Want to Invest in Real Estate? Consider REITs

As we continue to mature and focus on our careers, we may start to prioritize building wealth. Many people use retirement accounts and the purchase of stocks and bonds to grow their money over time but there are other ways to build wealth. Another type of investment to look into is real estate. Although there are many different types of real estate investments, one option to consider is real estate investment trusts also known as REITs.

What are REITs? Real Estate Investment Trusts (also known as REITS) are large funds that are full of real estate investments. These investments can be single-family homes, multifamily homes, apartments, or commercial buildings. Just like you can purchase an individual stock from one company, you can also purchase an individual REIT, which is a small share of a company that owns various forms of real estate. I prefer to invest in stocks via index funds and I also prefer to invest in REITs through index funds. A REIT index fund is a large fund full of smaller REITs that are each invested in many different types of real estate. When you invest in REIT index funds you are a partial owner of several different types of real estate investments, just like when you invest in other index funds you are a partial owner of several different types of stocks or bonds.

Why are REITs a good option? REITs are another type of investment option that can help you make a profit on your money, especially the money you have in retirement accounts. Many people use their employer-sponsored 401Ks or IRAs to invest in various types of stocks and bonds. REITs give you a chance to add index funds that are full of real estate deals. Adding real estate to your investment portfolio can make your portfolio more diverse (since you’re adding another investment class), increase your profits (since they have the potential to make you even more money each year), and add increased protection for your investments (since it can shield your money from some of the day-to-day changes and volatility of the stock market).  For example, there may be times when certain stocks and industries lose some of their value, but real estate prices don’t change as often. Regardless of the economy, everyone needs a place to live.

How do REITs compare to other types of real estate? REIT index funds are very large real estate funds full of smaller real estate deals and each of those smaller deals are invested in many different types of real estate. By investing in REIT index funds, you own a small part of hundreds if not thousands of real estate deals. Unlike investing in real estate directly by purchasing homes or buildings alongside other investors or with your own money, when you invest in REITs you are much more removed from the daily operations of the properties. You are not making decisions on which properties to purchase, how to manage/renovate them, or when to sell them. Because you have less responsibility, you make less profit than more direct investors. However, you also have less risk. If one property fails to sell in a timely manner you are not out of hundreds of thousands of dollars. REITs give you a chance to get started in real estate and diversify your portfolio in a safe, less-aggressive, more “hands-off” way.

How do they compare to other types of index funds: REITs are similar to other types of index funds that are full of stocks and bonds. Because they are so similar to these other investments, you can usually add REIT index funds to your retirement accounts or purchase them the same way you purchase other index funds. In terms of investment returns, the percentage return on your profit can vary from year to year, but over a longer span of time, REITs tend to do pretty well. Over the past 5 years, investors who had REITs made over 15% profit on their money, those who invested solely in index funds with stocks made an average of 10% profit of their money. Past performance doesn’t guarantee future returns, but REITs can certainly be a good type of investment to have in your portfolio.

FYI: If you’d like to learn more about REIT index funds check out Vanguard, Fidelity, or other investment institutions. If you’d like to read about individual REIT stocks to consider, check out this article.

5 Steps To Take As You Get Started in Real Estate

1. Determine your niche or area of interest. When it comes to real estate investing there are many different types. Some people choose to buy old homes, renovate them, then resell them at a higher price. Others choose to purchase single family homes and rent them out to tenants for years. While a few others may choose to pool their money together and invest in an apartment building over a certain length of time. Whether it’s one of these 3 methods or another one, the first step to take before you actually invest in real estate is to determine which area of real estate investing would be best for you.

2. Educate yourself on the struggles and achievements of people in that industry. Once you pick a type of real estate investment to focus on, your next step is to educate yourself on the pros and cons of people in that industry. Learn about common mistakes to avoid and hurdles you may have to overcome. If you’re going to invest money into a deal you want to know as much as you can about it and be prepared for the good and bad that may occur. It’s hard to adequately fix an issue you didn’t expect or prepare for, so be proactive. Listen to podcasts, read books, skim blogs, and network with people who have experience in that area so that you can learn from their experiences and increase your chance of success when you start making your own investments.

3. Determine your goals and criteria. Despite our best intentions, not every deal within your target real estate niche will be good investment for you. In order to determine which deals you should invest in and which ones you should pass up, you need some objective investment criteria. For example, some people who focus on single family homes decide to only purchase houses in cities that are close to where they currently live so that managing tenants is a bit easier. Other people who focus on multifamily properties choose to only focus on apartments that are in a certain condition or have a minimum amount of units. Yet and still, other people may be open to different kinds of deals but choose to only invest with certain established investors. Whichever investment criteria you choose make sure you have good evaluation standards as well. Ie. You will only invest if the cap rate is “X” percent or if you have “Y” amount of dollars in cash flow or have an internal rate of return of “Z” or more on your money.  Do some research and determine you investment and evaluation criteria.

4. Write down how you’ll gather money for this investment. Just like it’s important to pick your niche and evaluate the investment correctly, it’s also imperative that you know where you’re going to get the money. Do you have enough saved on your own or will you need to pay the seller in money installments via seller financing? Do you plan to get a mortgage from the bank and pay back the loan over many years or do you plan to use private funds that require repayment much sooner? Do you have friends and family who can help you out or do you have some loan you plan to take out from something else you’ve purchased? There are plenty of options, but you need to at least think about which ones may make sense for you depending on the type of investment you want to make and the appropriate amount of risk you plan to take.

5. Start identifying potential deals and practice analyzing them. Lastly, you need to practice evaluating deals. No one wants to invest a ton of money then lose it all in a bad deal. Practice picking out good deals and evaluating smart investments with people who are more experienced. Ask questions about what made a deal good or bad so you can learn how to more efficiently evaluate deals on your own and reduce that chance that you’ll lose money in an investment. This practice will also make you a little less nervous when you finally do invest money for the first time.  

What do you think? Are you going to take these steps as you get started in real estate?

7 Main Types of Real Estate Investing

There are many ways you can get involved in real estate investing. Before you put money into a deal, you should first learn about the different types of real estate and the various ways to invest in them. While some paths require more time or result in larger profits than others, it still benefits you to familiarize yourself with different strategies so you can find the one that’s best for you. The main types of real estate investing are:

1. Land. Yep, you read that right. Owning a patch of land or an acre of grass, is a type of “real estate” if you will. Some people purchase areas of land they believe will be profitable in the future with the hopes of making more money when they sell it for a higher value. For example, if investors suspect that developers will soon build new homes near an area of land, they might buy that land knowing that its market value will increase as the area develops and increases in value. More often than not, people inherit land, especially when a relative who owned the land passes away. When this happens, people may elect to keep this land in the family as a way to pass on wealth. Other times, people build homes or commercial buildings on the land in the hopes of creating more investment opportunities. Some real estate investors specialize in finding undervalued land and selling it to contractors or other investors for a profit.  I don’t plan to do real estate investing through the purchase and sale of raw land, but many other investors prefer this method.

2. Single Family Homes. When I mention real estate investing with single family homes most people think I am referring to the purchase of a residential home or the renovation of an older home (similar to something they’ve seen on HGTV). As you can imagine, real estate investing is more complicated than that. For starters, the term “single family home” is what real estate investors call a house built for a single family (i.e. a 3 bedroom/2 bath house, a 4bedroom/3bathroom house, or some similar variation). To be a real estate investor with single family homes you don’t just buy a home and live in it. (Doing that simply makes you a homeowner). Real estate investors who focus on single family homes do more than that.

   They can purchase homes below market value (via a foreclosure or through savvy negotiations) and then sell them for a higher price (i.e. wholesaling). They can purchase an old home, renovate it themselves to increase its market value, then sell it to people looking to purchase a new home (i.e. Fix and Flip). They can also purchase a home, renovate it (by adding some modern appliances and newer fixes) and then refinance it with a bank (to withdraw some of the “equity” or value in the house as cash) and sell it. Lastly, people can purchase a home, rent it out to tenants, and use part of the tenants’ monthly rent check to pay off the mortgage in an effort to build wealth long term.

3. Small Multi-family Homes. This refers to duplexes, triplexes, and quadruplexes. Single family homes are built for one family, but small multi-family homes are build for...you guessed it: multiple, smaller families. Usually, it comprises 2-4 “sets” of 2bedroom/2bathroom family homes that are all connected to each other as a single building with separate walls and doors for privacy. Investors who prefer this type of real estate usually purchase or build these small multi-family properties and rent out each unit to a different family. For example, the owner of a duplex will have two different “families” or tenants living in the building (one on Side A and the other on Side B). Each family will pay the owner a monthly rent.

   Another way investors make money from small multi-family homes is to “house hack” or live in one side and rent out the other side. For example, if a real estate investor just purchased a triplex (3-unit multi-family home), he or she may choose to live in one of the units and rent out the other two units. Many investors like this method because it allows them to purchase a property to live in and invest with simultaneously. Plus, small multifamily investing allows them to collect a large amount in total rent money (since they receive multiple checks) without having to purchase multiple homes.

4. Large Multi-family Homes. Technically this refers to multi-family homes larger than 4 units, but usually this is just the fancy term for “apartment buildings.” Believe it or not, apartment buildings aren’t nearly as hard to invest in as people may think. Although it is unlikely that you will have the time, desire, or money to purchase an entire apartment building on your own, most of the times, people invest with others. In fact, most apartment buildings are owned by a group of people. When people decide to put their money together to invest in an apartment as a group we usually call that a “real estate syndication.”

   In real estate syndications you have general partners and limited partners. The general partners act as “active investors” and they are the people who find potential apartment buildings to purchase, evaluate the properties, and secure the financing from the bank. The limited partners act as “passive investors” and they are the people who put some of their money into the deal (along with other people) and leave all the details up to the general partners.

   Together, the general partners and limited partners invest in apartment buildings and tend to make a large profit. The details of real estate syndications can be quite complex, but essentially investors make money by purchasing undervalued apartment buildings. They then increase the value of these apartments by renovating them and raising the monthly rent. After a few years, these investors will either sell the building for a higher price or refinance it with the bank. Either way, the investors make a profit.

5. Commercial or industrial buildings. This type of real estate typically refers to strip malls, warehouses, or commercial buildings (ie. doctor’s offices, grocery stores, etc). Investors purchase these buildings, or build them, and then rent them out to companies or business owners who need the space. It is very similar to renting out a house. Instead of your tenants being ordinary people who want the space to live in, your tenants are business owners who want the space to sell products or services to consumers.

   The lease that tenants sign to rent space in these types of buildings is for a longer period of time (multiple years) and the business owner usually takes care of most maintenance problems and repairs him or herself (instead of calling the owner of the building every time the toilet gets clogged or the lights need to be replaced). As a result, owning these buildings gives you more assurance that you will get your monthly rent regularly and requires much less hassle.

   The downside is that these buildings are expensive to purchase. Unlike apartment buildings, there aren’t nearly as many syndications available. Investors typically purchase the building on their own, or with very few partners, which may cost them several hundreds of thousands of dollars, if not millions.

6. Real estate funds. This is when people put a certain amount of money into a large fund to invest with other people. Unlike real estate syndications, the managers of these funds use the money to invest in a variety of different real estate deals, not just one large deal. These funds are operated through companies and are officially called “real estate investment trusts (REITs).”

   Through these REITs people get to invest in more real estate deals than they would have been able to do on their own. As a result, REITs help investors diversify their investments and protect them from risk. If one real estate deal doesn’t work out, then they can count on the other deals in the fund to protect them from losing money. Many people prefer to invest in real estate using REITs because it is “passive.” You are not someone’s landlord, you do not have to do repairs or collect rent payments. You simply put your money into the REIT and let the manager of the fund handle all the details.

7. Debt servicing. Instead of finding deals, raising money, and managing the property some investors want to be much less involved. They like the high returns and profits that can be made through real estate but loathe everything else. As a result, they may choose to work on the debt side as a private money lender or tax lien investor. A tax lien investor typically pays the property taxes on a home that someone else has failed to pay. In order to prevent the home from going into foreclosure (being seized by the bank or the state), the homeowner must return the property tax money to the tax lien investor who paid them, with interest. Thus, the tax lien investor makes a profit from paying the property taxes of someone else.

   Private money lenders, on the other hand, are investors who loan money to other people that want to purchase real estate deals. Even though many people get loans from banks, real estate deals can be expensive and banks may refuse to loan you all the money you need. For example, a bank may loan someone 70-80% of the purchase price for an investment property, but then require that person to bring in 20-30% of his/her own money. If the person doesn’t have all of the money they need, they may choose to seek a private money lender instead. Typically private money lenders are sought out by people seeking to renovate an old home and sell it within a few months. Many wealthy people prefer to be private money lenders because they can get their money back much quicker and often times they can make a much larger profit lending the money at a high interest rate than they would have made if their money just sat in a savings account.

To Summarize, there are many different types of real estate. Your first step as a real estate investor is to familiarize yourself with each of them so that you can choose the route that is best for you. You can buy land on which to build or purchase it with plans to sell it to someone else. You can focus on single family homes and seek to rent them out, purchase them wholesale (for a low price) and sell to someone else for a higher price afterwards, or fix and flip them. You can try to house-hack, rent out small multifamily deals, or instead choose to focus on apartment buildings through real estate syndications. Once you have a decent amount of money, you may want to look into commercial and industrial buildings that you can rent out to other business owners. If you want to be much more passive and invest some of the retirement money you got from your job, REITs might be good option. Lastly, you can choose to be more on the debt side and invest in real estate through the purchase of tax liens or by being a private money lender. As you can see, there are many ways to invest in real estate. These are just some of the main types. All you need to do is pick the route that best fits your goals and lifestyle.

Tell me, which route of real estate investing do you think would be best for you? What questions or concerns do you have before getting started?