Real estate investing has become synonymous with today’s most prolific wealth-building strategies. In fact, the start of 2022 is making a strong argument that real estate belongs in almost every investor’s portfolio.
Over the first quarter of this year, the S&P 500 (which is largely regarded as one of the best ways to increase wealth over time) declined approximately 263 points, or about 5.8%. Following the first quarter, the leading stock market index has done nothing but drop in the wake of rising inflation and fears of a recession.
On the other hand, real estate investments have weathered the storm well. According to the National Council of Real Estate Investment Fiduciaries (NCREIF), private commercial real estate properties held for investment purposes returned an average of 5.3% to investors in the first quarter.
Residential real estate investors fared even better than their commercial counterparts. Research presented in ATTOM Data Solutions’ first-quarter 2022 U.S. Home Flipping Report suggests residential real estate investors made an average gross flipping profit of 25.8% in the first quarter.
The start of 2022 is a small sample size, but real estate investing has performed better than most other asset classes. It isn’t too late to start investing in real estate; far from it, in fact. 2022 appears to be full of opportunities for investors; they need to know where and how to put their capital to work. Reference this guide to learn how to get into real estate investing for beginners.
What Is Real Estate Investing?
Real estate investing is exactly what its name implies: the act of investing time and resources into assets held within the real estate sector in return for the chance to capitalize on future profits. Contrary to what many believe, however, real estate investing isn’t relegated to physical buildings alone; that’s an important distinction. In reality, there are countless ways to invest in real estate.
While most people associate property investing with flipping or renting homes, any strategy which uses real estate assets to increase profits, cash flow, revenue, income, and any other source of capital may be considered real estate investing. From real estate investment trusts (REITs) and tax liens to buying rental properties and flipping single-family homes, real estate investing is a diverse and attractive means to a single end: generating wealth.
Why Start Investing in Real Estate?
Real estate investing is a strategy that has proven it belongs in the pantheon of today’s best wealth-building vehicles. At this point in the year, few investment strategies (if any) have been able to help investors realize better returns than assets associated with the real estate sector. That said, there are a lot more benefits to real estate investing than profits. There are many reasons someone should consider investing in real estate, not the least of which include:
- Monthly Cash Flow
- Portfolio Diversification
- Inflation Hedging
- Long-Term Appreciation
- Saving on Taxes
Monthly Cash Flow
Monthly cash flow represents the flow of capital from one entity to another. As its name suggests, cash flow may either flow into or out of a company. Negative cash flow, for example, suggests a company is spending more than it makes. Positive cash flow refers to the net capital and cash equivalents received from an asset after expenditures are accounted for.
As it turns out, real estate investing can be a great source of monthly cash flow. Rental properties, in particular, can generate dependable monthly income through cash flow. Real estate investors may secure an investment property with a traditional loan from a bank and rent the home out for more than the monthly mortgage. In doing so, diligent investors may be able to pay down the recently acquired mortgage with someone else’s money. Capital left over after paying the mortgage and any additional expenses that may arise will turn into monthly cash flow.
Suppose real estate investors don’t want to become a landlord or even own physical property. In that case, they may generate monthly cash flow in the form of dividends by investing in real estate investment trusts. Any business trading on Wall Street classified as a real estate investment trust is required by law to pay out at least 90% of their taxable income to shareholders as dividends. Any investor who holds on to an REIT through the ex-dividend (reinvestment) date will receive a percentage of the REIT’s valuation in the form of income.
While all REITs are required to provide a dividend, not all pay them out monthly. A select few REITs will pay shareholders each month, but many distribute dividends quarterly or twice a year. The amount distributed will also vary from company to company, so be sure to evaluate dividend yields relative to the REIT’s performance before investing. The best real estate investments will have a sustainable yield with a long runway for growth and compounding.
Regardless of where it comes from, monthly cash flow can serve as a great source of income. Wise investors may reinvest cash flow into their portfolios to boost income and compound returns over time.
In its simplest form, diversification is a strategy implemented by most investors to mitigate risk. If for nothing else, diversifying one’s assets increases a portfolio’s resilience and limits downside. A well-diversified portfolio is less susceptible to significant and immediate losses because a wide variety of assets can serve as a hedge against volatility. The more unique assets one holds, the less their portfolio is at risk of declining from a single event.
If, for example, a portfolio is made up entirely of property investments, a downturn in the housing sector or the recurrence of a similar mortgage crisis like we saw in 2008 could erase the entire portfolio’s gains. Not unlike “keeping all your eggs in one basket,” a lack of diversification can weigh down all of the assets being held by the investor.
Instead of dedicating an entire investment portfolio’s allocation to a single asset or industry, investors should diversify their holdings amongst many different assets, including real estate. Again, real estate shouldn’t be the sole asset held in a portfolio, but rather a compliment to other assets which are more inclined to act as a hedge against volatility.
Fortunately, diversifying a portfolio with real estate assets isn’t all that difficult. Investors may choose to invest in a physical property by buying a rental home or flipping a house. For even more diversification, investors may open a new position in a real estate investment trust or similar exchange-traded fund (ETF). Doing so may award investors the opportunity to tap into several industries unrelated to real estate and reduce the portfolio’s exposure to risk. Through REITs, investors may diversify their portfolios with everything from timberland to data centers, and everything in between.
Diversification means something different to every investor, but it’s widely believed that a diversified portfolio is safer to own than a non-diversified portfolio. As a result, investors will need to weigh their risk/reward tolerance and build their own portfolios accordingly.
The most underrated reason aspiring investors should consider investing in real estate is the ability to use leverage. More commonly referred to as borrowing money or taking out a loan, using leverage grants cash-strapped investors the ability to acquire assets they can’t afford to pay for in full. It is worth pointing out that leverage is unique to purchasing physical real estate. Whereas stock market investors must pay the full value of the equity at the time an order is placed, those who buy real estate may acquire a loan to cover the purchase price.
At first glance, the ability to use leverage doesn’t appear to be anything special, but its benefits are greatly underestimated. Not only does leverage allow investors to purchase high-value assets, but it greatly reduces the barrier to entry. With leverage, anyone who qualifies for a loan can secure a deal. Seasoned investors may even use leverage to acquire multiple properties at the same time, greatly increasing the potential for profits over shorter periods.
In addition to giving everyone the power to invest in property, leverage also increases liquidity. Without the need to tap into their own savings, investors may retain access to their own capital. Whether they save it for a rainy day, invest it in something else, or use it to increase their debt-to-income ratio, remaining liquid is always in an investor’s best interest.
Real estate looks particularly attractive heading into the second half of 2022. Real estate becomes more of a hedge as the Federal Reserve increases interest rates to combat the inflation onset by the pandemic and years of government stimuli. While the cost of acquiring physical real estate is near an all-time high, those who already own property are already reaping the rewards. If for nothing else, homes tend to increase in value as inflation rises.
Homes cost more to build in an inflationary economy. To offset higher costs, homebuilders will sell their products for more, inevitably driving up the prices on existing homes. A rising tide lifts all boats; or, in this case, rising inflation increases all home values.
Current owners with fixed-rate mortgages will enjoy paying the same amount each month for an appreciating asset. On the other hand, landlords will be able to raise rental prices as demand for rental units inevitably increases. When home prices rise, those who get priced out of the market are forced to become renters and contribute to higher rates of competition. With more renters competing over units, landlords may increase their prices.
One of the more obvious reasons to start investing in real estate is the ability to realize long-term appreciation. That’s not to say a house is guaranteed to appreciate in value, but rather that history has taught us that homes increase in value more often than not. Over the last 10 years, dating back to the bottom of The Great Recession, the median home value in the United States has appreciated about 110.7%.
More recently, supply and demand constraints brought about by the pandemic have increased home values at a more rapid pace. Since the pandemic began, the median home value in the United States has increased somewhere in the neighborhood of 38.2%.
Despite 10 consecutive years of appreciation, national home values look like they still have room to run. The economic indicators that have resulted in historic appreciation over the last decade are still in play. Most notably, there isn’t enough inventory to keep up with demand, which props up prices.
Moving forward, prices should continue to rise on the heels of supply and demand. As long as there are so few weeks of available inventory and pent-up demand, prices should continue to rise. As a result, investors who get in now, even at these high prices, may have a chance to benefit from appreciation.
Saving on Taxes
Real estate is one of the best tax shelters in the investing world. Depending on the particular investment, qualifying investors may be able to significantly reduce their taxable income in a given year. Real estate investors may make deductions unique to their field thanks to the Internal Revenue Service. That said, nobody will make the deductions on an investor’s behalf; they need to know what they can and can’t do if they want to take advantage of them. Consequently, investors will want to consult a tax professional to determine which tax benefits they qualify for.
Some of the most popular tax benefits include, but are not limited to:
- Capital Losses
- 1031 Exchanges
While these tax benefits (and many more just like them) may not directly put more money into the pockets of real estate investors, they do allow them to save an incredible amount of capital at tax time. In reducing their taxable income, real estate investors may simultaneously increase their liquidity and perhaps even build a cash position to invest in more assets at a later date.
What Are the Types of Investment Real Estate?
Real estate is the largest asset class and biggest store of wealth in the world. As recently as 2020, Savills (one of the world’s leading property advisors) suggested the global real estate market cap was $326.5 trillion, a 5% increase over 2019 and a new record. In fact, the global real estate market is more valuable than all of the world’s equities and debt securities combined.
The sheer size and volume of the real estate market is hard to wrap your head around. Yet, for as big as the real estate market is, almost all of its assets can be broken down into four primary types of real estate. There are exceptions, of course, but most of today’s real estate assets will fit under one of the following categories:
Residential Real Estate: As its name suggests, residential real estate is a term reserved for real property (the land and any building occupying the space) intended for residential purposes.
Commercial Real Estate: Any buildings and the land they occupy which are zoned for business use are considered commercial real estate.
Industrial Real Estate: Real property designated for manufacturing, production, research and development, storage, and distribution facilities is considered industrial.
Raw Land: While it may not contain any buildings, raw land is undeveloped land and belongs in its own real estate category.
New real estate investors will need to learn the differences between each asset type before making an investment of their own. Different rules apply to each, so be sure to familiarize yourself with the asset class you are most interested in before making a move.
Before You Start Real Estate Investing
An investment in property can be as simple or as complex as you want it to be. Whether you are investing in real property or REITs, there’s an exit strategy for anyone at any skill level. That said, future investors are not advised to simply jump into the real estate market without being prepared.
You could argue that the best way to start investing is to simply begin, but new investors would be doing themselves a disservice if they didn’t put in a little work ahead of time. In particular, there are a few things new investors should ask themselves before they buy their first real estate asset:
- What do you want out of real estate investing?
- Are you ready to be a landlord?
- How much debt do you have currently?
- What leverage do you intend to use?
Why Do You Want to Invest in Real Estate?
Knowing why you want to invest in real estate is just as important as the act of investing in real estate, if not more so. Your “why,” as it is often referred to, is essentially the motivation that will help you set goals and help you navigate through tough times. Without a goal or reason for investing, it is impossible to gauge any rate of success; nor is it possible to formulate a well-crafted plan.
Are You Ready to Be a Landlord?
Anyone looking to break into the long-term rental industry needs to first ask themselves whether or not they are ok with being a landlord. While the prospects of owning a rental property are enticing, being a landlord can take a lot of time and hard work. Even those with a single property will be expected to cater to the tenant’s every need, whether it’s late night phone calls or expensive appliance replacements. Of course, hiring a third-party property manager is always possible. Enlisting the services of a qualified property manager will cost a portion of the rents collected, essentially reducing cash flow, but the investment may be worthwhile. A property manager can take care of all the work and free up investor’s time to acquire more deals and grow a portfolio.
Pay Down Personal Debt
While it is by no means a requirement to be debt free when becoming a real estate investor, it is a good idea to pay down any high-interest debt. Personal debt, like credit cards, can weigh down an investor’s debt-to-income ratio and make it more difficult to qualify for a traditional loan. As a result, securing capital to buy a property becomes either more difficult or more expensive (or both). A favorable debt-to-income ratio, on the other hand, is more likely to serve as an asset when leveraging money.
Secure a Down Payment
Anyone who wants to buy real estate will most likely need to leverage someone else’s money. Access to capital is pivotal in succeeding in the real estate industry, whether through a hard money lender or a traditional loan. Without a loan or access to hard money, investors won’t be able to get the real estate assets they desire. That said, investors will need to know where the money is coming from before they even secure their first deal.
3 Best Ways to Get Started in Real Estate Investing
Investing in real estate can be a scary undertaking for those on the outside looking in. After all, a single real estate transaction consists of numerous obstacles to overcome with a lot on the line. Fortunately, not all exit strategies are created equal; some are inherently easier to execute than others. While investors may dive headfirst into complex scenarios, new or unseasoned investors may choose an easier way to get started.
There are many ways to start investing in real estate, but some of the easier ways include:
- Rent Out a Room You Own
- Invest in REITs (Real Estate Investment Trusts)
- Invest in Rental Properties
Rent Out a Room
As simple as it may sound, renting out a single room in an existing home is a rudimentary form of real estate investing. Not unlike leasing an entire property, homeowners may capitalize on cash flow collected from tenants. Tax incentives will differ from their detached counterparts, but the positive cash flow can help offset a large portion of the existing mortgage. With the average rent for a single bedroom in the United States resting somewhere around $1,169, renting out a room in a home could prove lucrative and serve as a great introduction to the world of real estate investing.
Invest in REITs
Real estate investment trusts are public companies traded on Wall Street that own, finance, or operate income-producing real estate assets. As a result, stock market investors may essentially become real estate investors by purchasing shares of an REIT. While owning shares of a REIT may not give investors a tangible real estate asset, it does allow them to own a piece of a company that generates profits from several different types of real estate. Investing in REITs will allow investors to diversify amongst office buildings, malls, apartment complexes, hotels, self-storage facilities, warehouses, and almost any other type of income generating real estate. Perhaps even more importantly, total annual returns from REITs have outpaced the S&P 500 for the better part of the last 30 years. From 1972 to 2019, REITs provided investors with a total annual return of 13.3%. The S&P 500, however, gave investors a slightly more modest 12.1% over the same period of time.
Real estate investment trusts are a great way to start investing in real estate because there is a low barrier to entry. Investors only need access to a brokerage and they’ll be able to purchase shares of any publicly traded REIT. That’s not to say there aren’t nuances in choosing the right REITs, but rather that these equities are a lot easier to get into than physical real estate.
Invest in Rental Properties
Investing in rental properties may not seem like the easiest way to get into real estate investing, but there are strategies that tilt the odds in investors’ favor. In particular, new investors should consider buying a multifamily property. While buying a property with multiple units may sound complicated, it can actually improve profit margins and reduce risk when done correctly.
If, for example, new investors choose to buy a single-family home, their entire income is dependent on a single tenant. The instant the tenant misses a payment, 100% of the expected cash flow will be gone and the investor will have to pay the mortgage out of their own pocket. In other words, the investor’s exposure to risk is increased when their income is dependent on a single tenant.
Those who can secure a multifamily property can reduce the risk of delinquency with each additional tenant. If one tenant out of three units misses a payment, it’s entirely possible to cover the mortgage with the cash generated from the other two units. As an added bonus, real estate investors may also generate multiple sources of income from a single property.
Expert Tips for Getting Started in Real Estate
Understanding how to invest in real estate doesn’t require reinventing the wheel. Instead, new real estate investors should take out of the book of their most successful predecessors. There are plenty of successful investors who are willing to share their experience, and their advice is invaluable.
There are countless tips for getting started in real estate, and a lot of them are great for new investors to listen to. However, some tips are inherently more valuable than others. Therefore, those looking for the best place to start should reference the following:
- Find the Right Location
- Make Accurate Calculations
- Consider a Property Manager
Find the Right Location
The golden rule of real estate still applies: Location, location, location. Nothing is more important to a real estate investment than its location. The physical location of a property will ultimately determine the level of demand and returns it generates. That’s why they say, ”It’s always better to have the worst house on a nice street than a nice house on a bad street.” If for nothing else, it is possible to change almost any aspect of a property. The location, on the other hand, is literally and figuratively set in stone.
Make Accurate Calculations
Real estate is a numbers game. Every potential investment must be preceded with due diligence and an accurate calculation. Otherwise known as “running the numbers,” calculating a potential real estate deal will reveal everything there is to know about a property, not the least of which will determine if the deal is worth pursuing. An accurate calculation can tell investors where money is best spent, and perhaps when it should be held onto. Additionally, accurate calculations will ultimately determine the direction of a project; they will tell investors everything from which house to invest in to which materials to use on the rehab. The original calculations will serve as the foundation for an entire project and whether or not it is worth investing in.
Consider a Property Manager
Rental property investors are strongly advised to hire a property manager. While the cost of doing so will run investors upwards of 12% of the rent collected, the fee should be viewed as more of an investment. By paying a property manager to take care of everything from finding renters to addressing issues with the property, investors can save a lot of time and anguish. However, the real benefit of hiring a property manager compounds with the addition of each asset. Free from having to manage the properties themselves, renters can use the time they save with a property manager to add more assets to their portfolio. Each home will require more money to go to the manager, but the income is almost entirely passive. Investors can continue adding real estate assets to their portfolios without taking any more of their time.
Real estate investing is a proven strategy that belongs in almost every portfolio. However, the industry can be intimidating for those with little to no experience; it can scare away plenty of aspiring investors with the potential to succeed before they even get their start. Thankfully, the diversity of the real estate industry also grants new entrepreneurs a variety of ways to get started, some of which are inherently easier than others. New investors are free to take on any challenge they want, but the best part about real estate investing is that anyone can do it. An investment in real estate is an investment in the future, and there is no better time to start than now.
This guest post has been contributed by our friends at FortuneBuilders.