There are literally hundreds (or more) of potential investments you could make in the housing market, but most can be classified into three main categories:
- Other real estate companies
With that in mind, let's go through each of these and discuss the specific ways you could invest in them, as well as some of the important pros and cons of each one.
Investing in properties
The most obvious way to invest in the housing market is to own residential real estate. However, there are several ways to do this.
Rental real estate
For starters, you could buy residential rental properties -- single-family homes, multifamily homes, or commercial apartment buildings. And although owning rental properties can be a great way to build wealth over the long run, being a landlord isn't for everyone.
Investing in rental properties involves a lot of risk. You could run into costly maintenance issues, your properties could sit vacant for a while, or you might have to deal with evicting a bad tenant, just to name a few of the things that could go wrong. Plus, investment properties can be a major time commitment, even if you hire a property manager to handle the day-to-day operations.
Don't get me wrong, I'm not trying to talk you out of investing in rental properties. In fact, I own a few myself and it's my favorite way to invest in real estate. Just be fully aware of what you're getting into first.
Another way is to buy properties to make repairs and sell them at a profit, otherwise known as a fix-and-flip.
On one hand, fix-and-flip strategies can be highly profitable, especially in strong housing markets. However, this is more of a business than an investment, and it can be very easy to lose money on a fix-and-flip if you don't know what you're doing. If you have any desire to pursue fix-and-flips as a real estate investment strategy, I strongly suggest that you learn as much as you can about how it works and the risks involved before you get started.
Real estate investment trusts
You can also invest in residential properties indirectly through real estate investment trusts, or REITs. These are specialized companies that pool money from investors to develop, buy, and/or manage real estate assets, and there are several excellent publicly-traded REITs that invest in residential properties. AvalonBay Communities (NYSE: AVB), Equity Residential (NYSE: EQR), and Mid-America Apartment Communities (NYSE: MAA) are a few good examples.
You can check out our REIT homepage to learn more about these, but there are some general advantages to investing this way. For one, REITs are a passive way to invest in real estate and require less of a time commitment than owning properties directly. Second, REITs can spread your risk out among hundreds or even thousands of properties, so a vacancy or unexpected maintenance cost won't do much damage. And third, REITs are highly liquid investments -- a publicly-traded REIT can be bought or sold immediately at the click of a button.
Also, REITs tend to pay above-average dividend yields compared to other types of stocks, which makes them a fantastic way to invest in the housing market through a tax-advantaged retirement account like an IRA.
Crowdfunded real estate
A relatively new way to invest in real estate is through crowdfunding. You can check out our crowdfunded real estate homepage for more information and to research investment opportunities, but here's the general idea:
When an experienced real estate investor identifies an opportunity, say to buy and renovate an older apartment community, they may not have the capital required to complete the project all by themselves, so they may choose to list the opportunity on a crowdfunding portal to raise money from individual investors in exchange for an equity interest in the project.
This can be a highly illiquid and higher-risk way to invest in residential real estate, but the return potential is also high. If you have a relatively high-risk tolerance and money that you won't need for at least a few years, crowdfunded real estate could be worth a look.
Just to formally define the term, homebuilders are companies whose primary business is building new homes and selling them for a profit. And although many homebuilders are private companies, there are quite a few that are publicly traded on major stock exchanges.
Homebuilders generally perform well when housing demand is strong. However, there are a few things to keep in mind. First off, demand isn't always across the board. There can be lots of demand for lower-priced starter homes even while demand for luxury housing is weak, and vice versa. Plus, homebuilder profit margins are highly dependent on the cost of lumber and other materials -- when lumber costs are high, it can be less profitable to build homes, especially at the lower end of the market.
Perhaps most importantly, homebuilders can be highly cyclical (economically sensitive) when compared with rental properties. Think about it this way -- if you own a rental property and a recession hits, your tenants will probably keep paying rent. However, a recession can cause home sales to drop dramatically.
With that in mind, homebuilders can be highly profitable when things are going well, and can certainly make smart long-term investments in housing. Just to name a few of my favorite homebuilder stocks, you might want to check out NVR (NYSE: NVR), LGI Homes (NASDAQ: LGIH), and Lennar (NYSE: LEN).
Other ways to invest in the housing market
So far, we've discussed the two most obvious ways to invest in the housing market -- real estate and homebuilders. However, there are several other ways you can bet on the housing market through the stock market that could be worth a look.
Some are online real estate businesses that should benefit from strength in the housing market. For example, Realogy (NYSE: RLGY) is the company behind popular real estate brands such as Coldwell Banker and Century 21. Zillow (NASDAQ: ZG) and Redfin (NASDAQ: RDFN) are both disruptive real estate technology and sales platforms, and have both started to buy and sell properties themselves.
In addition, there are some businesses that aren't directly involved in real estate, but that stand to benefit from a strong housing market. For example, retailers who supply homebuilders with lumber and other materials, such as Home Depot (NYSE: HD) and Lowe's (NYSE: LOW), benefit from increased construction activity as well as from renovations.
Which is the best way for you to invest?
Unfortunately, there's no one-size-fits-all answer to this question. Each way of investing in the housing market has its own pros and cons that should be taken into consideration, along with your own investment goals and risk tolerance. For example, a crowdfunded real estate deal might be perfect for someone with lots of money to invest that they won't need for a while, but this could be a terrible choice for a retiree who relies on their investments for income.
Furthermore, the best answer for you could be a combination of these investments. For a personal example, I have several REITs in my retirement accounts and also own a small portfolio of rental properties.
The bottom line is that while there isn't a perfect way to invest in the housing market, there could be a perfect investment strategy for you.