Investing in a rental property means you buy a residential building or unit and rent it out to tenants. This would make you the landlord of the property, which comes with a ton of responsibilities. You’d be responsible for the upkeep, paying the mortgage, property taxes, repairs, finding tenants, and insurance — just to name a few. You could also hire a property manager to handle the day-to-day tasks, but that would be an added expense to consider.
As a landlord, you’d make money from the rent you collect from your tenants and from price appreciation if you sell the property for more than you paid for it.
- Can benefit from tax write-offs
- You gain monthly supplemental income from tenants
- Rising values on the market may also increase the value of your investment
- You could live on the property while renting out rooms or other units
- Money you earn from tenants can be used to pay down your mortgage
- You may have to deal with problematic tenants
- You’ll need to fill vacancies quickly, so they don’t negatively affect your income
- You won’t be able to instantly sell your property if you need quick cash
- You’re responsible for maintenance and repairs
- You’re responsible for paying the bills, such as the mortgage, taxes, insurance, and possibly utilities
If you are an HGTV fanatic, then the term “house flipping” will probably sound familiar to you. Flipping a house is when you buy a house to renovate and then resell it for a profit, or you buy a house, hold it, and then sell it at a profit. While it might look easy on TV, house flipping is often considered the riskiest form of real estate investing but also the most lucrative.
With house flipping, you run the risk of not being able to sell the property at a price that will turn you a worthwhile profit on your investment. In addition, things like budget increases and renovation mistakes can eat into your finances. It’s a good idea to enlist the help of seasoned professionals such as contractors, interior designers, and attorneys, but these will also cost you money to employ.
- Can be very profitable if done right
- Since these are often short-term projects that don’t require you to manage a property, you may see a fairly quick return
- Can take advantage of 1031 tax-free exchanges
- Selling could be difficult, and you’ll be on the hook for the mortgage if you can’t get tenants or buyers
- You’ll need to really know the market, or else you risk losing money
- Could be difficult to keep renovation costs low
- You’re responsible for renovations or hiring a team to do it
Real Estate Investment Trusts
Real estate investment trusts, or REITs, are companies that own and typically operate various real estate properties. Properties can include things like hospitals, office buildings, malls, hotels, apartment buildings, and even mortgages or loans. Investors purchase shares in real estate portfolios and contribute money to a pool, and professional managers decide how to invest it. If you don’t want to deal with the responsibilities of managing a property, investing in REITs might be the move for you.
One of the biggest appeals about REITs is that they’re required to pay out 90% of their profits to investors in the form of dividends each year. REITs are also fairly easy to invest in, and compared to other real estate investments, REITs are objectively affordable. You can typically expect to pay a minimum of $1,000 to $2,500 to invest, but sometimes it could be even less. One leading downside to keep in mind is that REITs are vulnerable to downturns in the market. So, if the market crashes, you could lose a good amount of money.
- Have the benefit of being highly liquid since they trade on the stock exchange
- Don’t have to deal with managing a rental property
- Offer high dividend payments
- You can often avoid paying corporate income tax
- May offer the opportunity for appreciation
- Offer portfolio diversification across many properties or across real estate sectors
- Easy to invest in and depending on the stock, it takes little money to get started
- Subject to market risk and stock fluctuations
- You’re taxed on dividend earnings
- Potential for high management and transaction fees
- Can maintain a lot of debt
- You’ll need to spend time researching and evaluating individual REITs to find the best one for you
Real Estate Investment Groups
Similar to REITs, a real estate investment group (REIG) is a company that buys or builds a set of properties and then sells off parts of that property to investors. REIGs often purchase apartment buildings, and investors buy one or multiple units within the building. The nice thing is investors don’t have to worry about managing the units, dealing with maintenance, or finding tenants; that responsibility falls solely on the company that operates the investment group. In exchange for this management, the company takes a percentage of the monthly rent.
- Easier to invest because resources are pooled
- Much of the work of investing in real estate can be spread out amongst members
- Don’t have to manage the properties
- Some groups provide learning and networking opportunities, such as guest speakers and conferences
- Some REIGs charge very high fees to join
- Disagreements among group members can hinder the success of the investment
- Will require you to do some digging in order to find a reputable group (some groups may engage in fraudulent activity)
Real Estate Limited Partnerships
Real estate limited partnerships (RELP) function similarly to REIGs. They provide investors with a diverse portfolio of real estate investments to buy, lease, develop, and sell. A general partner, usually an experienced property manager or real estate development firm, recruits investors to be limited partners in exchange for a share of ownership. Partners are considered “limited” because RELPs only exist for a finite amount of time, typically 7 to 12 years. RELPs are a private investment, meaning they aren’t traded on public stock exchanges like REITs.
- Partners may receive periodic distributions from income generated by the properties
- Can be very profitable when properties sell
- Don’t have to manage the properties
- Investment minimums can be very high; most minimums are $2,000 or above, and sometimes much more
- Will require trust and reliance on the general partner who manages the property
- Subject to income tax
Real Estate Mutual Funds
Real estate mutual funds are yet another way to diversify your portfolio and invest in a basket of real estate assets. Arguably the simplest way to invest in real estate, mutual funds take the guesswork out of deciding what to invest in. A professional portfolio manager will choose the best real estate investments for you using expert research. Real estate mutual funds invest primarily in REITs, which, depending on strategy and goals, typically provide investors with a much larger asset selection than can be achieved through buying individual REITs.
- Funds are pretty liquid
- Opportunity to diversify your exposure to real estate with a relatively small amount of money
- Don’t have to manage your portfolio or do much research
- There are expense ratios, which are ongoing fees you’ll need to pay to own the mutual fund
- Rising interest rates can affect the returns of mutual funds
- You’ll have no say in what companies are invested in or how they are run
- There are no tax benefits