Investing in real estate has plenty of benefits. A steady flow of extra income, relatively low volatility and the appreciation in the value of properties are factors that make real estate a good investment.
But, there are also some downsides. Real estate can be a poor investment if buyers lack the time, experience or capital to get started. Plus, investors can’t buy and sell a property as easily as other financial assets, such as stocks.
What Is Real Estate Investing?
Real estate investing is when an investor purchases a property with the intent of making a return. Real estate investors can take either a passive or active approach.
Passive real estate investing is when an investor chooses to be a landlord, using the property as a rental unit. Active real estate investing, on the other hand, refers to “home-flipping” where the investor aims to buy and sell quickly for a gain in periods of high economic demand.
In both cases, it can be profitable. The two ways of earning money from real estate are through:
- Income from rental agreements
- Return on invested capital through price appreciation
Common real estate investment transactions are for residential properties, commercial properties and condominiums. Wealthy real estate investors will sometimes purchase several units located together all at once.
Why Is Real Estate Is Good Investment?
Real estate is a good investment due to solid recurring returns from tenants as well as appreciation in the value of the property.
As such, investors who don’t use financing will always retain ownership of the property, which can be sold later. Plus, it’s one of the most stable asset classes and a great store of wealth.
Why Is Real Estate Not a Good Investment?
Real estate investing is not a good investment for someone who needs open access to capital. Real estate is highly illiquid — meaning it can’t be converted to cash easily. The reasons behind this include:
- Complexity of buying and selling agreements
- Ability to find someone willing to make a big ticket purchase
Inexperienced real estate investors who don’t understand the ins and outs of the market may face further struggles. Without prior knowledge, an investor could overpay or purchase a property in a poor location. Not to mention, ongoing capital will be required for property maintenance, renovations and upkeep.
This can lead to difficulties finding tenants or the inability to resell a property, which could leave investors trying to dig their way out of a hole. It can become increasingly difficult when economies fall on hard times, as was the case in the 2008 financial crisis.
How Do You Invest in Real Estate?
New investors can invest directly in properties themselves, or they can choose to invest through real estate investment trusts. Here are some of the options.
Residential Investment Properties
Residential real estate investments target townhouses and apartments, which are either multi-family or single-family properties. Residential real estate investments are preferable for smaller investors or those building a diverse real estate portfolio for passive income over time.
Commercial Investment Properties
Commercial real estate is made up of warehouses, stores, hotels and office buildings. Businesses will rent the space on a per-square-foot basis. Commercial real estate investments are suited for high-net-worth individuals and investment funds due to the large ongoing costs and capital required.
Real Estate Investment Trusts (REITs)
REITs are a type of investment fund that invest the majority of their assets in real estate. Owning a publicly traded REIT is similar to owning shares of an individual company on the stock market — it can be bought and sold frequently. However, there are non-publicly traded REITS, which are not as liquid.
Four core benefits of publicly-traded REITs are:
REITs generally specialize in a particular sector, such as telecommunications, data centers or shopping malls. They are a great way for retail investors to get exposure to the real estate market.
How Much Can You Earn From Real Estate Investing?
The median real estate investment return is 8.6% per annum. However, returns will vary based on the type of investment. Here are the historical average returns from different real estate investments:
- Residential properties: 10.6%
- Commercial properties: 9.5%
- REITs: 11.8%
Is Real Estate Better Than Stocks?
When considering getting into the real estate market, investors should weigh up other options that may be more suitable. Here’s a comparison of real estate and stocks in certain categories.
Real estate is far more stable than the stock market. This is because of trading frequency and tangibility. Stock ownership isn’t tangible, and shares can be traded by the second due to high liquidity. Real estate is a hard asset that generally carries a higher price tag, making it more difficult to transact in.
Stocks can also undergo significant price swings based on a company’s earnings report or other real-time announcements that give ongoing information about business performance. On the other hand, real estate tends to react to economic news at a slower pace.
Although the entry costs are higher for real estate, it also provides tax deductions where applicable. However, property tax must also be paid — with rates varying by state. This can be a deciding factor in what makes real estate more or less attractive to buyers.
Rental property tax deductions and depreciation deductions can be made before gross income is calculated. Stocks held for longer periods have their own tax advantages, but short-term trading will incur higher capital gains rates.
Long-term annual stock market returns average roughly 9%. However, once inflation is accounted for, returns are recorded to be as low as 6.8%. Most real estate investors achieve an annualized return of 8.6%, but the property is deemed to show strength against inflation in comparison.
This is because rental yields tend to adjust upwards as land, labor and material costs rise. House prices have also kept up or even beaten inflation over a long period, according to Colin Lizieri, a professor of real estate finance and economist from the University of Cambridge, as reported by Bloomberg.
Is Real Estate a Good Investment Right Now?
Investing in real estate right now has been argued both ways. Some experts believe it is a safe haven asset that can protect against inflation, but others in the industry think that rising mortgage rates and the possibility of a recession dampen the short-term outlook.
Fannie Mae’s Home Purchase Sentiment Index recently dropped below 2011 levels, suggesting a pessimistic view from a consumer standpoint in regard to buying homes right now.
Can owning real estate make you rich? Definitely. However, it’s important to understand all of the capital requirements, regulations and tax codes of local areas before investing. If investors lack expertise, investing in REITs can be a brilliant alternative.