Whether you’re a beginner or a seasoned investor, understanding different approaches to real estate investing can help you choose the best fit for your resources, desired level of involvement, and risk tolerance. You may be surprised that there are ways to invest in real estate that don’t require significant money or time.
Consider the following six ways to become an active or passive real estate investor.
Own your home.
If you own your home, you’re already a real estate investor. It provides shelter and the ability to build equity over time. For instance, if you bought a house for $300,000 and it appreciated 3% per year, you’d have a $600,000 home after paying off a 30-year mortgage!
Another benefit of home ownership is building equity by gradually reducing your mortgage balance with regular payments, known as amortization. If you have a fixed-rate mortgage, each monthly payment includes both principal (the amount you borrowed) and interest (the cost of borrowing), with the proportion changing over time.
For example, at the beginning of an amortizing loan term, your payment is mostly interest, with a small portion reducing your principal balance. But with each monthly payment, you pay slightly less interest and more principal. As you pay down your original mortgage balance over time, you slowly increase your home equity–assuming your home’s market value remains steady or increases.
With potential price appreciation and a declining mortgage balance, owning a home allows you to build equity that can boost your net worth. You can even tap a portion of your home’s equity to spend any way you like by taking out a home equity line of credit (HELOC) or a home equity loan.
How do capital gains taxes impact your ability to succeed as a real estate investor? Laura explains what to know about selling your home and the taxes you could owe. Listen in the player below as you read on.
Become a landlord.
The second way to become a real estate investor is to buy a property you rent out to create positive cash flow or at least break even. You might purchase single-family or multifamily homes on your own or with a partner as an active investor. This strategy requires significant upfront capital for a downpayment, ongoing maintenance, and tenant vacancies.
In addition to being capital-heavy, managing properties and dealing with tenants isn’t for everyone. I started investing in real estate as a do-it-yourself landlord decades ago. After dealing with tenants who didn’t pay rent, damaged properties, and left them filled with junk, I decided to let a professional manager take over the hassles!
Turning my rentals over to a property manager was one of the best decisions I made as a landlord because they increased rents and better screened potential tenants. A good manager typically charges 10% of your gross rent per property–or maybe less if you have multiple properties. So, unless you have the patience, skills, and legal knowledge to manage tenants, factor the cost of property management into your financial analysis.
If you can find undervalued properties that are likely to appreciate and provide net cash flow after expenses, they can be excellent investments. And many costs, such as repairs and maintenance, are tax-deductible, offsetting your rental income.
When you buy an investment property, lenders typically require at least a 20% to 25% down payment. Plus, they usually have stricter underwriting requirements for your income and credit than buying a home you plan to live in. You’ll also need landlord insurance and a healthy cash reserve to cover unexpected repairs and months of potential vacancies.
If you know an experienced real estate investor, partnering up with them could be a great way to share income and expenses, learn the business, and understand how to analyze potential deals. Another tip is to work with a Realtor or real estate agent with experience finding, buying, and managing rental properties. There’s no substitute for having a local expert who understands the market where you want to invest.
One investment strategy is buying a multifamily property like a duplex, triplex, or small apartment building and becoming an on-site landlord. If you’re willing to live in one unit and rent out the others, you can actively manage a property while cutting your personal housing expenses. Or you might live in one room of a home or condo and rent out rooms to others.
Another investment strategy is purchasing commercial property, such as a retail building, warehouse, or office space, and renting it out. Commercial property is generally more expensive, and the leases are more complex than residential. But a commercial investment could appreciate faster than residential, depending on its location and features.
I’ve owned residential and commercial property and can tell you from experience that neither is a guaranteed way to make money. The market or neighborhood can go down, causing you to accept a lower rent than you’d like, operating expenses can be higher than you expect, or it can take a long time to find a qualified tenant.
I started investing in real estate by keeping my first home instead of selling it when my husband and I moved into a larger home. That’s a relatively easy way to become a real estate investor–you move out and put a “For Rent” sign in the yard.
Not only is it easier to rent out your old home and buy another one, but it’s less expensive than financing a new investment property. As I mentioned, getting a mortgage for a non-owner-occupied property requires a larger down payment and typically comes with a higher interest rate.
Just be sure your existing mortgage lender allows you to convert your residence into an investment property without paying a penalty or refinancing into a more expensive, non-owner-occupied loan. Be aware that once you switch your insurance from a homeowner’s to a landlord or commercial policy, the lender will know you no longer live there. So, read your mortgage or call your lender to ensure you understand what’s allowed.
RELATED: 7 steps to recession-proof your finances
Buy a vacation property.
There’s been a growing trend to buy a second home before a first home for a vacation property and short-term rental. As I mentioned, buying a property that won’t be your primary residence means paying at least a 20% downpayment, a higher interest rate, and having to pass stricter underwriting requirements compared to a home you plan to live in.
So, whether you can afford a vacation home as a first or second home depends on your income, savings, financial goals, and potential earnings from the property. If you turn a property into a short-term rental, such as for Airbnb, be aware that you typically must collect and remit additional taxes, such as occupancy and sales tax, to local and state governments in many jurisdictions. And managing a short-term rental on your own could be a significant time commitment.
Buying a vacation home might stretch your budget unless your finances are in great shape. For instance, do you have a healthy cash reserve equal to at least three months of living expenses? Are you investing at least 10% of your pre-tax income for retirement? And have you eliminated any high-interest debt?
If you check the box on those financial fundamentals, buying a second home first may be an excellent investment. Consult with a tax professional about tax obligations for short- and long-term rental income so you can factor it into your decision.
RELATED: Pros and cons of buying an investment property before a first home
Fix and flip houses.
If you love home rehab shows or are handy with repairs, you may think that “flipping” investment properties looks easy. The idea is to find an undervalued property in a great area that needs cosmetic updates. I’ve done several house flips and can tell you that knowing what a remodel will cost is more art than science.
I was in the floor covering business for many years, and you only know what’s under an existing floor once you take it out. In other words, to account for many structural and financial unknowns, you must buy a home well below its fixed-up market value to make sufficient profit.
You must estimate renovation costs like a pro, and it helps if you can do some of the renovation work yourself. So, flipping houses is the most active form of real estate investing because you become a full-time project manager, supervising multiple trades at once.
If you decide to become a real estate flipper, always get a thorough home inspection so you understand invisible potential costs. Be clear about estimated expenses, the property’s potential market value, and how long it will take to sell after renovating. Working with an experienced partner can help you avoid missing the mark, so you come away with some profit for your time and effort.
If you’re thinking about buying a home, one advantage homeowners get is qualifying for money-saving tax benefits. Laura answers a listener question and covers various ways buying a home can improve your financial life compared to renting. Listen in the player below!
Buy real estate investment funds.
If you want to become a real estate investor but avoid searching for deals, being a landlord, or managing extensive renovations, consider passive options. One is buying a mutual fund or exchange-traded fund (ETF) that invests in shares of companies in the real estate business, such as builders and material suppliers. That gives you exposure to potential real estate growth without owning it directly.
Another option is investing in a real estate investment trust or REIT. These companies invest in income-producing commercial real estate and pay out regular dividends. For instance, they may own vacation properties, hotels, healthcare facilities, retail centers, self-storage, and warehouses. You get real estate income without buying, managing, renovating, or financing any property yourself.
Some REITs trade on an exchange, like a stock, and others, called non-traded REITs, aren’t traded publicly. You can also get exposure to a diversified real estate portfolio by buying a fund that owns a portion of multiple REITs.
Invest in private real estate opportunities.
Another way to become a passive real estate investor is to participate in private real estate deals, also known as syndication. Private investments allow you to become a real estate investor without the hassles of tenants, renovations, or risks of losing money by trial and error.
According to Denise Piazza, CPA and managing partner of One Street Capital, a private equity real estate firm, the upfront investment could be as low as $25,000. She says, “Our firm specializes in finding institutional-quality commercial investments and offering them to investors who want to finance projects with an expert team. By joining an investor network, you can get real estate education and access to potential deals.”
Denise says potential investment returns on private real estate depend on how much you invest and the skills and experience of the management team. So, doing your homework is essential. She recommends reviewing a project’s financial forecasts, looking at an investment firm’s track record, and getting references from other investors.
Whether your goal is to diversify your investments, create passive income, or create a hedge against inflation, private real estate investing can be an excellent opportunity for higher returns without the risks of becoming a hands-on, active investor.