Real estate is often a lucrative investment that can provide passive income and long-term capital appreciation, and it can also be a smart way to diversify your portfolio outside of the traditional portfolios of stocks, bonds, and mutual funds.
While a home may be your first foray into real estate investing, there are plenty of other ways to get into the market, from rental properties and home flips to real estate investment trusts (REITs) and online real estate platforms. Here are six investments to consider to diversify your portfolio with real estate.
Buy a rental property
Buying rental properties and renting them out to short-term or long-term tenants is a classic way to invest in real estate. A big benefit of being a landlord is that you can deduct many expenses associated with the property, including maintenance, repairs, insurance, utilities, management fees, mortgage interest, and depreciation.
Of course, rental properties have their downsides: they are expensive upfront and a time-consuming investment. You may have to deal with late payments, property damage, and unruly tenants. Still, with the right property, you can enjoy positive cash flow and long-term capital appreciation. Plus, if you sell your home and exchange it for a “like-kind” property, you can take advantage of a 1031 exchange to defer capital gains taxes.
Rent a room
House hacking is a great way to try your hand at real estate investing. With this strategy, you rent out part of the home you currently live in, like one room, the basement, the attic, or an accessory dwelling unit (ADU). Depending on the condition of the space, the upfront costs can be minimal, and the extra income can help you cover your monthly housing costs while you pay off your mortgage and build equity.
A more advanced house hack is to invest in a multifamily property, meaning you live in one unit and rent out the rest. Whether you're renting out a room or half of a second floor, you can find long-term tenants or, if permitted, open up the space for short-term rentals using an online platform like Airbnb.
Use an online real estate investment platform
Online real estate investment platforms (also known as “crowdfunding websites”) are new in the world of real estate investing. These platforms match developers with interested investors who pool their money to fund real estate projects, starting with as little as $500. In return, investors receive debt or equity in the project, plus monthly or quarterly dividends if all goes well. These investments offer higher potential returns than publicly traded REITs, but they are riskier and generally less liquid, meaning you may not be able to sell your shares quickly.
Some platforms are only open to accredited investors, while others, such as RealtyMogul, offer opportunities to both accredited and non-accredited investors. Investors typically pay an annual management fee ranging from around 0.25% to 2.50% (depending on the platform). Other fees may also apply.
Reselling a house
Flipping houses involves buying discounted properties, renovating them, and selling them at a profit. With the right property, you can make a profit faster than managing a property, but it's not as easy as it looks on TV. To be a successful flipper, you need to be able to see the potential in a property and have the vision to make it happen. You also need ample cash, a team of trusted contractors, and accurate cost estimating skills to ensure you make a profit.
Good project management skills are also a plus: the faster you can sell a property, the less you’ll have to pay in holding costs, such as mortgage payments, utilities, property taxes, homeowners association (HOA) fees, and insurance.
Buy REITs
If you want to invest in real estate without the responsibility and hassle of rental management, REITs are a great option. REITs are companies that own and operate income-producing properties such as apartments, offices, warehouses, medical facilities, hotels, and retail centers. Similar to mutual funds, REITs pool the capital of multiple investors and own a portfolio of assets. Investors purchase shares in the REIT and receive a pro rata share of the income.
A major selling point is that most REITs are publicly traded on a stock exchange, making them an easy and liquid way to gain exposure to real estate. REITs make money by leasing space in the properties they own and collecting rent; investors, in turn, earn money through dividends. By law, REITs must pay out at least 90% of their taxable income as shareholder dividends each year.
Investing in Real Estate Investment Groups (REIGs)
A real estate investment group (REIG) is a club of private investors who pool their money and expertise to buy income-producing real estate. If you want to own rental property but don't want to shoulder the sole responsibility of management, a REIG can be a good option. REIGs leverage the buying power (and experience) of the entire group to invest in many different types of property, including apartments, condominiums, and commercial buildings.
On the plus side, REIGs allow you to learn from other more experienced real estate investors while participating in deals that expand your niche. On the downside, however, membership fees can reduce your benefits, and partnering with an inexperienced or underskilled group can result in a failed investment. Still, if you do your research and find a group that aligns with your goals and risk tolerance, REIGs can be a worthwhile venture.
Timestamp: Real estate investment has great potential
Real estate investment offers many benefits, including stable cash flow, long-term appreciation of your assets, portfolio diversification, tax benefits, capital utilization, etc. Of course, there are also drawbacks, such as lack of liquidity, high upfront costs, and the reality that real estate investment is a long-term struggle.
Still, it's helpful to remember that there are multiple ways to invest in real estate, and some are better suited than others. For example, if you're looking for an investment that gives you direct control and allows you to optimize your taxes, rental properties might be a good option. If you want a hands-off approach and more liquid assets, REITs might be a good choice. If you want the best of both worlds, investing in rental properties and REITs might be a good idea. Ultimately, you don't have to choose just one type of investment.
Ultimately, investing in real estate depends on your goals, risk tolerance, and time horizon, and working with a financial advisor to research your options can help you find the investment that's right for you.
Frequently Asked Questions (FAQ)
How much do real estate investors make?
There's no limit to how much money a real estate investor can make. For example, Donald Bren, founder of The Irvine Company, is said to have made a fortune of $15.5 billion by investing in commercial real estate. Of course, most real estate investors don't achieve such success.
According to data from Nareit, if you invest in equity REITs, you can expect annual total returns of about 6% to 11%, based on performance over the past 50 years. As of July 31, year-to-date returns were 5.03%.
You can also get a job in this field: according to ZipRecruiter, the average annual salary for a real estate investor is $139,851. Ultimately, your earning potential depends on where you live, your investment choices, the number of deals you have, your time commitment, your risk tolerance, your capital adequacy, and sometimes a little bit of luck.
What are the advantages and disadvantages of investing in real estate?
Like all investments, real estate investing has pros and cons to consider. On the plus side, real estate investing offers portfolio diversification, passive cash flow, long-term capital appreciation, and tax benefits such as deductions, depreciation, and capital gains tax deferral. On the minus side, real estate investing takes time, the property can decline in value, income can be volatile, and it can be difficult to sell quickly.
Of course, different types of real estate investments have different risks and rewards, so be sure to do your research before deciding whether a particular investment is right for your goals, risk tolerance and financial situation.
What are the biggest tax benefits of real estate investing?
The tax treatment of real estate investments varies depending on the investment method.
Owning a rental property offers the most tax benefits, including the following deductions:
Mortgage interest. Property and occupancy taxes. Insurance. Maintenance and repairs (improvements must be depreciated). Utilities. Advertising. Legal and professional fees. Travel expenses associated with property management. Home office expenses. Depreciation. Employee and independent contractor wages and salaries. Losses not covered by insurance. Deferred capital gains taxes (from a 1031 exchange). Up to 20% of net rental income (this deduction is scheduled to continue through 2025).
If you rent out a room in your home, the same rules apply, except you can only deduct the expenses associated with the space you actually rent out, not your entire home (similar to how the home office deduction works). For example, if you have a 1,200 square foot home and rent out a 300 square foot room, you can deduct 25% of the cost of your home (300 ÷ 1,200).
The tax treatment of home flipping is complicated and depends on whether the Internal Revenue Service (IRS) considers you an investor or a dealer (we recommend working with an advisor). If you form a limited liability company (LLC), you may be able to deduct certain expenses in home flipping, such as home improvement costs, property taxes, and building permits on the property you sell. However, the cost of capital improvements is generally not deductible. Instead, they are usually added to your basis in the property, which can reduce your capital gains liability when you sell.
While other types of real estate investments don't offer the same tax benefits as rental properties, you are still taxed on your income, dividends, and capital gains. A financial advisor or tax professional can help you optimize your tax strategy to get the most out of your real estate investments.