Investing in real estate has historically been a reliable way to build wealth. Property values tend to increase over time, and real estate investing often comes with tax advantages. Plus, real estate helps you diversify beyond asset classes like stocks and bonds.
There are plenty of ways to become a real estate investor, and not all of them require you to own your home or buy physical properties. In this article, we’ll explain some of the best ways to invest in real estate, no matter your budget.
class="wp-block-heading" id="best-ways-to-invest-in-real-estate">Best ways to invest in real estate
The best type of real estate investment for you will depend on your personal finances. If you want to buy a home or investment property, you may need a good credit score and cash for a down payment.
Some investments are only available to individuals with a high net worth. For example, many real estate syndications — where a group of investors pool their money to finance real estate projects — are only available to accredited investors, defined as someone with a net worth of at least $1 million or an annual income of $200,000 (or $300,000 with a spouse or partner). Other investments, like REITs, allow you to buy real estate with just a few dollars in a brokerage account.
You also need to consider how hands-on you want to be with your investment. For example, if you don’t want to deal with tenants or property management, becoming a landlord or owning an Airbnb may not be for you.
Fortunately, there are plenty of ways to invest in real estate, no matter what your budget or preferred level of involvement. Here are seven ideas to get you started.
Buy your own house
Buying a primary residence is how many beginners get their start as real estate investors. You build home equity every time you make your monthly mortgage payment. Given that real property tends to appreciate over time, owning a home is often a good investment when you stay put for the long term. An owned residence is the most valuable investment for many households in the U.S.
Though a 20% down payment used to be the norm, a typical down payment for first-time homebuyers is around 8%, according to the National Association of Realtors.
Be prepared for lenders to scrutinize your finances if you’re buying a home. Many lenders want to see that your total housing expenses — meaning your mortgage, plus your property taxes and insurance — won’t exceed 28% of your monthly income.
Become a landlord
If you want to generate income through your real estate investments, becoming a landlord could be a logical move. You could rent out a home you already own or buy an investment property.
But think carefully about your financial goals before making this leap. Many people think becoming a landlord is a good way to earn passive income. However, many experienced landlords will tell you that renting out properties is anything but passive. You’ll need to research your local market to determine rent, advertise your property, screen potential tenants, handle maintenance and repairs, and deal with legal issues if your tenants stop paying rent or damage your property.
If you want to be a landlord but don’t want to deal with day-to-day issues, you could hire a property manager. The average property management company charges between 8% to 12% of monthly rent, though, so be prepared for these costs to take a bite out of your profits.
Pro tip: Many lenders require a down payment of at least 15% if you’re buying an investment property.
Flip houses
House flipping is a real estate investment strategy where you buy a property with the goal of reselling it at a profit in a short timeframe, often less than a year. Some house flippers buy a fixer-upper, undertake renovations and repairs and then sell the home at a higher price. Others look for homes in areas where home values are rapidly rising, aiming to profit from strong local market conditions.
Many house flippers who buy fixer-uppers follow what’s known as the 70% rule: Essentially, the purchase price and the cost of repairs shouldn’t add up to more than 70% of the home’s after-repair value (ARV), which is the amount you believe the home could be worth after renovations.
Say you estimate a home’s ARV will be $200,000, but it requires $50,000 worth of repairs.
Under the 70% rule, you’d calculate the maximum price you’re willing to pay as follows:
$200,000 (estimated ARV) x 0.7 = $140,000
$140,000 – $50,000 (estimated repairs) = $90,000 maximum purchase price
House hacking
House hacking is a way to generate cash flow from a property you’re living in.
House hackers typically buy a multifamily property, like a duplex or triplex. They live in one unit while renting out the other(s), using the rental income to cover their mortgage and other housing costs.
Alternatively, some people buy a single-family home and rent out a room.
Invest in REITs
A real estate investment trust, or REIT, allows you to invest in real estate without actually buying properties.
A REIT is a security that owns (and typically operates) income-producing properties like apartment buildings, office complexes, warehouses, or data centers. They’re bought and sold on stock exchanges in the same way you buy and sell shares of stocks, which makes it easy to invest in publicly traded REITs using your brokerage account or individual retirement account (IRA).
Real estate investment trusts tend to be popular with investors seeking dividend income. Due to their tax structure, they’re legally required to pay out 90% of their annual taxable income to shareholders through dividends.
It’s also possible to invest in multiple REITs with a single investment through exchange-traded funds (ETFs). Many real estate ETFs are passively managed index funds that track the performance of the overall commercial real estate market in the U.S. or a large swath of it.
Use a real estate crowdfunding platform
Online real estate crowdfunding platforms allow you to pool your money with other investors to fund real estate development projects. Many platforms offer crowdfunded REITs, which are often privately held. That means their shares don’t trade on the stock market.
Like publicly traded REITs, crowdfunded real estate can be a good source of passive income. However, many platforms charge high fees and require significant minimum investments. Fundrise only requires $10 to start investing in real estate, but many crowdfunding sites have minimum up-front investments of $1,000 or higher.
Buy fractional shares of real estate
A growing number of startups now allow you to buy fractional shares of real estate. These investing platforms are similar to crowdfunding sites in that they allow multiple people to combine their money for a real estate investment.
The big difference is that when you buy fractional shares of real estate, you choose the individual property you want to invest in. Also, you’ll generally invest in single-family residential or vacation homes instead of commercial properties.
Pros and cons of investing in real estate
Like any investment, real estate comes with risks and rewards. Here are some pros and cons to consider before adding real estate to your investment portfolio.
Pros
- Property appreciation. Property values and rents tend to increase over time, making real estate a viable way to build wealth. One reason property values usually trend upward is that it’s impossible to create a larger supply of land in response to growing demand. Long-term appreciation can make investing in real estate a good hedge against inflation.
- Potential stream of income. Real estate can produce steady cash flow, whether you’re collecting monthly rent as a landlord or passively investing through REITs and earning dividends.
- Diversification. Investing in multiple asset classes, like stocks, bonds, and real estate helps you diversify your portfolio and spread out your risk. Though it’s possible for home prices or commercial real estate values to drop, the real estate market tends to be much less volatile than the stock market.
- Tax advantages. Real estate comes with a bevy of tax advantages. For example, homeowners who itemize their tax returns can deduct mortgage interest, while if you own rental property, you can deduct depreciation. You can also exclude up to $250,000 of capital gains for tax purposes (or up to $500,000 if you’re married filing a joint tax return) if you sell your main home at a profit.
Cons
- High up-front costs. You typically need a decent sum of cash for a down payment to buy physical real estate, particularly if you’re buying investment property. If you’re buying distressed properties with the goal of flipping them, you may need to pay cash, as lenders may be unwilling to provide financing.
- Ongoing expenses. If you own property, you’ll be responsible for maintenance and repairs, along with property taxes and insurance.
- Illiquid investment. Physical property is an illiquid investment, meaning you can’t easily cash in on your real estate holdings without incurring substantial costs.
- Interest rate sensitivity. High interest rates generally spell bad news for real estate because it costs more to borrow money. When mortgage rates are high, real estate prices don’t necessarily drop in response. Many homeowners may avoid listing their houses because they’ve locked in low mortgage rates and don’t want a new loan at a higher rate. Due to the low inventory, prices often remain high, creating a challenge for first-time buyers.
- Lower returns than the stock market. Though real estate is usually less volatile than stocks, the S&P 500 index has historically produced higher average annual returns than real estate.
Who should invest in real estate?
Anyone who’s looking to add real estate to their investment mix can do so through REITs, real estate ETFs, crowdfunding, or fractional ownership. Some of these investment opportunities allow you to get started with just a few dollars.
It’s a bit more complicated when you’re buying physical property, though. You’ll probably need a healthy credit score and a down payment to invest in real estate. If you’re buying a home you plan to live in, you may be able to put down as little as 3% (or 0% if you’re a veteran who qualifies for a VA loan).
But if you’re buying rental property or commercial properties, like office buildings, down payment requirements are typically much higher. Many lenders require a down payment of 20% to 25% for a commercial loan.
Regardless of the type of real estate investment, it’s essential to have enough savings to cover an emergency. Unexpected repairs can get expensive quickly. If you want to rent out your property, you also need savings in case your tenants fail to pay rent.
Finally, it’s also important to be aware of the tax considerations. Though real estate carries major tax benefits, it can also increase your tax bill.
For example, if you sell a home you owned for less than a year, your profits are treated as short-term capital gains and taxed at ordinary income rates. Rental income is also taxed as ordinary income, though many property owners can take advantage of tax deductions to reduce their liability.
If you earn dividend income from passively investing in REITs, you should also be prepared for the tax bill. REIT dividends are typically taxed as ordinary income, but the rules can be complex. Consult with a professional, like a certified public accountant (CPA), to be sure you understand the tax consequences.
FAQ
Can I invest $100 in real estate?
Yes, it’s possible to invest $100 (or even less) in real estate if you buy shares of real estate investment trusts, or REITs. Another option is to buy shares of exchange-traded funds that invest in many different REITs. Some crowdfunding platforms and fractional shares companies will also let you get started with $100 or less.
Is it a good time to invest in real estate?
As of June 2024, interest rates are the highest they’ve been since the mid-2000s, which makes it more expensive to invest in real estate. However, interest rates aren’t the only factor to consider. The best time to invest in physical real estate property depends on your personal finances and local market conditions. A financial adviser can help you determine whether it’s a good time to invest in real estate based on your circumstances.
What is the minimum down payment on an investment property?
Expect a minimum down payment of 15% if you’re buying an investment property, though each lender has its own requirements. Lenders will also consider other factors, such as your credit score, debt-to-income ratio, cash reserves and whether you have other mortgaged properties in setting the terms of your loan.
