So you want to dip your hands in real estate and get a piece of that lucrative pie. You have enough capital and more than enough confidence to know you can make it. But do you have enough knowledge to see what’s behind the glamorous curtains of real estate investing? This is a game of risks and rewards, so knowing the basics can tilt the odds (slightly) in your favor.
What Is Real Estate Investing?
Real estate investing involves the purchase, management, development, ownership, business dealings, rental, and/or sale of real estate for profit. Real estate is any asset that consists of a piece of land and any properties on it such as buildings, facilities, and natural resources. Real estate is capital-intensive and highly dependent on cash inflow. The management of this exchange of resources (assets versus expenditures) is the most important thing to know when investing.
Unlike other forms of business like manufacturing or services, there’s no guarantee that people will buy or rent a room in the condominium you built. The economy can collapse or your property can devalue and you will be left with assets that cannot be moved or liquidated easily. In contrast, a manufacturer can sell their goods easily at lower prices to recuperate or mitigate the losses.
In other words, the very nature of unstable factors makes real estate investing a risky endeavor. One wrong move and you can find your property bleeding money with negative returns. But if you strike gold, you will reap a hearty amount of dividends. Your real estate’s value can skyrocket and you will have the enviable problem of whether to sell the property while it is at its prime or keep developing it for more long term revenues.
Types of Real Estate Investing
Real estate investing comes in many forms, each with its own risks and rewards. Here are the 8 types of real estate investments:
- Commercial real estate
- Mortgage lending
- Sale/leaseback transactions
- Real estate investment trust (REIT)
Cash Flows of Real Estate Investing
A typical real estate property generates money for the investor through the following means:
- Net operating income (NOI) – the sum of all positive cash flows (rent and income), minus the expenses (fees and taxes)
- Tax shelter offsets – depreciation, tax credits, and carryover losses which reduce tax liability
- Equity build-up – appreciation of the investor’s equity ratio (the income of the property pays for its debts)
- Capital appreciation – appreciation of the market value of the asset which becomes cash when sold
Benefits of Real Estate Investing
Aside from the glamorous title, there are other advantages to being a real estate investor.
1. Passive Cash Flow
After you have paid off the initial expenses, a valuable property can give you income even when you’re busy doing other things.
When doing real estate investment, you are not at the mercy of a CEO. You are your own boss and only you can make the business decisions to make your investments prosperous.
3. Tax Benefits
The cash flow you receive from rentals is not only subject to self-employment tax but also benefits from depreciation.
4. Value Appreciation
If your property becomes a prime asset after a long time, it will remain a profitable property regardless of the economic climate.
How to Get Started in Real Estate Investing?
You cannot go guns blazing on your first foray into real estate investing. Always start small and then work your way up. Keeping that in mind, here are beginner real estate investments you can dive into:
1. Real Estate Investment Trusts (REIT)
Real estate investment trusts allow you to invest without the physical real estate. Sounds confusing? Think of buying stocks. REIT works by investing in existing real estate properties owned by established companies. If the property is selling well, you get big dividends. But the risk is you cannot move your investment share as REIT is hard to sell. To buy a publicly traded REIT, you will need a broker and a brokerage account.
2. Invest in Rental Properties
An example is a condominium unit. If you have already bought your room, you can lease it to other people through Air BNB or as a direct rental, for example. Or if you have multiple rooms and are still paying for the unit, you can rent out the others. What happens is you occupy the property you are investing in. Your property pays for itself until the return of investment becomes positive.
3. Buy, Develop, and Re-Sell
This is a costlier option, as you will need more money to make money, so to speak. The cost of the property itself plus the costs of development could set your cash flow back to negative. But if you develop it and appraise it well, you can re-sell the property for a bigger profit. The risk here is that it takes time to develop a property and re-selling is not a guarantee.
4. Try Online Investment
There are other people out there who want to finance their projects – and you can step in as an investor. There are online platforms that connect investors such as yourself to real estate developers. You generate your profit through debt and interest or equity.
And here’s the rub: these investments are purely speculative and you cannot trade your share like a stock. Also, these platforms are open only to accredited investors with an income folio of more than $200,000. In other words, either you’ve made a lot before, or you already have a huge amount of cash.
Conclusion and Tips to Succeed
Real estate investing is risky business, as they say. The bottom line for any aspiring real estate developer: study, study, study. Study the risks versus rewards. Know when to fold or go all-in. Learn the trick of “reading the wind”; that is, observing market trends and the economic situation. With experience, you can master the rules to stay in the game or get ahead of the competition.