Active real estate investing takes patience and hard work, but it also comes with a lot of enticing perks.
First, you retain complete control over your investments. How many equity investors can say that? You control the renovations, the contractors used, the tenants selected, the Realtor, the marketing tactics, and more.
Second, you can forecast your returns with incredible accuracy. The calculus isn’t exactly, well, calculus: you buy a property for $100,000, put in another $40,000 in repairs, and sell it for $200,000, minus soft costs. Your projections of the renovation costs, soft costs, and sales price will need a little wiggle room, but ultimately you can predict your returns far more accurately than you can with equities.
There are also the advantages we touched on earlier, from tax benefits to leverage to inflation-adjusted returns.
Here are four forms of active real estate investing, along with tips on what kind of investor each suits best.
Looking for a low-cost option for how to get into real estate investing? Consider wholesaling.
Wholesaling properties involves finding a good deal, putting it under contract, and then flipping the contract to another investor. The beauty of it? You never actually own the property.
Say you hear that your neighbor’s girlfriend’s uncle has a vacant property he doesn’t know what to do with. Let’s assume the numbers are the same as the example above: it needs $40,000 in work, with an after-repair value of $200,000.
You make an offer of $100,000, with assurances that you can settle quickly. Once the contract is signed, you send an email to your network of real estate investors, offering the deal to them for $110,000.
Ten minutes later you get your first response: “I’ll take it.” Four hours later you’ve assigned the contract to the investor, made a tidy $10,000 profit, and never once had to pick up a hammer, borrow financing, hire contractors, or do any of the other work of actively buying real estate.
Which is not to say wholesaling is without its own risks. While the above example is how it plays out in an ideal world, the risk wholesalers run is that they fail to place their contract with a buyer. In that case, they have several options: buy the property themselves, or cancel the contract and potentially forfeit their deposit.
With that said, many wholesalers grow adept at placing contingencies and loopholes in their sales contracts, to maximize their odds of withdrawing without penalty.
Who wholesaling is best for: Investors who want to learn how to invest in real estate, but aren’t ready to buy a flip or rental properties just yet. It’s a great strategy for how to start investing in real estate with little money.
Fix and flip
Ever watched HGTV? You know the premise of flipping houses.
House flippers buy homes that are undervalued or need repair work. They then complete any repairs needed and resell the homes, typically less than a year after the initial purchase, for a profit. (Further reading: How to Flip a House in 8 Steps.)
Worried that it’s too late to get into the flipping game? This year, flipping reached an 11-year high. While it’s not the get-rich-quick scheme that TV shows make it out to be, it can be an incredibly effective way to earn money with a quick turnaround.
Like any other form of investing, flipping houses comes with its own risks. Your contractors could take your deposit and flee to Argentina, or the repair costs may go over budget, or the property may not sell for your estimated after-repair value (ARV).
With experience, house flippers learn how to mitigate and minimize these risks. The more projects you collaborate on with contractors, the more trust you’ll establish. The more you know a particular market, and the more trust you build a with a Realtor, the less likely you are to overestimate your ARV.
Who house flipping is for: Investors with enough cash to cover a down payment, closing costs, the first renovation draw, and soft costs, who are aiming for fast profits and high velocity of money. Novices should consider coaching, courses, mentors, or senior partners to help them learn real estate investing without the costly mistakes, given the sums involved!
Long-term rental properties
Like the idea of ongoing rental income? Buy-and-hold rental properties make excellent sources of passive income, and grow your net worth to boot!
Similar to house flipping, investors can forecast their returns with surprising accuracy, by averaging long-term expenses. The catch that trips most new investors is that rental expenses that impact cap rates and returns aren’t obvious like renovation expenses in a flip. They happen irregularly, such as when the plumbing goes haywire or the property needs a new furnace.
Ongoing landlord expenses don’t just end with physical repairs and maintenance. Tenant vacancies and gaps in payment streams are an expense many new investors overlook. Property appreciation is also not guaranteed, even if it’s statistically likely.
Who rental properties are for: Investors looking for passive income while still retaining control over the assets and management. Typically, rental investors will need a down payment of at least 20% of the purchase price of a rental property, so some cash is required.
Short-term vacation rentals
With the rise of Airbnb and similar owner-driven vacation rental websites, more real estate investors than ever before are investing in vacation rentals.
One perk of vacation rentals? They’re flexible: the owner can rent the property when they feel like it or use it themselves at their leisure. Vacation rentals can be a great entry point for getting started in real estate investing. Homeowners can rent a single room in their home on Airbnb, and develop a sense for the rhythms and required work of being an Airbnb landlord without having to buy a new property.
As a cautionary note, beware that many cities and states impose restrictions on vacation rentals. Check your state and local laws before committing to this route!
Who short-term rentals are for: Homeowners looking to earn extra money and learn real estate investing gradually. They also work well for second home buyers who want to offset the costs of their vacation homes, while gaining experience in how to invest in real estate. Even long-term rental properties can sometimes earn higher returns as short-term rentals.
Passive real estate investing options
Does the idea of all that work make your eyes start to cross? Not everyone has the time, money, or inclination to learn how to invest in real estate actively. And there’s nothing wrong with that.
While passive real estate investing options don’t offer the same control or predictability that active real estate investments boast, they come with their own benefits: far less labor and skills are required, and sometimes with lower barriers to entry.
Want to diversify your investment portfolio to include real estate, without all the work and hefty cash requirements? Here are five ways to invest in real estate passively.
It’s possible to instantly invest in real estate online, by buying and selling shares of Real Estate Investment Trusts (REITs) on a publicly traded market. Many REITs are traded on public stock exchanges (e.g. ticker symbol REM), offering shares for anyone to buy. The REITs then use that money to purchase and manage income properties, from office buildings to apartment buildings to shopping centers.
Purchasing shares of a REIT requires far less time or knowledge than directly buying a rental property. Plus, to avoid paying federal income taxes, REITs generally pay out at least 90 percent of its taxable income to shareholders each year as dividends.
On the other hand, investors must pay management fees (some over 100 basis points) to a REIT. A publicly-traded REIT may also offer fewer diversification benefits from stocks and bonds than other real estate investments because it is traded on exchanges alongside stocks.
Not all REITs are traded publicly. Privately-held REITs operate similarly to publicly-traded REITs but are not purchased on public exchanges. Although private REITs may offer more diversification for investors than those that are publicly traded, they are usually less liquid, requiring money to be tied up for seven years or more. Private REITs can also lack transparency, giving investors little understanding of what real estate is actually held by the REIT.
Who REITs are for: Anyone looking to diversify their portfolio to include real estate, but who want nothing to do with learning how to invest in real estate actively.
In recent years, technology-enabled alternatives to traditional real estate investment have emerged. Options range from real estate crowdfunding investments into commercial properties—in which investors receive an equity share—to debt offerings for real estate professionals fixing and flipping properties.