How to Start Investing in Real Estate: The Basics

Real estate can be a valuable addition to an investment portfolio. Not only is each piece of real estate unique, they're not making any more of it. Real estate is a great way to enhance your investment, no matter what type of real estate investing you pursue.

There is a huge range of options for real estate investors, whether you want to be a very hands-on investor or a completely hands-off one.

Image source: The Motley Fool.

Overview

What to know about investing in real estate

Investing in real estate is the pinnacle of investment achievements in the eyes of many new investors. Unlike stocks and bonds, real estate can be touched and stood upon, regardless of market conditions. When the market tanks, you still have a piece of the planet that's not going anywhere. For plenty of investors, this is a sort of comfort they can't find in other types of investments that may seem more ethereal -- even if they're secured by very real companies.

Unfortunately, a lot of people have the flawed belief that real estate can only increase in value, which is not true. If a property falls into disrepair or an area is no longer popular, you could see smaller returns or even a collapse of your property's value. Unlike stocks, you have to maintain real estate -- whether you do it yourself or hire someone -- and you have to pay other expenses, such as taxes and insurance, even if you're not making a profit.

Although real estate does tend to retain some kind of value even in the worst of times, it's hardly a sure thing. Like any kind of investment, it's important to understand your real estate market, your competition, your potential clients, and your property's potential for income. Most real estate investing isn't very sexy, but it can serve as a balance to riskier stocks and other investments such as cryptocurrencies.

Today's real estate investors also have the added challenge of trying to work within an increasing interest environment. Although the federal funds rate does not directly dictate the cost of real estate loans, it determines what banks pay to borrow money, and is felt acutely by borrowers. With real estate values up and interest rates on the rise, it can be more difficult (but not impossible) to make a profit with real estate in the near-term.

Seven ways to start

Seven ways to start investing in real estate

Although many people think of buying a small rental property when they think about real estate investing, there are actually a lot of different ways to get into the real estate market. Each comes with risks and rewards, and many are unique investment experiences.

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1. Land speculation

Land speculation happens when you purchase a piece of land with the intention of reselling it, either whole or in parts. In some areas of the country, you can own land but sell the water rights or the mineral rights to other entities such as mining operations or oil and gas companies.

Although land speculation is often a short-term form of real estate investing, a savvy investor who understands the needs of the industry they're courting -- oil and gas miners, farmers, homebuilders, or commercial developers -- can make a tidy profit by choosing the right land parcel at the right price at the right time.

Land speculation is pretty straightforward but can be risky. You'll need to understand exactly what benefits your land holds for its particular market, its current value, and its potential. You'll also need to hire experts to document all of this.

Because land speculation is generally about being a middleman between land sellers and land developers, there is a fair amount of risk involved, especially if the interest in property in your area starts to wane. Remember that mall they kept saying was going to go in 20 years ago and is still an empty patch of grass?

2. Property flipping

By now, everyone knows about property flipping. But what you see on television isn't the whole picture of what's involved in successfully purchasing a residential property, fixing it up, and selling it to someone who will love it. You'll need substantial capital to cover labor and supplies, as well as a construction crew or subcontractors you can trust. You also will likely be subjected to multiple inspections, all of which you must pass before being allowed to market your property.

Construction loans are possible, but they are often difficult to obtain as a first-time flipper due to experience requirements and other bank-imposed terms. However, in the current real estate market, a flip that's priced accordingly and will appraise for the asking price may not sit very long at all. Be prepared to make additional repairs that the buyer's inspector finds. No house is perfect, no matter how many people have been working on it.

In a worst-case scenario, your flip house can be converted into a rental property. This isn't ideal, of course, and it will take a lot longer to recover your investment, but it can be a solution if the property can't find a buyer. Sometimes, the market turns after you've started a project, and the only option you have is to keep going forward. Always have an exit strategy when getting into property flips.

3. Short-term rentals

Short-term rentals are a great way to make a little extra money with spare houses or accessory dwelling units (ADUs) already on your property. When you rent short-term rental units out by the night or the week, you can be very choosy about who gets the keys. You can also potentially see more significant returns than you would with a regular residential lease.

Take care that the neighborhood that houses your short-term rental property allows for that kind of transaction since many homeowners associations and towns are on the warpath against short-term rental landlords, and others have banned them outright. You also need to be right on top of your customer service game since guest reviews can determine your rental's popularity.

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4. Small-scale residential rental properties

Some people choose to invest in real estate by simply buying a few small residential properties. A couple of houses or a duplex might be a good starting point just to give you a feel for what it's like to be a hands-on landlord. Most very small landlords choose their own renters and handle their own maintenance (as well as their own evictions). As you build your property portfolio, it may make sense to hire a property manager. Early on, however, the margins are likely too slim for a manager.

Landlording is a business a lot of us already understand since we've almost certainly rented something from someone at some point. That makes it a bit more comfortable than, say, land speculating. However, you'll also have to enforce your leases and maintain the property, which can mean anything from collecting rent from stubborn tenants to calling out the plumber and the backhoe when a sewer line decides to randomly collapse at 3 a.m. on a Saturday.

5. Large-scale residential rental properties

Unlike small-scale residential rentals, larger-scale rental properties are generally pretty hands-off operations. These are often larger apartment buildings or housing communities with a single owner or even a portfolio of residential housing. Unless you have a significant amount of cash available, you'll invest in these properties as part of an investment group. The group can be a few friends who also have cash to invest or a firm that allows you to buy a share of a development.

Large-scale residential rental portfolios can be a really good way to get into real estate investing without any experience with landlording or construction. Pay close attention to the company that's managing the investment, though. They should have little debt, a cash cushion for the property's upkeep, and clearly defined goals for the future. Also, find out how long you have to stay invested before you can divest. Some groups will lock you in for a longer term than others, no matter what the market is doing.

6. Commercial real estate

Putting your money into commercial real estate can mean a lot of different things. You might build a small self-storage facility, or you could buy into a series of empty warehouses in an industrial park, a mini-mall, or even an office building. Leasing each of these properties takes a different kind of skill set, but at the end of the day, commercial properties tend to have higher values than residential real estate and often bring in higher rents.

Commercial real estate can be risky. Some types of real estate are difficult to rent in down markets. For example, during the COVID-19 pandemic, office rentals have been very hit-and-miss since some companies are having their employees return to work at the office, and others are still keeping workers at home. (Warehouses, on the other hand, couldn't be rented fast enough.)

When stepping into directly owned commercial real estate, it's very important to have a good property manager or real estate agent on your side. There are many ways to make a profit with commercial real estate.

7. Real estate investment trusts (REITs)

Real estate investment trusts (REITs) are funds that you can buy shares from on the open market. Unlike private real estate projects, REITs are traded just like stocks. Like stocks, REITs are essentially liquid -- as long as you don't mind losing money if you have to cash out quickly.

You won't have to worry about property management or any of the day-to-day issues with REIT investing, but you should be concerned with the leadership of any REIT and how their money is being spent. As with other fractional real estate investments, you want to be sure their debt is low, that they have a fair amount of equity they can tap in case of a market downturn, and that they have a long-term vision for their properties.

REITs are very transparent and have to disclose a lot of information about their income and expenses, making them a great way for first-time real estate investors to add a little real estate exposure to their portfolios. The risk with REITs is the same as with any kind of stock -- the company could fold, or you could lose considerable money due to someone else's mismanagement. Be sure to really explore the REIT before you make a buy.

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There's a real estate investment type for every investor

No matter what type of investor you are, there's bound to be a type of real estate investment that will fit your needs perfectly. Looking for something hands-on? Give landlording or flipping a try. Want something more along the lines of set-it-and-forget-it? REITs could be perfect for you.

As with any type of investment, though, be sure that you completely understand the terms of the real estate investment before you put any money on the table. Real estate is a long game, and it pays to make these decisions with a great deal of care and thought.

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