There are many different ways to invest your money, and if you’ve had a windfall of cash or a large savings account that you’re ready to invest, one area to consider is real estate. While these investments require you to put in money upfront, the benefits can include a surprising return for current and future income streams. Here are a few of the ways you can invest in real estate along with some pros and cons to consider with each option.
Own Rental Properties
Most people are familiar with this investment option. Owning a rental property can be a long or short-term investment that allows you to have a good bit of control over your return since you’ll be the one to set the rental rate. If you’re aiming for long-term, you’ll also be able to calculate how long it will take to pay off the mortgage and start making a larger profit. Here are some of the pros and cons of owning a rental property:
You can start making money off your rental property immediately. However, we recommend you work with an accountant to get your rental price set correctly. You need to consider charging an amount that is reasonable for your market, but enough to cover the current mortgage payments and taxes, possible damages, future updates, and if possible, a little extra to prepare for any vacancies you may experience over time.
There are many tax deductions associated with owning rental property that can lower your tax bill significantly. You will want to be aware of real estate rental tax laws to get the best bang for your buck. A CPA can help you with this as well.
Essentially, as you receive rental payments from tenants, they are paying the mortgage for you. After the mortgage is paid off, the money from rent each month can be used for personal living expenses. If you amass several rental properties over the years, by the time you retire, you could have a very healthy income stream from these properties.
Generally, properties appreciate over time, so your investment is growing in inherent value beyond rental payments from tenants. Just be aware that housing values can change over time and we still do not know the long-term impact the pandemic (and now inflation) will have on the housing market.
For a rental property, you’re going to need to put down about 20%. No matter what property you purchase, this is a sizable amount of money that could be used or invested in other ways, so it’s extremely important to talk with your advisor before buying a property.
Managing tenants can be tiresome if your property is not long-term. It will require advertising the property, reviewing applications, and meeting with tenants – all of which which might require outside help from a realtor.
It is also advisable that you work with a lawyer to ensure you have secure rental contracts (that are valid and legal in your state). It’s important to specify rental periods, tenant rules, occupants, damages, and more.
Any time you don’t have a tenant in your property, you will have to cover the costs on your own – which could include paying to keep electric, water, trash, internet, etc. services running while you’re showing the space to potential tenants.
House flipping is when you purchase a property with the intent to resell quickly. We generally think of house flipping as an activity that involves remodeling, but some properties can be purchased and re-sold at a profit without any renovations. To invest in real estate flipping, it’s important to have a deep knowledge of your market and constantly watch for what becomes available to purchase. But, if you have knowledge in (or are willing to learn about) real estate valuation, home renovations, and marketing/selling, house flipping can generate a return on your investment at a faster rate than many other investment options.
Although it’s a one-time return, the average time it takes to flip a house is 180 days, so if you can make a profit with your flip, you’ll see a very quick return on your investment. The general rule in house flipping is to spend no more than 70% of the home’s after-repair value minus the costs of renovating the property.
You need to have a deep knowledge of the real estate market(s) where you want to flip houses. If you take the time to learn about your market and you have enough cash, you’ll have an edge on competition.
Additionally, if you want to remodel before selling to increase profit, it’s also helpful to be handy – you’ll make more if you’re able to make renovations yourself.
Cash is king in real estate. If you want to be able to buy quickly (and at a lower cost), you’ll generally need a lot of liquid capital (aka CASH).
Even with a deep knowledge of the real estate market(s), no one can predict the future, so it’s difficult to know when a “hot” area might cool down.
If unable to sell the flip, your money can be tied up for longer than you desire. Since you’ll own the property, you’ll have the option to rent if the markets turn unexpectedly, but your liquid capital will be tied up.
Real Estate Investment Groups (REIGs)
If you’ve got the money to put into owning a rental property or flip, but you don’t like the idea of being so hands-on, this is an option that might work for you. With a REIG, you will pool your money with other investors to buy, renovate, sell, or finance properties. A common REIG example is that a company will buy or build a multi-unit property like an apartment or condo and then investors can buy the individual units. You can purchase only one – or as many as you’d like – and the company will handle everything from managing tenants to maintenance and filling vacancies.
Just like with owning a rental, you can start making money off your REIG very quickly. Having pooled resources with other investors allows for multiple investments, and this often generates larger returns.
You will get to be entirely hands-off aside from buying in and cashing checks. Investment decisions and management of properties are handled by the operating company.
Generally, there are no limitations on the activities a real estate investment group can be involved in, so a REIG can engage in several investing opportunities to create a portfolio of property investments. This can include investing in apartment buildings, rental homes, commercial buildings, or commercial units and extend into mortgage lending, property flipping, or collecting property management fees.
REIG partners typically have to be prepared to pay more cash as an initial investment than other real estate investment opportunities.
In exchange for dealing with all the tenants and business aspects of the REIG, the operating company takes a percentage of the monthly rents. You also need to do research on who is managing the REIG because its success is often dependent those making the investment decisions. If the REIG you join is governed by inexperienced people, you could lose money.
You will be tied to formal agreements that will likely have restrictions on when and how you can pull out of the group. If you decide you need to withdraw, you may not be able to recoup your investment or share of the profits immediately.
Within the REIGs bylaws, there will be set fees that are paid to the people managing the group. These fees can be costly, especially when profits are low or when losses occur. Generally, the fees are charged annually, but some are more frequent.
Real Estate Investment Trust (REIT)
If you like the idea of pooling your money with others to be involved in larger real estate transactions AND you like the idea of an investment that is treated more like a stock, this is an option for you. A REIT is modeled after a REIG so that you can pool your money with other investors and not have to manage a property, but they are bought and sold on the major exchanges, which allows individual investors to earn dividends from their real estate investments.
These act exactly as regular dividend-paying stocks, so REITs are a great investment for stock market investors who want regular income. Additionally, these dividends tend to be higher than many investments.
You won’t be stuck in an REIT. Because they are exchange-traded, this investment is highly “liquid” so if you need to sell and use the cash for something else, it’s fast and easy to get your money back.
A REIT usually only invests in one real estate sector, but those sectors cover most real estate property types, ranging from apartment buildings or hotels, to cell towers or data centers, to medical facilities, offices, retail centers, and warehouses.
REIT total return performance for the last 20 years has outperformed the S&P 500 Index, other indices, and the rate of inflation – making them an extremely sound investment choice.
A REIT does not offer much in terms of capital appreciation. As part of their structure, they must pay 90% of income back to investors, which means only 10% of taxable income can be reinvested back into the REIT to buy new holdings.
There are strict guidelines provided by the Internal Revenue Code to qualify as a REIT and on top of that, the REIT dividends you receive are taxed as regular income.
You’ll need to do your research before investing because some REITs have high management and transaction fees.
Real Estate CPA & Wealth Management
Avizo Group maintains specialized expertise in the real estate industry, and we work with clients to help them create strategies to maintain and grow their wealth. Whether you are a seasoned investor or looking to get started, we have the expertise to help you reach your goals. Contact us if you’d like to set up a meeting and learn more.
Carly is the leader of our Real Estate niche group. As part of our assurance team, she excels at performing internal control analysis, audits, compilations and reviews for real estate business owners, small companies, government agencies, 401k’s and not for profit organizations.