According to Forbes, real estate investing is not only one of the safest investments you can make, but it also has many benefits including appreciation, tax advantages, and the ability to earn passive income. Let's take a closer look at the different types of real estate investments and the pros and cons of each. A good starting point is to look at indirect versus direct real estate investments.
Indirect Real Estate Investments
For real estate investors looking for more passive investments, REITs and crowdfunding platforms could be the best route for you. Let's dive in.
Real Estate Investment Trusts (REITs)
Simply put, Investopedia defines a REIT as a "company that owns, operates or finances income-producing properties." Most are publicly traded REITs that operate like the stock market, enabling the general public to access a portion of ownership in large purchases such as hotels or condominiums. REITs collect rent from their assets and distribute them to investors as dividends.
Pros of Publicly Traded REITs:
- REITs are a great source of passive income
- REITs can help real estate investors diversify their portfolios
- REITs provide access to large real estate funds with little hassle or headache
Cons of Publicly Traded REITs:
- REITs can sometimes be expensive with hefty maintenance costs
- There are potential high taxes on dividends
The idea behind real estate crowdfunding is to pool money to fund a project. This offers investors the ability to become shareholders in properties with initial small(er) amounts and provides companies access to different kinds of capital. In many cases, real estate crowdfunding platforms put money into real estate investment trusts or similar investments. Companies such as CrowdStreet, RealtyMogul, and Fundrise have made crowdfunding trendy and brought access to real estate investments to the masses.
Pros of Real Estate Crowdfunding
- Crowdfunding makes investing tangible with a possible minimum of $500 to get started
- Less headaches and hands-on management than traditional real estate
- Online marketplaces offer a simple digital investing experience
Cons of Real Estate Crowdfunding
- Online platforms are illiquid and not ideal for those who are not playing the long game
- Many of these platforms are relatively new and lack a financial history, which could be seen as risky
- The development of the property and investments will be managed by someone else entirely giving you no control over your investment
Direct Real Estate Investments
A direct real estate investment is when you have direct ownership in the asset. An example is purchasing an apartment complex and managing it yourself. Let's take a more comprehensive look at what these kinds of investments look like.
Commercial Real Estate Investments
In simple terms, commercial properties are properties with 5 units or more or properties rented out to businesses rather than families and individuals. There are many commercial property types including:
- Multifamily Properties: A residential property with 5 or more rental units.
- Mixed Use Properties: A mix of residential and commercial units. An example is a restaurant on the ground floor with apartments on top.
- Retail Space: A rental building that is occupied by retail establishments, such as a clothing store.
- Office Buildings: A commercial space with tenants operating a business, such as a call center.
- Industrial Real Estate: A warehouse with a manufacturing or assembly space.
- Flex Space: A mixed-use property typically where there is a combination of office and warehouse space.
- Self-Storage: A special building designed with small bays that are leased for the storage of personal items.
- Pros of Commercial Real Estate Investments
- High income potential: According to NOLO, commercial properties typically have an annual return of 6-12%, compared to single family homes 1-4%.
- Business Hours: Commercial tenants leave after the workday and will not call you in the middle of the night.
- Flexible Leases: Commercial leases are less regulated than residential leases.
Cons of Investing in Commercial Real Estate
High Initial Investment: In a best-case scenario, you will need a 20% down payment. On a multi-million-dollar property, that makes the entry point quite high.
Large Time Commitment: Managing several tenants and negotiating leases is not only a lot of work, but also very nuanced. Many accredited investors will hire a property management company.
Risky: Often commercial properties are seen as higher risk than residential properties due to the public access. For instance, there is a higher chance of vandalism or parking lot injuries.
Residential Real Estate Investments
A single-family residential investment property is a single-family residence that is not owner occupied. There are many ways to invest in residential real estate. Here is an overview of the types of residential real estate investments.
Long Term Rental Properties
A long-term rental property is a single-family home a landlord will rent out long term. This asset class offers steady rental income and many tax benefits. Some of the drawbacks include the time commitment and headaches associated with managing a property. Many real estate investors will hire property managers to assist with tasks such as collecting rent and handling maintenance.
Short Term Rentals
Vacation rentals are residential properties investors rent out for the short-term. These real estate investments provide a much higher rent potential than long term rentals yet have more expenses such as frequent cleanings and higher marketing costs. Many property owners outsource the management to a property manager.
Buy and hold real estate investments are income producing real estate assets that investors hold onto in their investment portfolio. On the other hand, flipping houses is a real estate investing strategy designed to make lots of money one time. A real estate investor will purchase a physical property that needs major repairs, renovate it, and sell it. While the earning potential is huge, this strategy require money upfront and often hard money loans to finance it. It is also heavily dependent on the real estate market. Often, investors will work with a real estate agent to ensure a smooth and profitable real estate transaction.
Real estate wholesalers sell properties quickly to interested parties before the original contract goes through. When done correctly, wholesalers can get quicker returns on investments without worrying about construction or improvements. One of the drawbacks is the quick turnaround time to find a buyer.
Residential Real Estate Investing Pros
Ability to Generate Income: Collect rent every month or make a large profit on the sale of an investment property.
Appreciation: If you are a buy-and-hold investor, one of the biggest pros is the appreciated value of the property over time.
Portfolio Diversification: Real estate is a way to diversify your investments beyond stocks, bonds, and ETFs.
Residential Real Estate Investing cons
Expensive to Get Started: In addition to closing costs and fees, the down payment will often be a minimum of 25%.
Very Hands On: Even though it is considered a passive investment, these types of real estate investments require nuanced knowledge and ample time. Buy and hold investments involve advertising, payment collections, maintenance and repairs, and more. Other real estate investments, such as wholesaling depend on intensive knowledge, research, and effort.
Illiquid: Even flippers and wholesalers have to deal with physical real estate that involves closing, escrow, and negotiating. Buy and hold investors should play the long game to build wealth over time.
Another type of direct investment is purchasing undeveloped land to either sell to real estate developers or develop yourself.
Pros of Raw Land
Low Maintenance: Compared to other types of real estate investments, raw land does not have many maintenance costs.
Less Competition: Raw land is not as competitive as other types of real estate investments.
Cons of Raw Land
Many Nuances: Raw land can have many nuances compared to other types of real estate investments. Zoning restrictions and permitting costs are examples.
High Down Payments: Given that land is a vaguer real estate investment, the down payment can be up to 50%.
Which Real Estate Investment is Right for You?
There are clearly many investment opportunities when it comes to real estate. Whether you want to invest in rental properties or flex spaces, the investment strategy that is best for you will come down to your personal circumstances. We always recommend consulting your counsel and performing due diligence before real estate investing. If you're interested in purchasing a long term or short term rental property, get in touch with us to learn more.