But out of any financial market that warrants excitement, for investors new and old, real estate could be number one for a wide variety of reasons.
More and more people are seeing the benefits of real estate investment, even if they don’t completely understand what real estate investments mean, how to get into them, and the ones that best suit their financial needs.
Let’s go over all the details of the real estate investment world. After reading this article, you’ll have a beginnerreal estate investor’s understanding of how to develop a smart investment strategy that will help you make the most out of this lucrative market.
What is Real Estate?
Real estate is an asset of land that includes everything that is inextricably connected to the land.
This can relate to human-created objects like buildings and structures of all sorts as well as natural parts of the environment: trees, water, and other types of natural resources. These combined assets that make up a given parcel of real estate can be sold, leased, or developed by the property owner.
What Makes Real Estate Different Than Other Types of Investments?
- Preference of Location
- You Can Improve Real Estate
- Real Estate Is Scarce
- Investments Increase Permanently
Real estate has distinctive features that differentiate it from other investment types. Familiarizing yourself with these unique aspects of real estate will help you make better decisions about how you should enter into a real estate investment.
1. Preference of Location
A given real estate’s value can be driven by the preference tied up in its location or area. Not all real estate properties are equal. This differentiation of value between any two assets goes deeper than the actual quality of the asset but where the asset is located.
Area and location are crucial economic factors that drive the value of a given real estate asset. Property taxes, for example, drastically impact valuation. You could have two carbon copies of the same building, but whether that building is located in a city or a rural area, for example, will drastically affect the asset’s overall value.
2. You Can Improve Real Estate
The technical term for any alterations to a given real estate asset is called an improvement. Any given asset, whether it’s any sort of building type or the land itself, can be improved upon to increase its value.
This makes real estate a dynamic investment because it can actively be changed in a definite way that is almost guaranteed to increase its value. Anything from a new fence to a transformative overhaul of the land can affect the value of real estate as an asset.
3. Real Estate Is Scarce
Scarcity describes an asset’s short supply. Real estate is a good example of an asset that has scarcity baked into it. In a specific example, property like housing is something that people will always need. Essentially, as long as there are people around, there will always be a demand for real estate.
While we can develop more buildings, we can’t create more land. Real estate has a fixed supply. When demand for a property almost always outpaces the rate at which new properties can be developed, the scarcity of real estate will reliably sustain its value.
4. Investments Increase Permanently
Certain improvements to a real estate asset will virtually increase the property’s value permanently. The amount of capital that goes into making these kinds of improvements is factored into the value of the asset, effectively raising it forever.
Improvements made to a property like drain connections in the land, wiring that connects it to the local grid, water connections, and ingrained developments to the property land will automatically increase the value of the asset.
Because they are so difficult to remove and often necessary, these kinds of permanent value-increasing measures make real estate a stable investment.
Types of Real Estate
- Commercial real estate
- Industrial real estate
- Raw land
- Residential real estate
- Special purpose real esate
No two real estate assets are the same. From the value and location of the land to the buildings on that land, real estate has a diverse range of types that allow investors to be more selective with where they decide to invest.
1. Commercial Real Estate
This real estate asset class describes properties that are utilized as spaces to conduct business. Commercial real estate assets may offer the most diversification of any real estate investment because there are so many types of assets an investor can buy into. For this reason, investors often opt for commercial real estate to fill out diversified portfolios.
Commercial investment properties include apartment buildings, medical facilities, hotels, office buildings, restaurants, malls, retail storefronts, gas stations, and more.
Like residential properties, commercial real estate assets earn an income for their investors through the rent paid to the property owner. Most businesses lease their commercial space.
Because there’s such a high cash flow in these properties—these businesses operate for success—commercial properties can be a lucrative investment for investors.
2. Industrial Real Estate
Industrial real estate serves businesses but at a different point in their operational process. While commercial properties serve as places of business, industrial properties are places where a company or business produces, distributes, stores, or researches and develop new products or services.
They are places that foster the back-end operations of the business, like factories, warehouses, laboratories, and power generation plants. Not accessible as other property types, industrial properties still present opportunities to investors, usually through rent paid or mortgage interest generated by the property.
3. Raw Land
The simplest form of real estate, raw land, describes property types with the most potential for investment opportunities because they are effectively blank slates of real estate. Examples of raw land are properties like vacant lots, farmland, ranch pastures, timberlands, or plain undeveloped land.
Certain types of raw land can be quite affordable because investors only buy the land itself. The development or harvesting of materials on that land is where the expenses come in, but those expenses can be quite rewarding to investors who buy into the land that can generate an income.
4. Residential Real Estate
This is the type of real estate you’re probably most familiar with. Residential real estate properties are property types designed and zoned to be living spaces. This includes condos co-ops, single-family houses, duplexes, townhouses, and multifamily residences.
For investor purposes, residential properties are a popular area for investment, especially for private ownership. Residential real estate earns investors an income through rental income paid by the lessees or by selling the property for a profit.
Investors should expect residential properties to come with a high amount of legal red tape, as there are many regulations and laws in place across the country to ensure the quality of livability of a given home.
5. Special Purpose Real Estate
This type of real estate refers to publicly owned or operated property, especially for community-based functions.
Special purpose properties include government buildings, water treatment plants, libraries, churches, temples, schools, and parks.
Given its community-oriented purpose, special purpose real estate doesn’t often present investment opportunities, making it the least likely to pull in investors.
Types of Real Estate Investment
- Private ownership
- Property rental
You know the economic factors that make real estate unique and the types of properties that make up the real estate market. Let’s look into the ways that investors can buy real estate.
Private Ownership
This type of real estate investment is usually what most people think of when they consider real estate investment.
Private ownership describes the kind of real estate investing where individual investors take it upon themselves to acquire real estate assets.
More often than not, private ownership usually deals with residential properties or raw land properties. However, in some cases, investors might invest in commercial spaces like offices.
Private ownership of this kind is also known as an active investment. This means that the investor isn’t just putting capital down to acquire the asset but also time and additional money into the assets going forward.
As the property owner, investors who pursue private ownership must manage the property on their own, as opposed to the kind of investment where one buys in and leaves it at that. There are a few ways that private ownership can be used to earn an income for the investor.
Property Rental
Property rental is extremely popular to earn a passive income from a real estate asset. The property owner will lease out their property to a tenant looking to occupy the space.
More often than not, residential properties make up the majority of rental properties for individual investors. Single-family homes, condos, and rooms in multi-family homes are among the most popular real estate assets leased out as rental properties.
The owner, or landlord, draws up a rental contract with the tenant, which lays out the tenant’s responsibilities and the landlord’s obligations. This amounts to the rent paid by the tenant while parsing out which additional expense will be covered by whom: utilities like gas, electric, or water, for example.
Under this dynamic, the property owner is accruing enough income from rent to make a profit on their investment.
Residential properties can be expensive. The average sale price for a single-family home was around $500,000 last quarter nationwide.
Rental income from the tenant will help the owner pay off the remaining debt on the house to eventually earn the pure owner profit once all the acquisition costs on the property have been paid off.
What Are the Pros and Cons of Property Ownership?
Pros of Rental Properties
Because the owner has equity in the asset, they are the primary beneficiary of income earned by the rent. When rental properties run as planned, they can be a great, long-term asset. For the most part, rental demand remains high over time.
This kind of property investment is also a good hedge against inflation. As prices rise, rent tends to consider that, meaning that these real estate investments will be unaffected by inflation–if not perform better.
Cons of Rental Properties
Renting can become risky when owners get caught up in legal tangles with tenants. Furthermore, running a rental property is a lot of work, making it a full-time job and less of an investment.
It’s a very expensive way to get into real estate initially. Property is expensive, so investors have to overcome a high financial threshold to get started.
What Is House Flipping?
House flipping is a strategy where investors buy a property, clean it up, and then sell it for a higher price than they paid for it.
The first step is for the investor to buy a property. Usually, a fixer-upper type of situation wherein the investor marks the necessary renovations to the property to increase its value.
When the improvements have raised its value sufficiently, or if the market has become hot enough on its own to drive up the asset’s price, the owner sells the property at a higher price than the one they acquired it for, earning them a profit on their initial investment.
House flipping is another way to make a return on privately owned real estate assets, and one that is widely popular.
Again, this real estate investment type deals primarily with residential properties. The prices for homes are exploding, so investors are hoping to find a solid investment by buying houses, then selling them at a higher value.
Pros of House Flipping
House flipping can be a great way to quickly profit on a hot commodity like residential real estate property.
Demand for property rarely goes down. It’s an almost unprecedented seller’s market. The hot market combined with sufficient improvements to a property can yield investors a high return using this method.
Cons of House Flipping
House flipping is great when all goes according to plan. But the results can be disastrous for investors if there are disruptions in the process.
Sometimes a fixer-upper can be more costly than investors think. Repairs can add up, and if circumstances change, the owner might have trouble selling the asset and get stuck with a significant amount of money tied up in a property they can’t get rid of.
What Are Real Estate Investment Trusts (REITs)?
Real estate investment trusts (REITs), unlike private ownership, are passive real estate investments, meaning they are much more hands-off than strategies like property rental or house flipping.
REITs were created in the 1960s to allow everyday investors to participate in a stable, lucrative market like real estate. With high financial thresholds involved in strategies like house flipping, property rental, and other active real estate investments, REITs allowed investors an easier option.
A REIT is a corporation whose earnings are generated through real estate assets financed or owned by the trust. The trust will acquire a certain range of assets and earn an income through collecting rent from the tenants leasing those assets or from the profit generated by the sales of the assets.
Like any company on the stock market, REITs are publicly traded, meaning that the financial threshold for investment in this type of real estate investment is significantly lower than the active ones.
Pros of REIT Investments
Because they operate like publicly traded companies, REITs have far higher liquidity than their active investment counterparts. Liquidity describes the ease with which an asset can be turned back into liquid capital. Where a home can take months to turn into capital, REIT shares can be traded within a span of hours.
REITs also offer commendable returns. They are legally required to pay out 90% of their taxable income to investors through dividends. Combined with an annual return rate of around 11% on average, they are a solid way to get into the real estate market at a low cost.
REITs can be specific to different subgroups giving you more investment options to choose from. You can get into office REITs, residential REITs, retail REITs, and more.
Cons of REITs
One of the downsides to the fact that REITs are publicly traded is that they have a higher degree of correlation to the stock market. As a result, they are a riskier, less stable investment.
Correlation is a measure of how much one asset’s performance affects the performance of another. Real estate investments generally have a low correlation to other markets as they tend to be isolated from the general trends that affect the stock exchange.
REITs differ from most real estate investments in this regard.
The dividends paid out by REITs are untaxed, which means that investors must take on the burden of making up that tax payment as well.
Private Equity Real Estate Funds
Private equity funds are the perfect balance between the stability of private ownership and the passive investment of REITs.
Like REITs, private equity funds pool investor money in order to acquire income-earning real estate assets. Unlike REITs, they are not publicly traded. They tend to have a much smaller investor pool, so they can move faster on hot commodities in the real estate market.
Professional money managers lead these funds intending to generate a profit for their investors through the assets in their portfolios.
Pros of Private Equity Real Estate Funds
Private equity funds give out high returns to their investors because they can be more selective with their asset acquisitions. These can navigate competitive markets easily because they are often private, elite groups that outpace larger entities like REITs
Investors have more equity in the portfolio assets because the pool of investors tends to be much more trim compared to REITs.
They are hyper-focused real estate operations that get results.
Cons of Private Equity Real Estate Funds
Funds like these are more selective with the pool of investors that can participate in the. Most funds require participants to be accredited investors. Funds can range on the amount of capital needed to sign on.
Invest With The Best
This guide to real estate can help you start your journey towards real estate investment. Christina is here to take you on our 40-decade-spanning legacy in one of the country’s hottest markets, Los Angeles. Get started with us today if you’re ready to step into this lucrative market.
Sources:
Types of Real Estate Investments: Everything You Need to Know | Rocket Mortgage
Average Sales Price of Homes Sold for the United States | Economic Research