In simple terms, it can be understood as any land, building, infrastructure and other tangible assets that are usually immovable but transferable. While a traditional mortgage usually requires an equity payment of 20-25%, in some cases an equity payment of 5% is sufficient to acquire a complete property. This ability to control the asset at the time the papers are signed emboldens both real estate flippers and homeowners, who can, in turn, take out second mortgages on their homes to make down payments on additional properties. Here are five key ways investors can make money from real estate.
Owning rental properties can be a great opportunity for people with DIY and renovation skills, and who have the patience to manage tenants. However, this strategy requires considerable capital to fund upfront maintenance costs and to cover empty months. Real estate investment groups (REIGs) are ideal for people who want to own rental properties without the hassle of managing them. Investing in REIGs requires a cushion of capital and access to financing.
REIGs are like small investment funds that invest in rental properties. In a typical real estate investment group, a company buys or builds a set of flat blocks or condominiums, and then allows investors to purchase them through the company, thus joining the group. House flipping is for people with a lot of experience in real estate valuation, marketing and renovation. House flipping requires capital and the ability to make, or oversee, the necessary repairs.
This is the proverbial wild side of real estate investing. Just as day traders are different from buy-and-hold investors, real estate investors are different from buy-and-let landlords. For example, real estate flippers often seek to profitably sell the undervalued properties they buy in less than six months. If you invest in rental properties, you become a landlord, so you should consider whether you will be comfortable in that role.
As a landlord, you will be responsible for things like paying the mortgage, property taxes and insurance, maintaining the property, finding tenants and resolving any problems. A real estate investment trust (REIT) is created when a corporation (or trust) is formed to use investors' money to buy, operate and sell income-producing properties. REITs are bought and sold on major stock exchanges, just like stocks and exchange-traded funds (ETFs). To be a REIT, the entity must pay 90 per cent of its taxable profits in the form of dividends to shareholders.
In this way, REITs avoid paying corporate income tax, whereas a normal company would have to pay tax on its profits, which would reduce the profits it could distribute to its shareholders. Like dividend-paying shares, REITs are suitable for investors who want regular income, but also offer the opportunity for appreciation. REITs invest in a wide variety of properties, such as shopping centres (about a quarter of all REITs specialise in them), healthcare facilities, mortgages and office buildings. Compared to other types of real estate investments, REITs have the advantage of being very liquid.
Real estate investment groups (REIGs) are a kind of small investment fund for rental properties. If you want to own rental property but don't want the hassles of being a landlord, a real estate investment trust may be the solution for you. Real estate investment trusts invest primarily in REITs and real estate operating companies. They offer the possibility to gain diversified exposure to the real estate sector with a relatively small amount of capital.
Depending on their strategy and diversification objectives, they provide investors with a much broader choice of assets than can be achieved by buying individual REITs. Like REITs, these funds are fairly liquid. Another significant advantage for retail investors is the research and analytical information provided by the fund. This may include details on the assets purchased and management's perspective on the viability and performance of specific real estate investments and as an asset class.
More speculative investors may invest in a family of real estate investment funds, tactically overweighting particular property types or regions to maximise returns. Because it is backed by bricks and mortar, direct real estate investment also involves less principal-agent conflict, i.e. the extent to which the investor's interest depends on the integrity and competence of managers and borrowers. Even the more indirect forms of investment carry some protection.
REITs, for example, require a minimum percentage of profits (90%) to be paid out in the form of dividends. Unlike a stock or bond transaction, which can be completed in seconds, a real estate transaction can take months to close. Even with the help of a broker, simply finding the right counterparty can take several weeks of work. Of course, REITs and real estate investment trusts offer greater liquidity and market pricing.
But they come at the price of higher volatility and lower diversification benefits, as they have a much higher correlation to the general stock market than direct real estate investments. Real estate investment involves the purchase, management and sale or rental of real estate for profit. The improvement of real estate as part of a real estate investment strategy is often considered a sub-specialty of real estate investment called real estate development. A person who actively or passively invests in real estate is called a real estate entrepreneur or real estate investor.
Real estate has a low, and in some cases negative, correlation with other major asset classes, meaning that when stocks go down, real estate tends to go up. Real estate investment trusts are similar, except that they tend to be larger, deal in very large properties, such as shopping centres, and are listed on national stock exchanges like any other company. Although they tend to be safer and more profitable in the long term, long-term investors are unlikely to make a quick return on their real estate investment. Real estate has long been the investment of choice for those seeking to build long-term wealth for generations.
If you are already invested in stocks, bonds, gold and other securities, real estate offers a good way to diversify that investment portfolio and mitigate risk. By leveraging the purchase of an investment property, the periodic payments required to service the debt create an ongoing (and sometimes large) negative cash flow from the time of purchase. Real estate can be a sound investment, which has the potential to provide steady income and build wealth. And, as with any investment, there is profit and potential in real estate, whether the overall market is rising or falling.
The inflation-hedging capacity of real estate derives from the positive relationship between gross domestic product (GDP) growth and demand for real estate. To be successful, real estate investors must manage their cash flows to create sufficient positive property income to at least offset the costs of relocation. Individual properties are unique in themselves and are not directly interchangeable, which makes the valuation of investments less certain. Investment properties are often acquired from a variety of sources, including market listings, real estate agents or brokers, banks, government entities such as Fannie Mae, public auctions, sales by owners, and real estate investment trusts.
Real estate investments are also a great option once you've retired, as they help supplement Social Security payments and other retirement funds you may already have. Like many real estate investments, they are speculative and illiquid, so they are not easy to get rid of in the same way you can trade a stock. Finally, when looking at REITs, investors should distinguish between equity REITs that own buildings and mortgage REITs that provide financing for real estate and make forays into mortgage-backed securities (MBS). If you are not DIY savvy, consider investing in real estate through a REIT or crowdfunding platform rather than directly in a property.