A Beginner’s Guide to Investing in Real Estate
When it comes to choosing wise investments in today’s market, real estate consistently rises above the rest in terms of reliability and leverage (see last week’s blog on Leverage). Whether you’re looking to increase your assets and holdings or simply transition into self-employment, investing in real estate offers the best and most reliable way to do so, offering the highest return for initial cost and consequently the best bang for one’s buck.
There are two primary ways to invest in real estate, and the pros and cons of each will determine which one is right for you. For the cost-conscious and those given to relatively low-maintenance investments, a real estate investment trust, or REIT, may be their preferred choice. For the go-getters and those not averse to applying a bit of elbow grease, direct ownership is probably a bit more their style.
Real Estate Investment Trusts
A real estate investment trust, or REIT, involves less risk and upfront cost but boils down to one basic concept: the investor is buying shares in an extant trust which uses real estate to grow the fund. Much like stock or options, the investor buys shares in the trust while leaving the heavy lifting to experienced management, and their return is proportional to the amount of shares purchased. The valuation is three-tired – the fund based on the trust, the management and cash flow that supports the fund, and the value of the real estate itself. While it’s a good way to compliment an existing portfolio of stocks, the REIT requires potential investors to do their due diligence in research prior to investing, as the fund grows based on the purchase and sale of properties, which means that the overall availability of capital and ability of management are the keys to understanding the potential returns of the trust. REIT’s are a passive form of investment, but they do require intensive research and careful thought before investing.
Direct Ownership
If REIT’s are passive forms of investment, direct ownership is the complete opposite. Not only does direct ownership require careful research and decision-making (while weighing the trends of the local real estate market), it also necessitates hard work in renovating and maintenance of the property. In some cases, investors can buy an undervalued property in a hot market and flip it for a profit, but in most cases, the average real estate flip involves purchasing a under-maintained property, renovating it and building it up, and retaining it for a year or so to let the value increase according to the market. This involves securing funding either through another investor or through a mortgage, a good understanding of market dynamics, choosing good tenants that won’t destroy the property (or be late on rent) while waiting for the value to increase, and maintaining the property itself for a determined amount of time until its value increases. While it’s not for the faint of heart, direct ownership provides the most leverage and potential returns for those willing to put in the work.
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