Understanding the Different Types of Real Estate InvestmentsResidential Real Estate. Residential real estate is probably the best known and most understood real estate investment. Investing in traditional physical real estate can deliver a high return, but it also requires more money upfront and can have high ongoing costs. REITs and crowdfunding platforms have a lower financial barrier to entry, meaning you can invest in multiple types of real estate for much less than it would cost to invest in a single traditional property.
These alternative real estate investments also offer the distinct advantage of not having to leave home or put on pants to start investing. Publicly traded REITs, or real estate investment trusts, are companies that own commercial real estate (think hotels, offices, and shopping malls). You can invest in shares of these companies on a stock exchange. By investing in REIT, you are investing in the real estate that these companies own, without so many of the risks associated with direct possession of real estate.
But others, such as Fundrise and RealtyMogul, offer investors who don't meet those minimums known as non-accredited investors access to investments they might not otherwise be able to invest in. These investments often come in the form of untraded REITs or REITs that are not listed on the stock exchange. Since they are not publicly traded, non-traded REITs can be very illiquid, meaning that your funds will be invested for at least several years, and you may not have the ability to get your money out of the investment if you need to. Keep in mind that many crowdfunding platforms have a short history and have not yet weathered an economic recession.
Residential real estate is virtually anywhere people live or stay, such as single-family homes, condos, and vacation homes. Residential real estate investors make money by collecting rent (or regular payments for short-term rentals) from tenants of the property, through the appreciated value that their property accumulates between the time they buy it and when they sell it, or both. Investing in residential real estate can take many forms. It can be as simple as renting a spare room or as complicated as buying and changing a home for profit.
Commercial real estate is a space that is rented or leased by a company. An office building rented by a single company, a gas station, a mall with several unique businesses, and rented restaurants are all examples of commercial real estate. Unless the company owns the property itself, each company would pay rent to the property owner. If you prefer to be more impassive with your investments, REITs and crowdfunding platforms are easier ways to add real estate to your portfolio without having to own a physical property.
Some brokerage firms offer publicly traded REIT and REIT mutual funds. Alternatively, you can invest in private equity funds, hedge funds, opportunity funds, and other privately managed funds. Many invest in real estate in one way or another, and most cater specifically to reputable investors. If you invest in rental properties, you become a landlord, so you should consider whether you'll be comfortable in that role.
As a landlord, you will be responsible for things like paying the mortgage, property taxes and insurance, maintaining the property, finding renters, and resolving any issues. A real estate investment trust (REIT) is created when a corporation (or trust) is formed to use investors' money to buy, operate, and sell income-generating properties. REITs are bought and sold on major exchanges, as are stocks and exchange-traded funds (ETFs). To qualify as a REIT, the entity must pay 90% of its taxable profits in the form of dividends to shareholders.
By doing this, REITs avoid paying corporate income tax, while a regular company would pay taxes on its profits, which would affect the profits it could distribute to its shareholders. Like stocks that pay regular dividends, REITs are appropriate for investors who want regular income, but they also offer the opportunity for appreciation. REITs invest in a variety of properties, such as shopping malls (about a quarter of all REITs specialize in them), healthcare facilities, mortgages, and office buildings. Compared to other types of real estate investments, REITs have the advantage of being highly liquid.
Real estate investment groups (REIGs) are something like small mutual funds for rental properties. If you want to own a rental property but don't want the hassle of owning, a real estate investment group may be the solution for you. Real estate mutual funds invest mainly in REITs and real estate operating companies. They provide the possibility of obtaining diversified exposure to real estate with a relatively small amount of capital.
Depending on their diversification strategy and objectives, they offer investors a much wider selection of assets than can be achieved by purchasing individual REITs. Like REITs, these funds are quite liquid. Another significant advantage for retail investors is the analytical and research information provided by the fund. This may include details on the assets acquired and management's perspective on the viability and performance of specific real estate investments and as an asset class.
The most speculative investors can invest in a family of real estate mutual funds, tactically outperforming certain types of properties or regions to maximize returns. Because they are backed by bricks and mortars, direct real estate also entails fewer conflicts between principal and agent, or the extent to which the investor's interest depends on the integrity and competence of managers and debtors. Even the most indirect forms of investment carry some protection. REITs, for example, require that a minimum percentage of profits (90%) be paid as dividends.
Unlike a stock or bond transaction, which can be completed in seconds, a real estate transaction can take months to close. Even with the help of a broker, finding the right counterpart can be a couple of weeks of work. Of course, REITs and real estate mutual funds offer better liquidity and market prices. But they come at the price of higher volatility and lower diversification benefits, since they have a much greater correlation with the general stock market than direct real estate investments.
Residential structures are properties such as houses, apartment buildings, townhouses, and vacation homes where an individual or family pays you to live on the property. The length of your stay is based on the rental or lease agreement. Most residential leases are for 12 months in the United States. A new trend in residential real estate is the phenomenon of Airbnb entrepreneurs.
These investors buy properties, fix them and rent them on the Airbnb platform for short-term stays or vacation stays. Vrbo is another popular platform for this type of rental. Commercial properties consist mainly of office buildings and skyscrapers. If you took part of your savings and built a small building with individual offices, you could lease them to companies and small business owners who would pay you rent to use the property.
It's not unusual for commercial real estate to involve multi-year leases. This can lead to greater cash flow stability and even protect the landlord when rental rates drop. One consideration is that markets fluctuate and rental rates could increase substantially in a short period of time. However, it may not be possible to increase rates if commercial property is locked in older agreements.
Mixed-use properties are those that combine any of the above categories into a single project. For example, an investor in California saved several million dollars and found a medium-sized city in the Midwest. He approached a bank for financing and built a three-story mixed-use office building surrounded by retail stores. The bank, which lent him the money, took out a lease on the ground floor, generating significant rental income for the landlord.
The other flats were leased to a health insurance company and other businesses. The surrounding stores were quickly leased by a Panera Bread, a members' gym, a quick-service restaurant, a luxury retail store, a virtual golf course, and a hairdresser. Mixed-use real estate investments are popular with those with significant assets because they have a degree of diversification built in, which is important for controlling risk. Reality shows like “Flip This House” popularized the change of houses in the mid-2000s, and Flipping's appeal managed to survive the housing crisis and the Great Recession.
Of course, many new investors don't do well and end up losing money. Even those who do perform well are often surprised at the amount of work that goes into achieving it. Changing houses involves an investment of time and labor, not just money. If you don't feel like wasting your time with a hard money loan and a hasty renewal, another option is to make a life change.
Moves into a house that needs renovation, improvement over the course of a year or two, then sells it and pays only capital gains tax. Or you can avoid capital gains altogether if you qualify for a Section 12.1 exclusion. There aren't many investment strategies that allow you to keep tens of thousands of dollars in just a few months. Changing houses is one of them, but it carries its own risks.
So make sure you get the right numbers, especially repair costs, transportation costs, and post-repair value. Also, make sure you're comfortable managing and negotiating with contractors before trying your luck at your first opportunity. One option is to buy a property that needs renovation, but instead of selling it once finished, you keep it as a rental. BRRRR stands for buying, renovating, renting, refinancing, repeating, and it's a great way to finance 100% of your property purchases.
Just like changing homes, new investors often get into trouble by underestimating costs, especially renovation and maintenance costs. Much of their success is due to their ability to find good contractors who don't increase their costs mid-renovation. HomeAdvisor is a great place to find reputable contractors in your area. They put all contractors on their platform through a selection process to ensure that you are hiring the best company for your needs.
Roofstock includes a wealth of data, both about the property and the neighborhood. They include home inspection reports, title history reports, limit rate analysis and cash-versus-cash statements, neighborhood and property level appreciation history, local school data, and more. Most impressively, they offer two buyer guarantees, including a 30-day money-back guarantee and a 45-day lease guarantee for vacant properties. It's a great way to make investing in rentals easier, especially because you can get a low-interest mortgage with a small down payment.
Properties with two, three, or four units are still classified as residential by the mortgage industry, so you can apply for a standard mortgage for homebuyers. That could mean a down payment as low as 3.5% for an FHA loan, 3% for a Fannie Mae HomeReady loan, or 0% for a VA loan. Compare that to the standard 20% for an investment home loan, plus a higher interest rate to begin with, and you can see why house hacking is so attractive to say nothing of the whole benefit of “my neighbors pay my mortgage. The downside to that high dividend yield is that REITs often struggle to raise capital to grow their portfolio, as they have to immediately pay much of their profits to shareholders.
But if you're looking for a completely passive way to diversify your stock portfolio to include real estate, there's no easier option than buying REIT in your brokerage, IRA, or 401 (k) account. For short-term rentals, property managers typically collect about 25% of rent as compensation, more than long-term rental property managers. Long-term rentals provide more stability to landlords than short-term rentals because they usually come with leases that last a year or longer. They also provide investors with a steady stream of monthly income through the payment of tenants rent.
Acting as a landlord is rarely an easy job. You will be on the lookout for maintenance, repairs and any issues that arise with the property. As with short-term rentals, you can hire a property manager, but this can affect your passive income. Hard money loans have higher interest rates (between 7% and 12%) and shorter repayment periods (usually 6 to 18 months).
House hacking can serve as a particularly good move for young adults looking for an investment. Real estate hackers buy a duplex, triplex or fourplex and then live in one unit while renting the others to tenants. To start hacking homes, homeowners can apply for a Federal Housing Authority (FHA) loan and purchase investment property for just the initial 3.5%. And if you qualify for a Veterans Affairs (VA) loan, you could get even lower rates.
Another common advantage of house hacking is the ability to claim MACRS depreciation. When you own an investment property that generates income for at least one year, you can slowly depreciate the cost of ownership and deduct it from your rental income. For residential properties, the applicable MACRS depreciation period is considered 27.5 years, while commercial property uses a 39-year MACRS depreciation table to calculate deductible expense. Keep in mind that when a property is sold, the IRS requires you to include recaptured depreciation on the Section 1231 or 1250 property.
This requires the seller to realize the accumulated depreciation as ordinary income with a limit of 25%. Like long-term rentals, hacking homes requires investors to act as landlords, meaning they will be held accountable for any issues and repairs. Investing in commercial real estate comes with high risks, but also great rewards. Owning an office or retail space allows you to rent to businesses with lease terms that are often much longer than residential rentals.
If you qualify as an accredited investor, you may want to see this commercial real estate investment opportunity. Commercial real estate almost always has a higher price than residential real estate. As a result, you'll have to save a large sum of money before moving on. If you want to make a passive real estate investment, real estate investment trusts (REITs) can be an excellent option.
For interested investors, try looking for Streitwise, a professionally managed REIT targeting commercial real estate properties. The service serves accredited and non-accredited investors alike and charges up to 80% less than the company's unlisted REIT competitors. This platform targets multi-family complexes with between 100 and 200 units and uses monthly cash flow to renovate for an approximate period of 5 years. The types of real estate investments the rich choose, because they can choose not to participate in protectionist regulation.
Terrell also notes that, aside from monthly earnings, investing in real estate drastically strengthens your net worth. But these real estate companies aren't the only way to invest in real estate on public stock exchanges. That means you can indirectly invest in real estate by buying shares in companies that make a living in the real estate sector. Wholesalers find a good deal on a property, hire it, and then sell the rights to that contract to a real estate investor.
For investors with a strong focus on improving their local communities, investing in commercial real estate can support that approach. Of course, there are many residential real estate investment strategies to implement and different levels of competition in the markets, which may be right for one investor may not be the best thing for the next. If you have small amounts of money to start investing in properties, crowdfunding platforms such as Fundrise and GROUNDFLOOR allow investors to buy part of a specific real estate project. For those who aren't interested in learning things, they can still diversify into real estate through REITs, crowdfunding real estate loans, and maybe even real estate syndications or private notes.
The most significant decline in the housing market before the COVID-19 pandemic coincided with the Great Recession. That means you can invest money indirectly in real estate easily by investing in companies or funds that work well when housing markets do the same. As you expand and diversify your real estate portfolio, consider the following types of real estate investments. The inflation-hedging capacity of real estate is derived from the positive relationship between growth in gross domestic product (GDP) and demand for real estate.
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