If you are interested in building your wealth, you want to consider investing in real estate. However, in the United States, only a small percentage of people have invested in real estate outside of their primary residences. This is probably because of the huge costs of development and the long bureaucratic process of building the real estate projects. This article will guide you on the various ways you can invest in this asset class that has for years been dominated by the big companies.
One of the easiest methods of investing in real estate is through home ownership. When you buy a house, you invest in this space and you can add its equity value to your net worth. As a result, owning a home will give you a peace of mind knowing that you will not be paying any rent. At the same time, it will help you increase your wealth as the house price is likely to keep on increasing.
Another option is to develop rental properties for the residential and commercial space. In this, the model is simple. Find a good location, get approvals, find funding, build the properties, and find tenants. The challenge for this model is that it takes a lot of time and is usually expensive.
In house flipping, the idea is to buy a property, fix it, and then sell to customers at a higher price. Every year, more than 200K houses are flipped, which has attracted some leading companies like Zillow to the industry. The challenge with this is that it is often expensive and risky especially if the house fails to get a buyer.
Real Estate Investment Trusts (REITS) are another way of investing in the real estate industry. What is a REIT you may ask? A REIT is a public company that buys various real estate properties and derives income from them. Most REITs specialize on a single real estate sector like residential and telecommunication towers.
According to the US law, all REITs must invest at least 75% of all their total assets in real estate and return at least 90% of their profits to investors every year. REITs are mostly ideal for income investors, who want to benefit from the distributions from the companies. Examples of REITs are Kimco Realty, Duke Realty, and Boston Properties
Crowdfunded Real Estate
In recent years, a number of online startups have entered the real estate sector. These companies include Realty Mogul and Fundrise. As most people cannot afford to build property, these companies help tackle this cost problem. To do this, any person can go to their website, find an investment, and deposit their funds. This allows these investors to have a stake in multiple developments. However, keep in mind that these companies are relatively new, meaning that they have not been tested during a crisis.
Other than REITs, you can also invest in other companies. These are:
- Home builders like Pulte Group, Lennar, Toll Brothers, and LGI homes.
- Real estate online portals like Redfin and Zillow.
- Home building suppliers like Home Depot and Lowes.
- Real Estate technology companies like Realogic.
- Real Estate brokerages like Realogy
- Real estate services companies like CBRE and LaSalle.
If you don’t want to invest in an individual REIT, you can instead invest in REITs Exchange Traded Funds (ETFs). These are funds that hold multiple REITs. The benefit of these REITs is that they are diversified, meaning that a decline in one REIT will be offset by a rise in another one. Examples of these funds are: Vanguard Real Estate ETF (VNQ), Schwab U.S. REIT ETF (SCHH), and iShares U.S. Real Estate ETF (IYR) among others.
Why Invest in Real Estate
After understanding how you can invest in real estate, the next question is why you should do it in the first place. The following are some of the key reasons you should consider investing in the real estate industry.
- Diversification. Diversification is the process of investing in a number of assets at the same time. The goal is to hedge your risks so that if one falls, the other one will offset the decline. If you have invested in other asset classes like stocks and bonds, real estate can help you diversify your income.
- High Returns. When invested well, investment in real estate usually has high returns. This year, billionaire Ken Griffin bought a New York most expensive condo for more than $238 million. Obviously, the seller generated huge returns on their investment. Similarly, you too can generate huge returns by investing in the industry. Similarly, if you invest in REITs, you will generate huge returns.
- Peace of mind. An important of owning a home is that you will be at peace regardless of what happens in your professional life. For example, even if you lose your job or when you retire, you will always have a place to sleep. If you have invested in rental property, you will continue to have cash flow even when you retire.
- Passive Income. If you decide to build real estate, it will take you a lot of time and money. However, after you finish this, you will receive regular payments from your tenants. As such, this will be a good source of passive income.
Risks of Real Estate Investing
There are number of risks that come with the real estate investing. These are:
- Housing crashes: in the past decades, the housing market has risen and fallen. The worst came in 2008/9. When this happens, as an investor, you will lose the rental income and the equity value.
- Low liquidity: if you own physical real estate, exiting can be difficult. A good example is when rapper 50 Cent sold his mansion for $2.9 million, $8.4 million lower than the asking price. He had paid more than $4 million for the property.
- Time consuming: getting the approval and building a property can be time consuming. Instead, you can buy stocks within minutes.
- Expensive: building and managing a piece of property is usually expensive for many people.
- Uncertainties: when you build, there is usually no guarantee that the customers will come. In New York, more than 250K houses are vacant.
Like in all types of investments, real estate has its own risks such as what happened in 2008/9 crisis. The best way to go about is to diversify among different asset classes. A diversified portfolio is better than focusing on just the real estate industry in itself. For example, in your portfolio, you can allocate 25% to real estate and REITs, 25% to growth stocks like Facebook and Twilio, 25% to indices, and the remaining to income companies like P&G and Unilever.
Kasper is our expert for saving, investing and bank accounts. Kasper holds an MSc in Mathematics and worked with Mercedes-Benz and the Dutch tax authorities.