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While first-time investors often look to the stock market to dip their toe in investing, real estate investing is another area where it's possible to earn big returns over time.
If you're thinking about getting into the real estate game, here's what you need to know about the different types of real estate investments, how to start investing in real estate and pitfalls to avoid.
The Different Types of Real Estate Investments
Depending on your goals, how much you have to invest and how hands-on you want to be with your portfolio, there are several different types of real estate investments from which you can choose:
- Residential real estate: With this option, you can buy any type of residential property and make money by collecting rent from tenants. You can also opt to sell the property down the road to get the equity you've built up over time. Another form of residential real estate is fixing-and-flipping. With this approach, you purchase properties in poor condition at a steep discount, spend money to fix them up, then sell them for a profit—all typically within a year.
- Commercial real estate: This option is similar to residential real estate but involves buying buildings that house one or more businesses. As a landlord, you'll collect rent from the tenants as they operate their businesses.
- Raw land: Investors with a lot of capital may choose to invest in raw land, or empty lots where they or someone else may want to build residential or commercial properties in the future.
- Real estate investment trusts: Called REITs for short, these publicly traded companies own real estate portfolios, and you can purchase stock in them. REITs must return 90% of their taxable income to shareholders each year, so they can be a great way to earn dividend income. They also allow you to take advantage of the benefits of real estate investing without actually owning any property.
- Crowdfunding platforms: These investment platforms allow investors to invest in real estate properties in a way that's usually reserved for wealthy individuals. You essentially pool your money with investors around the world to purchase real estate, then earn a return based on your investment.
Does It Cost a Lot to Invest in Real Estate?
The capital required to invest in real estate can vary depending on your approach. For example, if you want to invest in a REIT (the least expensive option), you just need enough money to buy one share.
If you're thinking of purchasing raw land or properties, you'll typically need at least enough money for a down payment and funds to cover the mortgage and maintenance costs in the beginning. There are a variety of financing options available, and down payment requirements can depend on the lender, your credit situation, the type of property you're buying and the purchase price.
What Are the Risks of Real Estate?
Like any investment, real estate investing comes with risk. Because most forms of real estate investing are not directly tied to the stock market, the risks are typically different. Here are some to know about.
- Unpredictability: Like the stock market, the real estate market is unpredictable. While properties may appreciate well over a handful of years, there's no guarantee that growth will continue. If the real estate market crashes after you buy property, you could be stuck with a house that's way overvalued.
- Poor locations: Location is crucial in real estate investing. If you're buying residential property to lease, you want to buy in an area where people want to live, preferably for the long term. And if you're investing in commercial real estate, you want to avoid areas where there's historically been a lot of business turnover.
- Bad renters: There are a lot of things you can do to try to weed out bad renters, such as checking credit scores and calling previous landlords. But that's not a guarantee that you won't get stuck with a renter who pays late or damages your property.
- Vacancies: The idea of getting consistent rent payments every month is nice, but it's unlikely to happen. As long as you buy in a good location where the demand is high, you may not need to worry as much about regular vacancies. But even in good areas, a bad market could make it challenging to find renters consistently.
- Negative cash flow: Buying real estate comes with a lot of ongoing costs, including mortgage payments, property taxes, insurance, repairs and maintenance. If you end up receiving less in rent payments than you're shelling out for these costs every month, you could lose thousands of dollars every year. Make sure you account for every cost to try to avoid or reduce any losses.
- Lack of liquidity: While real estate may generally have less volatility than the stock market, there is one big disadvantage. That disadvantage is the lack of liquidity. If you need money now, you'll need to either sell the property or take out a home equity loan or line of credit—both of those approaches can take several weeks. With the stock market, you simply sell your shares, and you can have the money in your bank account within a few days, assuming you've made a gain on your investment.
Where Do You Start?
Real estate can be quite a bit more complicated than simply putting a few hundred dollars into a stock you're excited about. While it's relatively easy to invest via REITs and crowdfunding platforms, buying actual properties or land can take weeks and even months of research.
Start by educating yourself about the process using real estate investing resources like BiggerPockets and Roofstock. You can learn a lot on these websites about how to develop an investment strategy, how to account for taxes, how to calculate the return on investment on a property and more.
If you plan to purchase properties, you'll also want to enlist the help of a real estate agent who can help you find the types of properties you're looking for in or outside your area. You may also consider joining forums and groups on social media that are dedicated to real estate investing, so you can ask questions as you learn and start making your first investments. Also check with your bank to determine whether you're likely to qualify for a mortgage for your investment (assuming you're not paying cash).
Learning about real estate investing can be a steep learning curve, but over time, the efforts can pay off.
Does Real Estate Investing Affect Your Credit?
If you're buying into a REIT or crowdfunding platform, your credit history won't come into the picture at all. However, if you're taking out a loan to finance the purchase of a property or land, your credit will be a significant factor in whether you'll be able to get the financing needed to make your investment. In addition, making the investment can impact your credit history and credit score.
It can especially hurt your credit if you overextend yourself financially and have a difficult time paying all of your bills. Even one missed payment can have a significant impact on your credit score. If you purchase property and have problems renting it out, you could end up defaulting on the loan and having your property foreclosed on, which will cause years of damage to your credit. As a result, it's important to wait until you have enough cash flow and savings to weather the risks associated with real estate investing.
It's also crucial to build a good credit history before you begin investing to make it easier to qualify for lower interest rates on your loans, potentially saving you thousands or even tens of thousands of dollars over the time you own the property. Check your credit regularly to keep track of your progress and to spot potential issues you can address before they wreak havoc on your credit score.