Anyone who wants to increase their financial worth is advised to invest. When you invest, you let your money work for you by putting it in vehicles that can potentially return your money at steady rates. If you decide to place your extra cash in a bank, your money will grow at a much lower rate than if you were to invest it. Generally, investments are split into two; short-term and long term. When creating an investment portfolio, investment advisors advise that you distribute your risk by investing in short-term and long-term investments
Real estate investing is an excellent example of long term investment though it can also be a short term investment if you keep it for less than a year. There are several ways you can invest in real estate. Five of them are highlighted below.
- Purchasing Real Estate Investment Trusts (REITs) – This is a way of investing in real estate without owning any property. A REIT is a company that owns, finances, or operates income-producing real estate. You invest in real estate trusts through the purchase of individual stocks or mutual funds and earn a share of the income produced.
- Become a landlord – Here, you purchase houses for purposes of deriving rental income from the tenants. The startup capital needed is much larger than for REITs
- Real Estate Investment Groups (REIGs) – This is a good option for owning property while deferring the hassle of managing it. Typically, a company buys or builds houses then invites investors to purchase them. An investor will own one or more units of living space, but the company manages all of the units collectively.
- Flipping homes – In this case, you invest in a fixer-upper. You buy it at a lower cost, renovate it then sell it at a higher price. You need to ensure that the cost of renovation does not exceed the expected returns.
- Online Real Estate Crowdfunding Platforms – This method is relatively new. This method allows small real estate investors to fund big projects by reaching out to a pool of investors who contribute small amounts of money. You invest either through equity or debt.
There are many other ways of investing in real estate. You may be wondering why you should invest in real estate. Here are some advantages and disadvantages.
- Advantages of real estate investment
- Disadvantages of investing in real estate
Advantages of real estate investment
If you invest in rental properties, you can earn a positive cash flow every month. Cash flow is the money you get after all deductions like mortgage and taxes have been paid. This is one of the main reasons people invest in real estate. You can also invest in multiple properties, for example, through mortgaging, increasing your earning potential. Rental income is an excellent form of passive income as you regularly earn without working for it. If you have a good location and regular tenants, you can make enough to cover your expenses and even make extra.
Long term financial security
As long as your houses are well maintained, you can earn money successfully for an extended period. This is besides the fact that land and homes generally appreciate over time, making it a good investment option for those who want to hold an investment over many years. In this way, you can decide to purchase property as a retirement plan because it can earn allow you to make money even when you stop working.
There are some tax benefits you gain from owning real estate property. They include;
- Depreciation deduction from income
- Deferral of capital gains through 1031 exchange
- Mortgage interest tax deductions from income
- Cost of services such as rental apartment management and legal consultation
- Cost of repairs, upkeep, and maintenance
- Travel cost associated with the houses for example gas
- Property tax deductions
When you sum all these deductions, you realize that real estate is a real tax haven. You also don’t have to worry about paying self-employment tax on your earn rental income.
Building your equity
If you take the home on a mortgage loan, you have a lower stake in it. However, if you price your rent right, your tenants can pay off your mortgage, thereby increasing your equity. For example, if you own a $100,000 property but owe the bank $80,000 in mortgage, your equity is $20,000. If you pay off $50,000 through the rental income in ten years, you now owe the bank $30,000, and your equity is $70,000. Your tenants essentially buy it for you.
Benefits from capital growth
One of the things that make investing in real estate profitable is that capital assets such as land generally appreciate over time. For long term investors, if you spend $100,000 in a house in one year and it appreciates at a rate of 5% annually, after five years, the property will be worth $127,628.16. This is not always the case, but for most instances, it is the expected result seeing as land is a limited resource, and the demand is rising with time.
Hedge against inflation
Inflation is the increase in prices over time and the fall in the purchasing value of money. As a hedge against inflation, real estate primarily protects you from it. Real estate is an inflation hedge because houses and land maintain or increase in value over time. During times of inflation, rents and prices of homes typically increase, allowing you to fight against inflation. On the other hand, if you put your money under your mattress, it will buy you less in 10 years than it can now.
Leveraging other people’s money
This is another great advantage of investing in real estate. If you want to invest in stocks, you can do it with just a little capital. On the other hand, you need a lot of money to start investing in real estate. If you can’t afford to pay cash, you need at least the down payment, closing price, and other charges to own the home, and your mortgage will take care of the rest. This is where leverage comes in. You are leveraging debt (other people’s money) to increase the rate of your returns.
For example, if a home is worth $200,000 and you are needed to pay a down payment of 20%, all you need is $40,000 to purchase the home. If the property appreciates by a net worth of 5% annually, it is now worth $210,000 to the owner. Whereas if your $40,000 were to appreciate at 5% per annum, you would only be up by $2,000. By leveraging the bank’s money, you positively impacted your net worth significantly. The reverse is also true which is why some people refer to leverage as a double-edged sword,
You are free to make decisions affecting you.
If you buy stocks, you cannot direct the company’s board of directors to make certain decisions. You are at the mercy of their actions and decisions. However, if you own property, particularly rental property, and homes to flip, you can decide what can and can’t be done with those houses. You call the shots when it comes to which tenants to allow, which property to buy, how much rent to charge, who will manage your property etc. All these are decisions that you make based on what you think will positively affect your property.
Disadvantages of investing in real estate
You are at the mercy of the property market.
If the property market goes down, expect your investment to depreciate with it. If interest rates rise, your income reduces. Fluctuating demographics and volatile economies are factors you have no control over.
High capital and transactional costs
Buying property is not cheap. Not to mention, you need to pay additional costs such as taxes, closing costs, and legal fees, among other charges. Similarly, selling property has transactional charges. When it comes to ease of investing, shares will cost you much less significantly.
Need for management and maintenance
This is especially true for those who invest in actual properties. If you own a property, you are in charge of selecting tenants, asking for rent, and making repairs, among other tasks. You can hire a property manager to do it for you, but this will incur extra costs. Not to mention that tenants aren’t guaranteed, so you may have periods where your property is making no money for you.
Unlike stocks and bonds that you can sell on a whim, selling real estate can be long and drawn out. In case of an emergency, you may have to look elsewhere for other sources of fast money
These days, finding a house is as easy as visiting a Real estate listing like Movoto.com and picking a house. However, you have to do a lot of research to ensure that you are making a productive investment; otherwise, you may lose money in the long run instead of making money. Besides understanding the pros and cons of real estate investing, read about the whole investing process to extract as much benefit from the venture as much as possible.