Investment in real estate has the potential for excellent return on investment (ROI), but it also offers many pitfalls that can cost investors considerable money. As is the case in any investment, knowledge is power. The more research you do before investing, the higher the probability of success. There are many facets to successful real estate investment, so it’s best to learn about all of them before jumping into the market.
Different Types of Real Estate Investments
Not all real estate is the same. Properties can range from single-family homes to large apartment complexes. The “simplest” properties are single-family homes or duplexes in residential areas. These can be bought to rent them out or to “flip” them (sell them quickly at a profit).
You can even live in the property while renting out other units or rooms, which is a very good way to acquire a living space while making it essentially pay for itself. While rents can provide a steady stream of income, troublesome tenants can cause headaches and damage that may be more trouble than you can handle.
Flipping a property can garner a quick turnaround of money. If a property is undervalued and does not require heavy repairs, house flipping is a low-risk way to turn a profit. Most flippers buy property by taking out a mortgage that they don’t intend to hold onto and pay for long. However, if the property doesn’t sell quickly, it can become a burden. Because of the potential dangers in property flipping, it is important to have extensive knowledge of both the real estate market where the property is located and the economics behind house repair.
Also, keeping properties as rentals can be difficult and potentially expensive. Improvements can run into thousands of dollars, and some properties need extensive renovation before they can be profitably used as rentals.
A sudden drop in housing prices can also turn what looks like a sure profit into a major loss. Says David Meyer, vice president of growth and marketing at the real estate investment website BiggerPockets, “There is a bigger element of risk, because so much of the math behind flipping requires a very accurate estimate of how much repairs are going to cost, which is not an easy thing to do.” This can be alleviated by finding the right partner. “Maybe you have capital or time to contribute, but you find a contractor who is good at estimating expenses or managing the project,” he explains.
Real Estate Investment Trusts
Real estate investment trusts (REITs) are companies that are set up to own and maintain rental properties. They carry higher risks than treasury bonds or mutual funds but have certain advantages, especially now with inflation on the rise.
“Generally, REITs tend to do well in times of inflation,” notes certified financial planner Marco Rimassa, president of CFE Financial, an investment firm in Katy, Texas, “just because of their ability to increase rents and then pass that income on to [shareholders].”
That income can be considerable, as REITs are legally required to pay 90 percent of their taxable income in the form of monthly or quarterly dividends. Investors generally see dividend rates of 2 percent to 3 percent or more. Also, because the REIT runs and maintains the properties it owns, the investor is strictly hands-off—this means no dealing with tenant complaints or having to advertise for new tenants.
It is important to note that there are three different types of REITs: equity, which owns and operates real estate; mortgage, which holds mortgages on real estate; and hybrid, which combines the other two. Equity REITs rely on income generated from rents on the properties they own, while mortgage REITs offer mortgages and loans to others investing in real estate. Depending on current market conditions, either one of these could be the better investment, while a hybrid REIT can be a way to hedge your bets.
Knowledge Is Key
The primary factor in real estate investment is knowledge. A knowledgeable investor who takes the time to plan out an investment strategy is far more likely to be successful than one who has not. This seems obvious, but there is a lot to understand to succeed in real estate investment. Everything from the local market to mortgage rates to repair costs to tax implications must be investigated.
Failure to properly research and understand all the diverse elements involved in real estate investment will inevitably lead to costly mistakes. For example, errors in repair costs can completely eat up any potential resale profits, while buying a property at the wrong location can make reselling it slow and difficult. Real estate investment carries the possibility of excellent ROI, but it is much more difficult to succeed in this field than the various television “flipping” shows make it seem.