your purchase at the end of the month since builders’ bonuses often come on a monthly or quarterly basis.
Real estate investment trusts (REITs)
A REIT is a type of portfolio that’s traded on public or private exchanges. It allows people to invest in real estate in the same way they’d invest in a company, providing diversification for portfolios. REITs will often target real estate sectors, like apartment complexes or corporate offices.
What are common risks of investing in private REITs
When investing in a REIT, make sure you fully understand the tax implications. Income from current or accumulated earnings are treated as regular income. But when dealing with dividends, which are percentages of a company’s profits that are distributed to investors, the tax rate may change depending on the income bracket.
When dealing with REITs that are not publicly traded, you’ll be working within a fixed period of time where the REIT will either become liquidated or publically traded. This scenario creates the potential for fraud as REIT managers seek to avoid substantial investment losses.
Investors should also be on the lookout for fees as well as restrictions on the number of shares that can be redeemed before the full REIT goes liquid. Additionally, not all REITs are clear as to what properties they’re actually invested in. This creates an opportunity for unreliable investment.
Real estate limited partnerships (LP)
A RELP is what you get when several investors pool their resources to invest in property purchasing, development, or leasing. A general partner assumes full liability, while limited partners are liable only up to the amount they invest. The general partner tends to be a corporation, experienced property manager, or a real estate development firm. The limited partners are any individuals who provide funds in exchange for a percentage of the return.
What are common risks of investing in real estate LPs
RELPs lack liquidity because the investment is required for the entire life-time of the project. There may be construction delays and unforeseen expenses as well, which will extend how long it’ll take for the project to be complete. You may not even be able to resell your investment! Given the fluctuations of the real estate market, there’s no guarantee that your project will be sold at a profit. While not necessarily a risk, it is worth remembering that the majority of the decisions will be made by the general partner. As an investor your role is limited relative to the amount you contributed.
Mortgage-backed securities (MBSs)
An MBS is a bundle of home loans that are purchased from the banks that issued the loans. Investors get money as loans are paid back.
What are common risks of investing in MBSs
The risk of investing in an MBS made headlines worldwide as the culprit behind the 2007-2008 subprime mortgage crisis. An MBS carries the risk associated with the risk of the loans being paid back. In the case of the subprime mortgage crisis, loans with greater risk were repackaged and their level of risk was misrepresented to investors. Thanks to the crisis, an MBS can now only be purchased from a government sponsored enterprise or a private financial company. The mortgages must be issued by regulated and authorized financial institutions. The MBS is also subjected to oversight by accredited credit rating agencies.
Invest in real estate ETFs
An ETF is an exchange-traded fund. ETFs mimic an index of publicly traded real estate owners. The two most common indexes are the MSCI U.S. REIT Index and the Dow Jones U.S. REIT Index. These indexes cover 2/3 of all domestic, publicly traded REITs. These ETFs are known for their above average dividend yields.
What are common risks of investing in ETFs
ETFs carry market risks since they mimic a market index. While not a form of risk, ETFs have fees and taxes associated with them.
Real estate mutual funds
A mutual fund is a bundle of investments that’s professionally managed. The portfolio is usually diverse, made up of stocks, bonds, etc.
Invest in real estate notes
A real estate note is a contract that promises to pay a specified amount of money plus interest at a pre-agreed upon rate and length of time.
Consider hard money loans
A hard money loan is a short-term loan backed by real estate. They’re funded by individuals as opposed to by banks or credit unions. Usually, a hard money loan is expected to be paid back in 12 months, but it can last as long as two to five years. The payments are usually comprised of interest or interest plus principal, with a lump payment expected at the end of the loan.
Invest in real estate online
There are online platforms that connect real estate developers to financiers. The return comes in the form of either loan payments or equity. Payment is received on a monthly or quarterly basis. Like the overwhelming majority of real estate investments, working with an online platform is a speculative venture with low liquidity, so you won’t be able to pull out with the ease with which you can trade a stock.
The Bottom Line
Shelter is an indispensable necessity, and for this reason it comes in an abundance of shapes, sizes, and forms. This means there’s ample opportunity to make a profit! There’s so much opportunity that this primer only begins to scratch the surface. That’s good news because if you’ve got an investment itch, real estate is a sure way to scratch it!