You’ve probably heard of real estate investments and some success stories of people that have built their wealth through this investment vehicle. But did you know there are multiple real estate investment types? Read on to learn what they are and which might be best for you.
Oscar and German Buendia of REI Brothers left us with an interesting idea in our latest episode. They said that generational wealth comes from the returns of investments like real estate, rather than just stocks and bonds. But just saying “I want to invest in real estate” will get you nowhere. Let’s start with some basics.
Most real estate investment types will fall into two main categories: the traditional, physical real estate and the passive, non-physical property type. When starting your real estate journey, you will want to give some thought to which entry point you are most comfortable with. Do you want to be hands-on and even managing? Or do you want to passively invest by not being super involved with the actual physical, real estate industry?
Physical Real Estate Investment Types
This is what most people think of when they hear about real estate investing. This is also what the TV shows highlight. Taking this route can offer high returns, but it will require having more cash up-front than your passive real estate investment types.
Another thing to consider: serious real estate investors will often form a protective entity to hold their properties, rather than holding them all under their name. Doing this will allow you to separate (and thus protect) your assets. Common business entities for real estate investing are an LLC (Limited Liability Company) or an LP (Limited Partnership).
Thanks to channels like HGTV, flipping houses has become all the rage. With the magic of TV, flippers buy a run-down property, completely redesign it, and crank out a brand new, beautiful property to resell for a profit of $100,000 all in an hour! This type of quick ROI (return on investment) is what appeals to house flippers. In less than a year, people can, on average, bring in a profit of $62,700. This is about a 40% return.
House flipping is some of the most commonly known forms of real estate investing, and it’s one that typically requires a significant up-front cash investment. You need cash for the property purchase, cash for the rehabilitation, and cash for the labor, if you’re not wanting to do it yourself. Now, if you do choose to do it yourself, there’s the added cost of time, labor, and energy.
While the quick cash is certainly an appeal, you need to decide if the high risk and investment of energy is worth it for you. Also consider your level of experience. This form of real estate investing is for people that know the market and have access to a fixer-upper crew or are avid DIYers.
Wholesaling Real Estate
This is one of the entry path one of the brothers of REI Brothers took when starting his real estate journey. As a real estate wholesaler, you acquire a contract from the seller of a property to then sell that contract to a different buyer, at a higher price. Your profit is the difference between your purchase price of the contract and the point at which you sell. Compared to flipping, this real estate investment type does not require a lot of upfront capital because you’re not actually purchasing the property. You are holding the purchase contract and then selling it to an actual buyer. In other words, you are the middleperson.
Sounds easy? Not exactly. There is also some work required, as is the case with all physical real estate investment types. First, you need to find a good deal, but the extra leg of work happens in finding the right buyer—who will also pay more than you purchased it for! The potential risk? You can’t find a buyer and end up with a property purchase contract you didn’t even want.
Short Term Vacation Rentals
We’re talking AirBnB here, for example. You can either rent your own home during certain portions of the year, or you can be like The Young Retiree by 33 and purchase a property to use as a full-time rental property. The initial appeal? You can charge on a per-night basis. The risk? Depending on location and season, your occupancy rate might be low.
There’s a lot of research that needs to go into this. Research the area and what the potential appeal of vacationing in your location is. What are the draws? More importantly, who is your ideal guest? Understanding your ideal guest will allow you to set up your short-term rental property in a way that will effectively draw in guests. And don’t forget about the costs associated with maintaining the property and keeping it going, especially when you might not be able to physically access the property.
If any of the prior options were a little overwhelming, let’s look at turnkey properties as a real estate investment type. They are called turnkey because, essentially, the property is pretty dang close to having someone just “turn the keys” on it and live in it. These properties either have someone already renting or are in very great, ready-to-move-in conditions. This means: less stress, less energy, less time from you.
The con? You should expect to pay more, since these won’t be properties that are run-down. You can look at companies like RoofStock for these types of deals.
Long Term Holds
The first three options can fall into the short term hold area. The following three real estate investment types fall into long term hold approaches.
This DOESN’T mean you’re buying property where it’s cold!
B— buy; get a great deal by looking for a property you can add value to
R— renovate; start fixing that property
R— rent; rent the property once you finish fixing it and start bringing in cash flow
R— refinance; this process is the replacement of an existing loan with a new loan covering what’s owed in the first loan. This second loan should have better terms, which is easier to obtain once the property is rented and not vacant.
R— repeat; after you go through the refinancing, you take the money back out and use it to invest in other properties. You repeat the process!
This is long term because you’re essentially house-hacking your own home. This can mean, moving into a multi-unit home or simply living in a home that can accommodate multiple families. To put it simply: your neighbors or tenants are paying your mortgage.
Commercial Real Estate
This is for those who have experience and access to capital. Think, office buildings and spaces. You are essentially buying (or constructing!) a space that you can rent out to business owners. The benefit? Commercial real estate usually offer multi-year leases, meaning greater cash flow stability and peace of mind for you!
Passive Real Estate Investment Types
This next class of real estate investment types is for the hands-off investor. Passive real estate investing gets you into the real estate market without having to put any of the actual labor that goes into real estate investing. As someone who has tried real estate investing, I will be the first to tell you that active real estate investing can certainly be a headache.
Real Estate Investment Trusts, or REITS are a type of investment vehicle that allows you to invest in real estate, much like you’d invest in stocks from a company. REITs give investors exposure to the real estate market without actually having to go through a traditional real estate purchase. A REIT is essentially a pool of money from different investors used to purchase and operate income properties. You can buy and sell REITs on major stock exchanges just like any other stock.
In order to maintain its REIT status, the owning corporation has to pay 90% of its profits as dividends. Real estate investing through a REIT can also give investor access to nonresidential properties without needing the high capital that’s needed in a traditional manner of real estate investing.
Crowdfunding Real Estate
This is just like any other crowdfunding platform, except its for real estate. The appeal to this real estate investment type is that it is requiring less and less capital from investors, thus allowing more people to enter the real estate market. Essentially, you get a lot of people pooling their money together to purchase an investment property. No longer do you need to have a net-worth in the millions; you can invest with as little as $500 on Fundrise! When investing in real estate through crowdfunding, you gain the ability to become a shareholder and reap an equivalent amount in profit.
Much like the previous options, you get your money into a profitable market without having to 1) put in a high amount of capital and 2) invest a lot of time and energy into the process.
The Bottom Line
As a beginner real estate investor, you will need to be extra cautious. Yes, let the success stories of real estate investing inspire you, but don’t let them lull you into a false sense of reality. Real estate investing is not for everyone, so it’s important to educate yourself on all the options available to you. If you don’t have a lot of up-front capital right now, consider some of the more passive forms of real estate investing, like investing in REITs. Always consider: your access to capital, your timeline, and the time and energy you are willing to invest.
Check out these Yo Quiero Dinero partners to accelerate your real estate investing goals:
- Have your advisory fees waived for 90 days when you join!
- Roofstock makes investing in single-family rental properties radically simple.
- Check your credit & compare personalized offers for loans, without hurting your scores.