About the author:G. Brian Davis is a real estate investor who has owned dozens of investment properties over the last 15 years. He’s also the co-founder of SparkRental.com, an online resource which provides free landlord education and video series for anyone looking to build passive income from rentals.
Interested in learning how to invest in real estate, but not sure where to begin?
At first glance, new investors tend to notice only one or two obvious options for getting started in real estate: flipping houses, or buying long-term rentals. While these are the best-known real estate investment strategies, they’re far from the only two.
In fact, over the past few years, new forms of real estate investing have continued to grow in number and popularity. But before we get into the nuts and bolts of the many real estate investing niches, why should you invest in real estate at all?
Why real estate investing?
The simplest reason to invest in real estate: diversification.
If you own stocks or mutual funds, you know how volatile they can be. And because volatility signifies risk, investors are wise to spread their money across many sectors and asset classes.
But the advantages don’t end there.
Real estate comes with tax benefits: not only can investors write off every real expense (including financing costs), they can also deduct many “paper” expenses like depreciation.
If you invest in long-term rental properties, you not only get to collect passive income from monthly rent, but also benefit from appreciation over time, which pads your net worth. Another benefit is that landlords can raise rents to keep pace with inflation, even as their mortgage payments stay the same. That means their cash flow grows larger over time.
In the case of house flipping, investors benefit from a high “velocity of money” which means that the turnaround on their returns is fast (usually under a year). This way, they can keep reinvesting the same money into new houses and earning additional profit each time.
Real estate investors also benefit from leverage: the ability to build their own portfolio of assets using other people’s money. And while equity investors can buy stocks on margin, they certainly can’t borrow 80-90% of the cost like real estate investors can.
Using a hard money loan or other investment property financing, real estate investors can borrow up to 90% of the cost to buy a property, 100% of the renovation costs, and then turn around and sell it to literally double or triple the initial 10% cash they put up for the deal. Similarly, savvy investors use leverage to fund multiple house flipping projects simultaneously, since most of their costs are covered by the lender.
Starting to see the appeal of investing in real estate?
Real estate investment strategies depend on your goals
Are you looking for the relatively quick payday of a flip? The ongoing income of a rental property? Or perhaps you don’t want to be involved at all in the day-to-day real estate investing operations, and simply want to put up money as a passive investor?
Before you invest a cent, you should write out your goals, and then write out a real estate investing strategy based on them.
Real estate investing strategies fall into two broad umbrellas: active investing and passive investing. Within each, there are several real estate investing niches.
Active investing involves launching a real estate investing business. That means filing a real estate LLC, opening a business bank account, avoiding commingling of funds, etc. Even if you skip the LLC, you will still need to operate like a business, which includes putting in many hours on your nights and weekends, or making property investing your full-time job.
With that said, you can also make plenty of money through passive real estate investing.
Learning how to invest in real estate is itself an enormous undertaking. There’s a steep learning curve and a range of new skills to master, and the high barriers to entry contribute to the high potential returns.
Fortunately, new investors have plenty of options for free and inexpensive real estate education. Start with these Top 10 Real Estate Investing Podcasts, or if you’d rather read than listen, these are some of the best books on real estate investing.
Active real estate investing options
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.
Common perks include low management fees and the minimal involvement required from investors.
LendingHome is one such online crowdfunding platform. By way of example, LendingHome accepts passive investments from individual investors, and then uses the funds to finance active real estate flips. In our case, the minimum investment is $5,000, far less than the minimum cash required to buy a rental property or flip a house directly.
Other crowdfunding websites specialize in commercial real estate, or industrial real estate, or land, etc. Some require high minimum investments, and many (including LendingHome) are open only to accredited investors due to regulation. Remember: with debt offerings, investors do not actually own any property, although their investment is backed by real estate.
Each crowdfunding service is unique, so make sure you do your homework before investing. Part of that homework includes evaluating risk: what kind of default rates does a particular crowdfunding service see? What protections are in place for investors? What is the company’s track record of success?
Ultimately, do the returns justify the risk of default?
Who crowdfunding is for: Investors who want to lend money secured by real estate, but who don’t want to invest in real estate themselves. Crowdfunding is a viable way to invest in real estate online – or rather, to invest in debt secured by real estate.
Private equity funds
Have a lot of money to invest in real estate, but don’t want to invest actively?
One option is to invest in a private equity fund that specializes in real estate investments.
Wealthier investors can pool their money in a private equity fund, to invest in large scale projects. These funds are managed by an individual or a management group – who collects a fee for their services – to whom the individual investors typically delegate the day-to-day operations and oversight of the investments.
In general, only institutional and accredited investors are permitted to invest in private equity funds by law.
Who private equity funds are for: Wealthy, accredited investors who want to invest in large-scale, sophisticated real estate investment projects with other wealthy investors.
One real estate investing niche for private equity funds is to invest in Qualified Opportunity Zones.
Effectively, these opportunity funds are private equity funds that operate in designated low-income communities, and in return receive special tax incentives. They typically buy and improve real estate in these low-income areas, with the goal of revitalizing them.
Opportunity funds can be extremely profitable, but again, they represent a very specific real estate niche, and are generally only available to accredited investors.
Who opportunity funds are for: Accredited investors looking to take advantage of tax incentives.
Have a friend who knows how to invest in real estate with a golden touch? You could always lend them money directly.
Known as private notes, these loans offer few protections for investors. Read: high risk. Which is precisely why they tend to offer exceptional returns.
If you personally know a real estate investor with an outstanding track record of success, lending them money can be a quick, simple way to indirectly invest in real estate. While you’re at it, use the loan as an excuse to ask them to share their real estate investment strategies, and to learn real estate investing from them.
It’s hard to say no to someone who has lent you money!
Who private notes are for: Investors who have deep confidence in a specific real estate investor and are willing to accept higher risk for higher returns. And anyone looking to learn how to invest in real estate from a mentor in the bargain.
Your evolution and deciding how to invest in real estate
There are many ways to invest in real estate, but is one better than the other?
As you get more into real estate investing, your investing strategies will grow and evolve. You might start out wholesaling, or investing money through private notes with an experienced real estate investor. When you’ve saved enough money to cover the cost of your first flip, perhaps you go out and borrow a bridge loan to finance your first property to flip for yourself. Upon selling it and earning tidy profit, you can then turn around and invest it again, perhaps in a rental property this time, or in financing a larger flip!
The good news is that there is a real estate investing strategy for everyone. The clearer you are on your goals and which investment umbrella you fall under (active vs. passive), the clearer you’ll be on the right real estate investing strategies for you.
Start with a strategy that fits you today, and as you grow and evolve as an investor, tomorrow will bring new and different opportunities.
Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. Please consult your tax advisor. All calculations and information shown here are for illustrative purposes only. All third parties listed above are for demonstration purposes only and are not affiliated with LendingHome. All views and opinions expressed in this post belong to the individuals referenced. NMLS ID: 1125207 Terms, Privacy & Disclosures. Copyright LendingHome Corporation 2019.