For investors looking to diversify their portfolios, real estate can be a great option. While buying and then renting or selling a property can generate the largest returns, it not only requires a lot of upfront capital, it’s not without risk, as well. Other options, such as real estate investment trusts (REITs), REIT mutual funds and exchange-traded funds (ETFs) allow you to invest even if you don’t have tens of thousands of dollars to spare. Here are some of the most popular ways to invest in real estate. Of course, a financial advisor can also help you determine what type of investment is right for you, your current situation and your future goals.
Invest in REITs
REITs are companies that own commercial property such as office buildings, self-storage facilities, shopping malls and hotels. And just as you can buy shares of a company, you can buy shares of a REIT through an online brokerage. You can also buy shares of a REIT mutual fund or ETF.
REITs tend to pay above-average dividends to their shareholders, which makes investing in REITs particularly attractive. How do they manage this? By law, REITs can avoid the double taxation that most corporations face as long as they pay out 90% of their taxable income through dividends to their shareholders each year.
While the IRS generally taxes REIT dividends at your ordinary income tax rate, the Tax Cuts and Jobs Act also initiated a 20% deduction for pass-through income, which includes REIT dividends. In fact, the REIT dividend tax rate of 39.6% dropped to 29.6% for those in the highest tax bracket (however, it’s important to note that this deduction is set to expire on Dec. 31, 2025). Those in the lowest brackets may see even lower rates on the same REIT dividends.
While there are diversified equity REITs out there, most invest in a single sector. Examples include:
- Retail – shopping malls, strip malls and freestanding shopping centers
- Residential – apartments, single-family homes and other dwellings
- Healthcare– hospitals, medical offices, senior housing centers, etc.
- Industrial – warehouses, factory sites and other large business structures
- Hotels – everything from small motels to big-chain luxury hotels
That said, it’s important to pay attention to sector-specific risk when investing in REITs. Hotels, for example, may not be safe investments during a recession.
REIT prices tend to sink in high-interest rate environments, but they may still serve as a good long-term investment. And because the IRS generally treats your REIT dividends as ordinary income, they can serve as great retirement investments, too. A good portion of REIT shares exist within tax-deferred retirement plans like 401(k)s and individual retirement accounts (IRAs). If you have one of these accounts, you may already be investing in REITs.
Invest in Rental Properties
This is what most people probably think of when they hear real estate investing: buying a residential property and renting it out to tenants. To save money while doing this, you can also take advantage of a process called “house hacking.” This involves getting a residential loan for a property that you live in and rent out. Your tenants become your roommates, and you use their rental payments to make your mortgage payments. Ideally, you’ll also have extra cash left over to save or invest. Your own dwelling essentially becomes your investment property.
The key is to make sure your operating expenses fall below what you collect in rent. And while it sounds lucrative, you should be aware of the risks of investing in a rental property. You might end up with irresponsible tenants – they might cause damage to the property, pay their rent late or not pay their rent at all. Or they may drive you mad if you live in the property, too. And if the situation grows dire, the complex eviction process can stretch out for months.
What’s more, if the thought of getting a call about a broken pipe in the middle of the night makes your head spin, you could hire a property manager, but you’ll need to make sure you have the budget to do so.
You also have to pay close attention to the rental market. Rent is high in most major cities. But who’s to say it’ll stay that way? Nonetheless, you can open up a major source of passive income if you do your homework and prepare for the risks involved.
Try Online Real Estate Platforms
These days, all you need to get started in real estate investing is an internet connection. You can buy REIT shares, REIT mutual funds and REIT ETFs through an online brokerage. Or you can visit one of several online marketplaces, such as RREAF Holdings and iintoo. These websites list real estate projects that people can invest in.
On the other hand, robo-advisor Fundrise builds portfolios of real estate projects, which it then offers to investors. These portfolios range from an income focus to a growth appreciation focus. Like all real estate investments, this option is highly illiquid. So if you go this route, you should only use money you won’t need for at least five years.
Traditionally, the world of real estate was closed to small investors. Some platforms still require you to be an accredited investor, which the Securities and Exchange Commission (SEC) defines as someone whose earned income exceeds $200,000 ($300,000 if married filing jointly) in each of the last two years. Others sites, however, don’t have such high barriers.
Flip Houses
If you’ve watched HGTV, you’re probably familiar with flipping houses. Flipping houses is basically buying a property for cheap, renovating it and then selling it for a profit.
As with anything that can earn you some serious profits, this practice comes with serious risk. So it’s important to avoid the crucial mistakes first-time home flippers make.
Before you even find a home you want to pump some life into, you need to get acquainted with the housing market. Take a look at what homes in the area are selling for and check out what makes them appealing to homebuyers.
After finding a home you can reasonably bring up in value, you’ll need to estimate the costs of actually renovating the property. If you don’t have all the cash you’ll need, there are several smart ways to finance a house flip, including what’s called a flip loan. These short-term loans tend to carry higher interest rates than conventional mortgages, but the funding can come in as little as a few weeks.
If you’re flipping a home for the first time, you should consider hiring a professional contractor, who can teach you the ropes. An accountant or financial advisor will also come in handy when you’re crunching the numbers for taxes and keeping an eye on what can make the most profits.
Bottom Line
Investing in real estate can be a lucrative venture. And you have plenty of options to get started, including investing in REITs, house hacking or trying an online real estate marketplace. All are considered risky, however. So you should only invest money that you don’t need in the near future and make sure you understand all the terms of your investment.
Tips on Investing in Real Estate
- Before you make real estate a part of your investment portfolio, it’s a good idea to consult with a financial advisor who can make you aware of the potential risks. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- We briefly discussed house hacking. If this interests you, you may want to check out our study on the best cities to buy an investment property. We also offer some tips for investing in luxury real estate.
- If your interest in real estate stems from wanting to diversify your portfolio, you should know what asset allocation is right for your level of risk tolerance. Use our asset allocation calculator to find out.
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