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how to invest in real estate

For investors looking to diversify their portfolio, real estate is a great option. But 89% of Americans have never ventured into that kind of investing, according to RealtyShares, an online real estate investing platform. This is largely because of a lack of funds (61%) or know-how (19%).

But investing sites like RealtyShares and Fundrise mean you don’t need millions or even hundreds of thousands to invest. So do real estate investment funds (REITs) and REIT mutual funds and exchange-traded funds (ETFs). Read on for more about some popular ways to invest in real estate. Of course, the guidance of a financial advisor can also be a huge help.

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 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. Those in the lowest brackets may see even lower rates on the same REIT dividends, thanks to the country’s progressive tax structure.

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 to pay attention to sector-specific risk when investing in REITs. Hotels, for example, may not be safe investments during a recession.

In addition, REIT prices tend to sink in high-interest-rate environments. But these may 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. In fact, 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 becomes your investment property.

The key is to make sure your operating expenses fall below what you collect in rent. Sounds lucrative. Maybe even simple. But you should be aware of the risks of investing in a rental property. You might end up with the tenants from hell. They might cause damage to the property, pay late or not at all. Or they may drive you mad if you live in the property, too. If the situations 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 better have the deep pockets to hire a property manager.

You also have to pay close attention to the rental market. It currently means skyrocketing rent in 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 that it 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.

how to invest in real estate

Flip Houses

You’ve definitely heard the term before if you’ve seen HGTV. 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.

The Takeaway

how to invest in real estate

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 the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will 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.

Photo credit: ©iStock.com/chayakorn lotongkum, ©iStock.com/tulcarion, ©iStock.com/ALotOfPeople

Javier Simon, CEPF® Javier Simon is a banking, investing and retirement expert for SmartAsset. The personal finance writer's work has been featured in Investopedia, PLANADVISER and iGrad. Javier is a member of the Society for Advancing Business Editing and Writing. He has a degree in journalism from SUNY Plattsburgh. Javier is passionate about helping others beyond their personal finances. He has volunteered and raised funds for charities including Fight Cancer Together, Children's Miracle Network Hospitals and the National Center for Missing and Exploited Children.
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