The earth, they no longer make it. This is why investing in real estate has paved the way to wealth for many of the world’s top fortunes. Even those who made their money elsewhere invested in real estate. For example, Bill Gates is the largest private owner of farmland in the country. If you’re thinking about real estate investments, here’s what you need to know before you take the plunge.
Benefits of investing in real estate
Real estate is the classic way to build up wealth. Leased assets generate a steady stream of monthly payments. The owner must pay the mortgage, property taxes and maintenance costs. However, net cash inflows should prove significant.
Real estate creates equity. Most real estate increases in value over time. This provides a hedge against inflation. Of course, real estate can lose value. This is especially true if you bought the property at the peak of the market during a housing bubble. When this bubble bursts, it can take years before the property is worth what you paid for.
Investing in real estate offers tax advantages. For example, if you receive rental income from a dwelling, you can deduct various expenses. These include:
- Mortgage interest
- Property taxes
- Operating Expenses
- Management travel expenses
Then there is depreciation. Commercial buildings and fittings are depreciated over 39 years. You can deduct 1/39 of the construction and improvement costs for this period annually. Rental residential real estate typically depreciates at a rate of 3.63% for 27.5 years. Depreciation begins as soon as the asset is leased. The land is not depreciable, only the value of the buildings.
Disadvantages of investing in real estate
Although there are exceptions, investing in real estate is not a get-rich-quick business. First, you need considerable capital to get started. And these funds are usually tied up for a long time.
Maintenance is required. Lack of maintenance devalues the property and can lead to hazards. You never know when a maintenance issue may arise, and it’s often costly. Leaky roofs, burst water pipes, lack of heat, and similar issues all need immediate attention.
Investing in real estate means managing those investments. If you can’t do it yourself, you can hire a property management company. Keep in mind that these eight to ten percent rent payments eat into your profits. Even so, you will spend time checking in with the property manager regularly.
Real estate is not a liquid asset. If you have to sell quickly, you could sell at a loss or end up losing the property in a sheriff’s sale if the mortgage and taxes aren’t paid. Many real estate investors seek out such distressed properties to get the best deal. It’s good for them, but not for the owner who had to unload the package.
With real estate ownership comes the risk of liability. A tenant or guest can sue the landlord if they are injured on the property. Fortunately, investors can purchase homeowner’s insurance policies to protect themselves and their assets.
Extreme due diligence is required before purchasing a property. This is true whether you are buying an existing building or greenfield land. This particularly applies to tenants. Whether you invest in commercial or residential real estate, there is always the possibility of ending up with the tenant from hell.
One of the easiest ways to start investing in real estate is to buy shares in a real estate investment trust. REITs allow individuals to buy shares of income-producing real estate. These properties form part of the REIT’s investment portfolio. A big advantage of some REITs is liquidity. As these are publicly traded, shares are bought and sold like stocks. Buy REITs from a broker. As with many stocks, investors must pay dividends and capital gains on their REIT income.
There is a caveat. Not all REITs are publicly traded. Non-traded REITs are illiquid. They are not easily sold on the open market. The stock value of non-traded REITs is often difficult to discern. Generally, REITs that are not publicly traded do not have to provide an estimate of per-share value until 18 months after their offering closes. This means that you cannot gauge the stock price or the volatility of your investment for a significant period of time.
Types of property for investment
Residential rental property investment refers to the purchase of single-family homes or semi-detached homes. With the latter, the owner can live in one unit while renting out the other units. These properties are small. And usually consist of two to four units. In other words, these are properties that the owner could manage himself.
Other types of residential real estate are similar to commercial real estate investing. This includes investing in apartment complexes and retirement homes.
Investing in commercial properties has a higher income potential than investing in residential rentals. Commercial property tenants are generally businesses. Thus, the relationship between landlord and tenant is generally more professional than that of a residential tenant.
Commercial properties include:
- Mixed use
- Shopping centers
Many real estate investors start out as homeowners. In addition to buying rental properties, some landlords are looking for properties for sale that already have tenants in place.
Online real estate market company Zillow has advice for those considering going down the landlord route. First, find rental properties within your budget and without the need for major repairs. Perform calculations to ensure that the return on investment is potentially high.
Always budget for unexpected expenses, including tenant delinquency. Also, remember that you still have to pay expenses even if the unit is empty. Understand your local landlord-tenant laws, which vary by state. You need to know what you can and cannot do in the event of a tenant dispute.
After making sure the property is ready to move in, start advertising for tenants. Always perform a thorough background and credit check on any applicant. Have a real estate lawyer review your lease before the tenant signs it. Keep the property maintained.
Investing in Real Estate Considerations
Investing in real estate takes a lot of time and effort. You can make a lot of money, but you will put a lot of work into it. Even if you’re not a hands-on manager and don’t hire professionals, there’s still a lot of oversight needed. However, you could very well have a property that provides you with a stable income and produces a substantial profit when it is sold.
Jane Meggitt specializes in writing about personal finance. In addition to investing and planning for retirement, she writes about insurance, real estate, credit cards, estate planning and more. His work has appeared in dozens of publications, including Financial Advisor, Zack’s, SF Gate and Investor Junkie. A graduate of New York University, Jane lives on a small farm in New Jersey’s horse country.