4 ways to invest in real estate

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Interested in real estate investing? Here are some ideas on getting a foot into the market.

Investing in real estate is often touted as a way to potentially earn extra income and help build wealth over time. But there’s more than one way to do it, and when you hear people talking about investing in real estate, they could be referring to any or all of a few approaches.

The good news is that you don’t have to be a magnate to be a real estate investor. In fact, you can get into the game with as little as a dollar. Read on for 4 ways to invest in real estate—plus how to tell which of these ways might be right for you.

1. Investing in real estate by buying a home

Becoming a homeowner is one way to become a real estate investor. Homeowners often build equity in the home over time as they pay down their mortgage. Any potential increase in your home’s value after you purchase it can add to the value of your equity.

For many people, their home makes up the biggest slice of their net worth. For example, suppose you have $300,000 of equity in your home and an investment portfolio worth $200,000 (and no other assets or liabilities). In that case, real estate makes up 60% of your net worth.

Of course, becoming a homeowner is more than just an investing decision. Here are some of the considerations.

Pros of buying a home

  • Build equity. Paying a month’s rent buys a roof over your head for that period, but nothing more. Paying your mortgage also lets you build equity, or ownership value, in your home over time.
  • Potential inflation hedge. As an owner, you may benefit from any potential increases in your home’s value. Although it’s never guaranteed that real estate will rise in value over time, over long periods real estate has historically been a strong hedge against inflation.
  • Potential tax advantages. You may be able to deduct mortgage interest on your taxes (provided that you itemize your deductions). If your home rises in value while you own it, there are also tax rules that can help you keep more of those gains when you sell.
  • Security, pride, and peace of mind. The nonfinancial benefits of owning a home can be substantial. Owning where you live means you don’t have to worry about a landlord raising rent or not renewing your lease—and that you can paint the walls whatever color you want. It can mean more predictability in your housing costs, if you have a fixed-rate mortgage, and more power and control over the place you call home.

Cons of buying a home

  • High up-front cost. There’s no sugarcoating it: Buying a home can take a lot of money, and the difficulty of getting a large enough down payment together keeps many people out of the housing market.
  • High ongoing costs. High mortgage rates have made homeownership even more expensive for new buyers in recent years. Property taxes, insurance, maintenance, and repairs only add to the bill.
  • Significant commitment and responsibility. For some people, owning where they live isn’t the right lifestyle choice. If you’re unlikely to live in the same place for several years or you don’t want the headaches of repairs and maintenance, then you might decide it isn’t for you.
  • No guarantees in your home’s value. A dip in the broader real estate market or just in your local market could hurt the value of your home. If a downturn occurs when you need to sell, it’s possible you won’t recoup your original purchase price.

Is buying a home right for you?

Buying a home is not just an investing decision—it’s a budgeting and lifestyle decision too. Whether it’s right for you may depend on your finances, how long you’re planning to stay in one place, the cost of buying versus renting in your area, and other factors. Take a deeper dive into whether buying or renting is right for you.

2. Investing in real estate with REITs

Real estate investment trusts (REITs) are kind of like stocks, but for the real estate market.

They’re companies that own, operate, or finance real estate—like apartment buildings, shopping centers, offices, data centers, and more—but in many cases with shares that trade on exchanges, like stock. When you buy a stock, you become a partial owner in the underlying company. Similarly, when you buy a share of a REIT, you become a partial owner of the REIT’s underlying properties.

They offer a way to put real estate investing within reach of ordinary people.

Pros of investing in REITs

  • Low up-front cost. Buying one share of a REIT is much more achievable for many investors than buying an entire property. If you invest with a broker that offers fractional shares, then you may even be able to start with as little as $1.
  • Potential to earn ongoing income. REITs are generally set up to pay out regular dividends to their investors. Many REITs act as landlords to underlying tenants, and so pass most or all of the rent they receive on to their investors. That said, it’s important to be aware that those dividends aren’t guaranteed, and a REIT can always reduce its dividend payments.
  • Potential tax benefits. Most corporations face what’s called “double taxation,” because the company itself pays taxes on its income, and investors also pay taxes on their dividends and realized gains. REITs, however, qualify for special tax rules that most often allow them to pay no corporate income tax1 (though REIT investors still generally owe taxes on any dividends and realized gains).
  • Professional management. By investing in a REIT, you can access the potential benefits of real estate investing without the headaches of managing real estate. Choices like what properties to buy, what to do if a tenant is missing rent payments, or what to do if a property floods are in someone else’s hands.

Cons of investing in REITs

  • Requires research. Just as with buying individual stocks, if you’re going to invest in individual REITs you need to do some work to understand the REITs universe and choose specific investments.
  • Time and cost to build a diversified portfolio. While you could get started with as little as one share or $1, that doesn’t mean that you should. Instead, even just within the portion of your portfolio that you have earmarked for REITs, you’ll probably want to diversify—meaning you invest in a range of different REITs with different attributes. This increases the cost, both in dollars and in time, of building and maintaining a portfolio of REITs. And again, while a fully diversified portfolio may include some REITs, it may generally also include stocks and bonds, with diversification across many industries, sectors, and regions.
  • Subject to potential market volatility. Because REITs trade on exchanges like stocks, they can be subject to market fluctuations in the same way that stocks are.
  • Comes with unique risks. There is no guarantee that the issuer of a REIT will maintain the secondary market for its shares, and redemptions may be at a price that is more or less than the original price paid. Changes in real estate values or economic downturns can have a significant negative effect on issuers in the real estate industry.

Is investing in REITs right for you?

Investing in individual REITs might be right for you if you want to take a hands-on approach to real estate investing, but you don’t have the financial means or interest to buy investment properties. Just remember the importance of diversifying your portfolio across different types of investments, and also diversifying within the portion of your portfolio that’s dedicated to REITs.

3. Investing in real estate with mutual funds or ETFs

Another option for investing in REITs is to buy one or more mutual funds or ETFs that hold REITs. Mutual funds and ETFs are professionally managed portfolios that combine your money with that of other investors, and invest it in a basket of securities. They can offer a way to invest in a diversified, professionally managed portfolio of real estate without having to research a lot of individual REITs.

Pros of investing in real estate mutual funds and ETFs:

  • Diversification among many REITs. When you buy one share of a mutual fund or ETF, you become a partial owner of the fund or ETF’s underlying portfolio. Because most REIT funds and ETFs own dozens or even hundreds of individual REITs, these investments can provide broad diversification within the real estate sector.
  • Lighter lift on research and initial investment. Because they offer that diversification potential, you may be able to achieve your real estate investing goals by investing in just one or a few REIT funds or ETFs. That can mean less research, time commitment, and financial commitment on your end.
  • Professional management. With a mutual fund or ETF, one or more professional portfolio managers handles the work of choosing the actual underlying REITs in the portfolio, plus, in the case of actively managed funds, monitoring the portfolio and making changes as needed.

Cons of investing in real estate mutual funds and ETFs:

  • Still requires research. While it may take less research than choosing individual REITs one by one, you’ll still need to do some work to understand the universe of REIT mutual funds and ETFs, and to choose what funds or ETFs to invest in.
  • Ongoing expenses. Mutual funds and ETFs can’t offer that professional management for free. Rather, they typically charge an expense ratio, which comes out of your investment. These can vary widely, so make sure to research expenses and costs closely if you decide to go this route.
  • Depends on fund management team. As with buying individual REITs, with funds and ETFs a lot of the control is out of your hands. You can decide what fund or ETF to invest in, but you can’t control the exact decisions they make with your money while you’re invested.

Is investing in real estate mutual funds or ETFs right for you?

REIT mutual funds and ETFs might be right for you if you’re just getting started in the world of real estate investing. They can let you invest in a professionally managed portfolio and help you start to build your investing research skills.

4. Investing in real estate by becoming a landlord

Becoming a landlord means buying a property and renting it out to tenants. It’s what first comes to mind for many people when they hear “real estate investing,” though it can potentially be more work to break into than the options mentioned above.

As with buying a home, becoming a landlord is an investing decision but also a lifestyle decision. So in addition to thinking about whether it’s the right fit for your finances, you need to consider whether it’s the right fit for your personality.

Pros of becoming a landlord:

  • Build equity. As with owning the home you live in, owning a property that you rent out offers you the ability to build equity over time as you receive rental income and put it toward paying down the mortgage. And similarly, any increases in the property’s value may add to your equity.
  • Potential inflation hedge. Owning an investment property also provides this same possible inflation-hedging benefit as owning your own home.
  • Unique potential tax advantages. While the rental income landlords collect is generally taxable as ordinary income, there are tax deductions for a wide range of items—possibly including mortgage interest, property taxes, repairs, and depreciation, that can help reduce the tax bill.
  • Long-term potential for cash flow. If rents go up over time, they’ll be more likely to fully cover your costs and eventually even create an additional stream of income.

Cons of becoming a landlord:

  • High initial cost. Just as with buying a home to live in, you’ll need to build up enough funds for a competitive down payment, plus show that your finances are strong enough to get approved for a mortgage.
  • Lack of access to your cash. If something changed in your finances and you needed to free up cash, it might be hard to tap into the money that you have invested in your properties.
  • High initial and ongoing effort. While rental income is sometimes referred to as “passive income,” there’s nothing passive about becoming a landlord. In addition to the work of finding, buying, and maintaining your property, there’s the work of finding and vetting tenants, managing your relationship with them, and making sure you’re abiding by any applicable laws and regulations.

Is becoming a landlord right for you?

Buying just one property takes a lot of cash. If you’re considering this route, it’s important not to neglect key areas of your financial life, like your emergency savings and retirement savings. Becoming a landlord might be the right choice for you if you are on strong financial ground, you understand and are able to take on the risks involved, and you have the necessary interest, temperament, and free time required to successfully manage all the ongoing commitments and relationships involved in being a landlord.

Is real estate investing right for you?

Real estate investing can be rewarding, but in the end it’s just one way to get into the investing game. As mentioned above, keep in mind that most investors would be well served by a broad mix of different investment types spread across different sectors and industries. For many people, it makes sense for real estate to be part of that plan, but only one part.

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