There's always a "hot" part of real estate investing. One year it's flipping houses and the next it's vacation rentals.
Determining the best way to invest can be challenging. There are many options, and every investor has different needs.
To make it easier, here are seven popular ways to invest in real estate. They'll help you determine what makes an avenue of investing the "best" for certain investors -- including yourself.
Invest in REITs
Investing in a real estate investment trust (REIT) is one of the easiest ways to get started. There's a low initial upfront investment, shares are easy to buy, and REITs show strong performance over time.
These companies pool investor funds to purchase and manage commercial real estate. By purchasing a share of a REIT, your investment is spread across several assets. Returns are distributed in the form of a dividend. The chart below illustrates the performance of a $100,000 investment in equity REITs compared to the S&P 500 based on annual return since 1998.
The average return for REITs since 1998 is 10.26% while the S&P 500's is 8.10%.
REITs are best for the following investors:
- Those who have limited funds to invest or want liquid investments. You can invest in REITs with a few hundred dollars from a brokerage account and sell at any time.
- Those who have time to conduct due diligence on REITs to determine which are a good fit for their portfolio and financial goals.
- Those looking for passive returns.
Invest in Real Estate ETFs
Real estate exchange-traded funds (ETFs) are like mutual funds. But instead of stocks and bonds, the fund manager buys shares in REITs.
The main advantage of investing in a real estate ETF is diversification -- the fund manager selects various companies across multiple commercial real estate sectors. Returns are paid to investors as dividends.
Many real estate ETFs invest in similar mixes of REITs, though they vary in the number of shares owned, resulting in varied rates of return. Below are two of the largest publicly traded real estate ETFs and their performance in comparison to the S&P 500.
Real estate ETFs are best for the following investors:
- Those who have limited funds to invest or are looking for liquid, diversified investments. You can invest in real estate ETFs with a few hundred dollars from a brokerage account and sell at any time.
- Those who have time to conduct due diligence on various ETFs to determine which are a good fit for their portfolio and financial goals.
- Those looking for passive returns.
Invest in residential rentals
Residential real estate is a property with one to four units. This might be a condo, townhome, garage apartment, single-family home, duplex, triplex, or fourplex. Investors in residential rentals rent them to tenants over a set period -- typically one year or more. Ideally, the income from the property exceeds expenses, creating positive monthly cash flow.
Residential rentals are common strategies for real estate investments. Owning a residential rental can be simpler than owning other property types, like commercial real estate.
Buying residential real estate is an active form of investing, as the investor is directly involved in the process of finding, acquiring, and managing the investment -- including tenants. Hiring a third-party management company minimizes your involvement but doesn't eliminate all obligations.
Although this can be profitable, it requires significant time and effort. In most cases, buying a rental property requires more money up front than investing in a REIT or real estate ETF. Plan on at least a few thousand dollars, but know that some lenders require tens of thousands. However, there are ways to buy a property with little money down.
Residential rentals are best for the following investors:
- Those who have some investment funds saved and can allocate $5,000 or more to their investment.
- Those who want the cash flow or tax benefits from owning investment real estate and can dedicate time and effort to owning and managing the property.
- Those willing to learn about residential property investing and conduct due diligence on rentals.
Rehab a property
When most people think of investing in real estate, they think of flipping houses. Popular HGTV shows like Rehab Addict, Flip or Flop, Fixer Upper, and Property Brothers, have romanticized rehabbing properties as the ideal real estate investment.
Rehabbing (or "fixing and flipping") is the process of buying a property in need of repairs at below market value and improving the property to increase its value.
Although TV shows make it seem simple, rehabbing a property that produces a profit is no easy job. It's an active investment strategy that requires time and effort to find new investment opportunities, negotiate acquisition, manage contractors, keep costs down, and sell the property quickly.
Remember that you only get money when you buy, fix up, and sell a property. And, although you might see profits that range from a few thousand to tens of thousands of dollars in a few months, it's easy to lose money doing this, as well.
Rehabbing is best for the following investors:
- Those who enjoy construction or improving properties. At a minimum, you should have a good eye for design and basic construction knowledge so you can manage contractors.
- Those who want to earn income quickly and are willing to lose some of the tax benefits from owning rental real estate in exchange for larger paydays.
- Those willing to learn about and manage the rehabbing process.
Invest in a vacation rental
Vacation rentals are becoming a popular real estate investment vehicle largely due to the rise of home-sharing companies like VRBO and Airbnb. A vacation rental can be a room or a home that's rented for a short term, often nightly or weekly. It can be a great way to generate cash flow.
The success of a vacation rental is largely based on the location, amenities, and quality of the property. Short-term rental demand in the area also plays a major role. Owning vacation rentals requires time spent managing online listings, communicating with potential renters, managing calendars for bookings, and ensuring check-in and turnover are handled effectively.
This type of rental property has a higher vacancy rate than other rental types and is restricted in some places.
Vacation rentals are best for the following investors:
- Those who have some investment funds saved and can allocate $5,000 or more to their investments.
- Those who own property in decent condition in a desirable area for vacation rentals and are willing to share or rent space. Always check your local laws to ensure short-term rentals like this are allowed.
- Those who want to earn cash flow and are willing to learn about, manage, and rent a vacation property.
Invest in commercial property
Commercial real estate (CRE) is used for business purposes, such as retail or office space. Industrial buildings, apartment complexes, mobile home parks, and assisted living facilities also fall into this category. Commercial real estate is costlier than residential real estate, often requiring a greater down payment. There's usually more property to manage, too.
Investors in CRE need to dedicate ample time to learning how to properly invest in and manage the asset class before finding, buying, and managing an asset. With the larger upfront cost and significant time and effort required, many choose to invest in commercial real estate through alternative methods, such as REITs, ETFs, partnerships, or crowdfunding.
Commercial property is best for the following investors:
- Those who have significant investment funds saved and can allocate $50,000 or more to their investments.
- Those who want cash flow or tax benefits from owning commercial real estate and are willing to dedicate time and effort to owning and managing the property.
Invest in real estate crowdfunding deals
Real estate crowdfunding connects accredited investors with investment opportunities. These deals pool money from multiple investors to fund a real estate investment. The asset is owned and operated by the sponsor and the sponsor's management team, making this a passive investment.
Investors get returns in multiple ways, including dividends and preferred returns over time. Crowdfunding is a risky investment option and many variables affect the quality of an investment.
If you're interested in this avenue of investing, take a look at our complete guide to crowdfunding to determine whether it's right for you.
Real estate crowdfunding is best for the following investors:
- Those who are accredited and have $500 or more available to invest.
- Those who can review commercial investment opportunities and conduct due diligence on the quality of the investment.
- Those who want higher returns than most other avenues offer and are willing to wait longer to receive them.
- Those looking for passive returns.
What's the best way to invest in real estate right now?
There are times when specific avenues of real estate investing may be better than others because of current market conditions, but rarely is there one "best" way to invest over the long haul. The current investment fad may not be the best investment in 10 or 20 years.
There's no perfect model for investing. People have different financial goals, means, areas of interest, and specialties.
If you hate managing people and have a poor eye for design, rehabbing probably won't be good for you. If you're short on time and can't consistently find and review investment opportunities, never mind manage one, maybe real estate ETFs or REITs are better.
In general, the goal of investing is to build wealth over time and find investment opportunities that provide stable growth, income, and returns. Make sure you understand how the investment works, including how the return is calculated, the costs associated with that asset type, the risks, and the factors that contribute to a quality investment over time.
No matter which investment strategy you pursue, always conduct due diligence on the quality of the venture and the viability of the overall return. Continue to educate yourself on how to invest in that avenue to ensure you pursue worthwhile investments.