Investing in real estate has serious appeal. It can not only diversify your portfolio, but it can also create a long-term stream of income if done correctly. Whether you want to be a landlord or invest in real estate by way of a Real Estate Investment Trust (REIT), we’ve identified the key steps with our guide to real estate investing. Below, we explore the different types of real estate investing, and we outline process needed to begin.
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Steps You Need to Take to Start Investing in Real Estate
If you’re committed to the idea of real estate investing, you’ll need to establish a plan for getting started. These steps should help you with your goal:
- Do your research. You’ll have a range of options for real estate investments, but it’ll be useful to know about the different properties and investments available. There are generally five different types of real estate: residential, industrial, commercial, mixed-use and retail. After you’ve chosen the property, you can then pay for it.
- Use cash to pay the downpayment on the property. The other option is to finance the property through mortgages or other loans, but you’ll gradually lose money to interest payments. With cash you won’t have to pay any interest at all, and you’ll earn more money if your property’s value appreciates.
- Determine the tax implications of your investment. Taxes vary for different types of property, so it’s wise to know the applicable tax laws. You can also hire a professional, such as a certified public accountant (CPA), if you’d like extra help with this step.
- Prepare for risks. Any investment presents some level of risk, so you’ll want to be prepared for any unforeseen market fluctuations. If you take the rental property route, you’ll need to account for maintenance, repair and other costs. Any real estate investment will offer some semblance of uncertainty. Whether your property’s value appreciates or depreciates, you’ll need to have a solid back-up plan.
- Manage your investment(s). Closely monitoring both the market and your property will help you to anticipate any sudden market changes. If you’d like professional guidance here, a financial advisor can help you with things like budgeting, investment planning and asset allocation. Our free financial advisor matching service can help you find the ideal advisor.
Below, we compare different methods for investing in real estate.
Investing in Real Estate, the Old-Fashioned Way
The old-school way of investing in real estate is to buy an investment property. Then, you can either find tenants and collect rent, or you can re-sell the property for a profit. You can do this once, or as many times as you can afford. You can work your way up to real estate magnate status, be a serial house flipper or simply rent out your vacation home when you’re not using it. Just remember to factor in maintenance expenses, vacancy between tenants and property taxes when you’re deciding what’s affordable.
For most people, saving up to buy one primary residence is hard enough. Not to mention the fact that if you own an investment property you’re responsible for either managing it yourself or hiring a management company. Are you ready to get calls in the middle of the night when your tenant’s pipes burst? No? Then you’ll need to spring for a management company.
Folks who have their hearts set on early retirement and financial independence may find that owning real estate is a key component of their financial plan. That’s because investing in real estate can create large sums of (mostly passive) income, the Holy Grail of financial independence. On the flip side, if you find yourself owing more than your investment properties are worth and you have trouble finding tenants, real estate investing can backfire. It’s important not to get in over your head.
Real Estate Investing and REITs
Another option for those who don’t want the hassle of becoming full-on landlords is to invest in real estate via a Real Estate Investment Trust (REIT). When you buy shares in a REIT or REIT fund, you profit from the dividends that real estate companies pay out to investors. You can buy shares in a REIT, or buy a REIT mutual fund. These can be actively managed mutual funds, or passively managed REIT index funds. There are also REIT exchange traded funds (ETFs). REITs can be domestic or international.
There are equity REITs, mortgage REITs and hybrid REITs. Equity REITS are what most people think of when they think REIT. They own and manage income-producing properties, commercial or residential. The REIT has equity in its many properties and can afford to pass part of its income on to investors.
A mortgage REIT doesn’t have the same kind of equity. It lends money to real estate companies, either with direct loans or by buying mortgage-backed securities. Instead of getting their income from rents, they get their income primarily from interest on mortgage loans. As you’ve probably figured out, mortgage REITs are more leveraged, meaning that they’re riskier investments than equity REITS. There are also far fewer mortgage REITs than there are equity REITs. Hybrid REITs, as you might expect, combine the traits of equity and mortgage REITs.
Related Article: How to Invest in Real Estate Using REITS
Real Estate Crowdfunding
Recently, the crowdfunding movement has found its way into real estate investing. Several start-ups now let individual investors make small, medium or large investments in real estate, reaping rewards proportional to their initial investment. Real estate crowdfunding lets you have a little more control over your investments than you’d get with a REIT. You can review potential investment properties one by one and choose where you invest. Just make sure you’re investing with a reputable company, and that you’re clear on how you declare the income you earn come tax time. And remember that because you’re choosing individual properties, you’re not getting the same level of diversification.
Related Article: What Is Real Estate Crowdfunding?
Real Estate Taxes
You’ll need to consider the tax implications of investing in real estate, as this will give you a better understanding of how much you’ll spend versus how much you’ll earn.
Determining how your property is classified will help you understand which taxes you’ll need to pay. Common taxes for real estate include the short-term and long-term capital gains taxes. Both apply to income earned from selling property. The short-term capital gains tax applies to properties sold within a year. The long-term capital gains tax is for owners who sell their investment after they’ve held them for at least a year. You’ll want to study the federal income tax brackets to determine exactly how much you’ll pay in taxes.
Real estate investing can generate long-term wealth, but it also presents risks. If you’re interested, it’ll help to understand the different property types and applicable taxes associated with your investment. The real estate sector is only one sector of our big, complicated economy. Investment strategies like portfolio diversification can help you employ a proactive approach to unpredictable market swings. If you’re only invested in real estate, you could be in trouble when there’s a downturn in that sector.
Tips for Investing
- If you’re already diversified across stocks and bonds, you’re on track to meet your retirement savings goals and you have a fully stocked emergency fund, you may be looking to branch out. Real estate investing is a great way to chase returns, and because real estate often performs differently from stocks and bonds, it can add diversification. Just be prepared for some ups and downs if you’re investing for the long term.
- Whether you want guidance on whether real estate investments are right for your portfolio, or you need help monitoring your existing investments through the market’s ups and downs, you might find it helpful to work with a financial advisor. A matching tool like SmartAsset’s can help you find a financial advisor to work with to meet your needs. First you’ll answer a series of questions about your financial situation and goals. Then the program will narrow down your options to up to three suitable advisors in your area. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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