The three most common ways people invest in real estate are through homeownership, REITs and ETFs, and direct investment.
- How to Invest in Real Estate
- Invest in Real Estate With Home Ownership
- Crowdfunding Real Estate
- REITs and ETFs
- Directly Invest in Real Estate
- Final Thoughts
How to Invest in Real Estate
There are a ton of different ways to invest in real estate. In fact, I generally say that it’s possible to be successful in ANY niche in real estate.
…Just not all of them.
So, figure out how you want to invest, then focus on that. Don’t try to do everything or you’ll find yourself not doing well at any of them.
Invest in Real Estate With Home Ownership
The true costs of owning a home are often forgotten until after closing on the property. Owners should remember they need to spend anywhere from 1-2% of the value of the property on maintenance and upkeep.
Home ownership definitely has much lower returns than the stock market, in fact, returns are near 0% once inflation and maintenance are taken into consideration.
But there is one way to turn your home into an investment, and it’s called doing a “live in flip” or also “house hacking.”
You start by buying a home that is a bit run down, but it’s in a nice neighborhood. The goal is to do improvements over the next 2-3 years then you can step up to something nicer, or do it again.
Once you’re done with the work and ready to go, you can either sell it and pocket the profits (usually for no tax, as your personal residence is generally not taxed). You can also keep it and use it as a rental property if you’d like.
I started in real estate with the stepping stone approach. My first property was a 3-unit multifamily near my grad school. We rented two units and lived in one for free.
After a couple of years, we moved to a townhouse and rented out all three units. Then, a few years later, we moved out of the townhouse and into something nicer.
Each time we moved, the rent on the previous unit paid most of the cost of the new one. So, we were never coming out of pocket very much to make the transition.
There are a lot of different strategies to use your home to invest, here is another.
Airbnb and Short Term Rentals
Another way to turn your house into a cash machine is to rent out individual rooms. This is an especially useful option for younger people or families without children.
Buy a house with more bedrooms than you really need. You can even convert an attic or basement into a bedroom.
Then, get some roommates and rent out each room. Their rent will most likely cover all of your mortgage and utilities.
Another option is to use Airbnb. If you’re in a good area that people need to visit, you can earn a lot more per month than having a normal roommate.
Crowdfunding Real Estate
This is relatively new, but it’s becoming bigger and bigger every year.
Basically, you are investing a small amount of money into a larger deal and sharing in the risks and the rewards.
While people have been doing this for a hundred years in a more private way, it is very new to the internet.
The benefit is the best crowdfunding platforms do a lot of due diligence for you and that helps weed out the bad deals. Some of the platforms are limited to accredited investors, but others accept both accredited and non-accredited investors.
In case you are wondering, an accredited investor is someone who earned $200,000 ($300k if married) and has a reasonable expectation to continue earning that. Also, a net worth of $1m or more (excluding your primary residence) also qualifies you.
My favorite sites are Fundrise and EquityMultiple, both of which are unique and well established.
A couple sites let you invest in some deals for as little as $1,000 which is awesome. Most sites require $5,000 – $10,000 which is still good. A few require $20,000 or more which is more in line with what a standard syndication requires.
REITs and ETFs
A REIT, or real estate investment trust includes a huge array of offerings and can include investments in every niche in real estate. The requirement to be a REIT is it must distribute 90% of its earnings to shareholders.
It also has to pass a number of other tests in order to maintain its status as a REIT.
With exchange-traded REITs, you can theoretically buy just 1 share. but there are also private REITs with massive minimum payments which is why the minimum investment has a question mark next to it.
The great thing about a REIT is you can easily get some exposure to real estate in your portfolio. Simply buy into it with your brokerage account just like you would with any other stock or bond.
You’ll find that you could earn better returns if you invested directly into real estate yourself, but there is a tradeoff between time/convenience as well as the effort required.
Though you technically may own a portion of the real estate, you have absolutely no say in how it operates. You can’t decide on what real estate you buy or how it’s managed. You can only vote with your feet and sell your shares and move on.
There are 3 types of REITs – Private REITs, public exchange-traded REITs, and public non-traded REITs.
Directly Invest in Real Estate
People are afraid of this because they don’t want to “fix leaky toilets” or any number of other excuses.
Who wants to fix toilets? I don’t even think plumbers like to fix them.
The reality is direct investments can be as active or passive as you want them to be. You can actively manage your property, or go a more passive route.
So, you can fix toilets if you are hands-on, or you can just hire other people to do it.
The greatest benefit to directly investing in real estate is that you can leverage your returns. Also, you can find way better deals to invest directly in than in any other form of investing.
1. Repurpose your primary residence.
If you already own a home, you’re ahead of the game. If you don’t, buying one is a great way to get started in real estate investing. Look for a mortgage with little to no down payment, such as a VA, USDA, or FHA loan. Credit score and down payment requirements are usually a little more stringent for investment properties so, if this is your first home and you are planning to use it as your residence, you’re likely to get approved if you have decent credit.
That said, if you’re buying a home using one of these types of loans, you have to follow the stipulations of the loan agreement. These are generally not considered loans for investment opportunities, they’re for people purchasing a home for themselves.; Usually, there are requirements for how long you have to use the property as a primary residence. So, you may need to live in the home for a year before you’re allowed to rent it out or sell it.
One way that a lot of people get into real estate investing is by upgrading to a bigger home and holding onto their starter home to use as a rental property. There are many perks to doing this. First, you’re already familiar with the neighborhood since you lived there yourself. You know the type of tenants you can attract and what fair rent is for the area.
Second, you know everything about the house, including how old the furnace is, when the roof was last repaired, and whether or not the water heater will need replacing in the next year or two. Chances are you purchased the appliances yourself and you likely already know how to fix any minor problems a tenant might have. Renting out a property that you know intimately eliminates a bit of the learning curve and is a great way to get started.
2. Consider a duplex or triplex.
Whether you’re buying your first home or thinking about moving, buying a duplex is another smart and easy way to get into real estate investing. Down payments vary depending on the loan you qualify for but they’re usually on par with a single-family home as long as you plan to occupy one of the residences.
This arrangement has some of the same benefits as renting out a single-family home you used to occupy. If the duplex is in an area where you know you want to live, you’re probably already familiar with the neighborhood, schools, amenities, and anything else potential tenants would want to know. Also, since you bought the home and presumably spent some time looking at other properties in the area, you should have a good idea of how much you can expect to ask for rent.
If you manage this arrangement in the right way, the rent you collect from the tenant ends up paying a majority of your monthly mortgage payment. This is great because it means you can either cut back on your full-time job or save the extra income and build up more savings to invest in your next property.
3. Find a seller willing to pay closing costs.
There is a long list of closing costs to be paid before a home sale is complete. These include but are not limited to application fees, appraisals, home inspection, mortgage insurance, origination fees, pest inspections, and underwriting fees.
To lower the amount of money you need upfront when buying a piece of real estate, ask the seller to pay the closing costs. While not all sellers are willing to do this, some will be. This is often used as a way to incentivize the sale so it’s an especially useful negotiating tool if the seller is having a hard time getting rid of the property.
The downside to this is that you are often unable to negotiate on the asking price. This means that, while you don’t have to have as much money to put down at the time of the initial transaction, the overall loan is larger with the payments spread out over the life of the mortgage.
Is it worth it? That depends. Since you’re buying this as an investment property, it’s essential to make sure that any monthly rent you get from tenants living in the property is enough to cover the mortgage payment, ideally with a little bit to spare. If you can cover all costs with rental income, it’s a great way to get started in real estate investing.
4. Use a lender that is willing to work with you on closing costs.
Again, finding a way to work around having to pay upfront closing costs is an effective way to invest in real estate while saving thousands of dollars. If you can, find a lender that is willing to pay closing costs or work them into your down payment.
One thing to note about this option is that you probably won’t qualify unless you have a credit score of around 700 and a low debt-to-income ratio. Lenders need to see that you have a record of paying your bills on time even though you don’t have enough cash to cover closing costs at the time of the sale.
5. Dip into your home equity.
If you’re lucky enough to already own a home, taking out a home equity line of credit or loan is a great way to get a large chunk of money for investing in real estate. Depending on the lender, you can access between 70 to 80 percent of your home’s current equity.
Let’s say you paid $200,000 for your home and currently owe $150,000 on your mortgage. Your home equity is $50,000 which means you may be eligible to borrow between $35,000 and $40,000. If you’ve managed to pay off half of your mortgage, your equity in the home would be $100,000 and you may be able to borrow between $70,000 and $80,000.
As you can see, this is a great way to get your hands on a nice amount of money to invest in a rental property. That said, this is something you really need to think about, particularly if you share your home with someone else as they should have some input into a decision like this.
A home equity line of credit is not free money – you have to pay it back in addition to continuing your regular monthly mortgage payments and any mortgage payments on the new real estate. You should think of it as a second mortgage on your home. The interest rates on home equity lines of credit are usually a little higher than the prime rate but they’re much easier to get and don’t require closing costs or any type of cash upfront.
Presumably, you took out the home equity line of credit to buy a rental property. So, when figuring out what to charge tenants for rent, remember to factor in the new mortgage payment as well as any repayments on your new line of credit. Depending on how much you borrow, this could be easily manageable or a bit of stretch. If you get a good deal on a nice property or put a little of the money into fixing it up, you can likely get enough from rental income to cover the monthly expenses for the new mortgage and the home equity loan.
You can choose exactly what you want to invest in and what you don’t want to invest in.
Lastly, you can decide which properties to invest in and which ones to skip. You can also decide how to deal with problems or let someone else figure it out. You have a high degree of control.
The key to this is to first, determine your niche in real estate.
Then, it’s time to make offers and buy some property!