Are you beginning to dip your toes into real estate investment, but you’re not sure where to start? Do you have a future dream of earning passive income and gaining even more financial independence? You’d be surprised to learn that there are a variety of real estate investment avenues that don’t just involve becoming a landlord.
5 Types of Real Estate Investment
Read on to learn all about the different types of real estate investment you can get involved with today!
1. Fixer-Uppers (Fix and Flip)
If you’re a novice to investing in real estate, this is one of the most appealing options for you but also one of the most difficult. The name of the game is to purchase cheap properties that are in need of some major renovation, then contract the work and hopefully flip it for a higher price. You also have the option of keeping the property for rental revenue.
This isn’t recommended for complete novices because you need to have a good idea of the local housing market. You’ll also need to have a reliable crew composed of:
- An experienced appraiser
- Title and settlement company
- Skilled contractors
An appraiser will help you discover problems in the home that you may not have noticed. This can help you determine whether it’s even worth renovating.
According to Attom Data, homes in the third quarter of 2019 created a gross profit of $64,900, about 40.6% ROI. Home flippers take about 177 days from buying to flipping the home.
Just remember, the profit from fix-and-flip houses that are owned less than a year get taxed as active income at federal tax rates that can go as high as 37%. In contrast, profit made from properties held for one-year or longer benefit from much lower capital gains lower tax rates of only 0 to 20%.
2. Long-Term Residential Rental Properties
As we look at the different types of real estate investments, owning rental properties is probably one of the most common ways to earn passive income through real estate investment. If you own a building with four units or less, this is considered a long-term residential rental property.
With this approach, you’ll be able to enjoy the passive income of renters turning in their monthly rents. Even better, you can take advantage of tax benefits as your property depreciates.
However, you also need to become a landlord when you own rental properties, and this means keeping the building well-maintained and making sure you conduct the proper background checks on your renters.
You do have the option of hiring a property manager that can make your life far easier, but they typically take a percentage fee out of your monthly rent for their services.
3. Commercial Real Estate
Commercial real estate investments come in several different shapes and forms. These can include:
– Housing units with more than 4 units – Most commonly, these are multi-family apartments.
– Mobile home parks (MHP) – Communities of people living in mobile homes who rent sections of land with electrical and water connections.
– Industrial properties – Properties that are rented by companies who require industrial capacity for storage, shipping, manufacturing or other types of industrial applications.
– Office properties – Properties that are rented by companies who require office space. For example, an HR firm, dental office, law firm, or medical practice would rent this type of space.
– Retail properties – Properties that rented for retail purposes. Retail is defined as the sale of goods to the public for direct use (not re-sale).
– Income-Producing Land – In some cases, land that produces income can qualify as commercial real estate investment. Examples of this would be pay-to-park lots, land with mineral rights, pastureland, timberland, and recreational land.
3. Vacation Rentals
Vacation rentals can be an intelligent approach if you have a good idea of the area your rental is in and its nearby amenities.
Owning a vacation rental means your taking a step into the hospitality industry, so along with having a well-maintained, clean building, you also need to provide vacationers with the items a hotel would normally provide such as:
- Beautiful interior decor
- Freshly laundered linens
- Coffee maker
- Cooking utensils
- Internet access
- Access to washer/dryer
- And more
Vacation rentals give you a lot of flexibility because you have the option of renting out your own home or second home while you’re on vacation. However, the vacation rental industry is highly competitive, so you’ll need to find ways to make your property stand out.
You also need to be prepared for renters who don’t follow your rules and make it harder to clean up the property when they’re gone.
4. Real Estate Investment Trusts (REITs)
If you’re not ready to invest in a property or deal with the everyday hurdles of maintenance and renovation, then a real estate investment trust might be an option for you. This allows you to invest in shares of companies that own real estate.
With this approach you can enjoy substantial dividends, because REITs need to return a minimum of 90% of their taxable income to shareholders every year. You also won’t find yourself trapped in mortgages or feel the need to sell your property in order to get access to cash.
You have the option of easily selling your shares on the stock exchange if you’re ever in need of cash.
The downside of this approach is that you won’t benefit from the tax advantages traditionally associated with real estate and you can’t leverage your money — that is, use a mortgage to control a larger asset than you could purchase for cash.
It also means that you’ll be trading one paper asset (money) for another paper asset (shares of the REIT), which I don’t prefer to do. As often as possible, I prefer to store and multiply wealth in form of hard (tangible) assets.
5. Crowdfunding Platforms
Crowdfunding platforms are similar to real estate investment trust, but they can bring you higher returns and also higher risk. On many platforms, you’ll need to be an accredited investor. In the United States, this means:
- Your net worth is at least $1,000,000 excluding primary residence value
- Income of $200,000 each year for at least two years
- Expectation to make $200,000 in the current year
If you’re not accredited, there are other platforms that allow unaccredited investors to invest with them on untraded REITs, meaning they’re not traded on the stock exchange. An example of this is the real estate fund, Fundrise.com. It is an e-REIT that does not require you to be accredited and requires a minimum investment of only $500.
Similarly, Cardone Capital is a company that got approval from the U.S. Securities and Exchange Commission to open two real estate investment funds to unaccredited investors. It requires a minimum investment of only $5,000.
The downside of crowdfunded real estate is that you may need to invest your money for a manner of years. Meaning, your investment won’t be as liquid.
Remember that many of these crowdfunding platforms are relatively new, so it’s important that you do your research beforehand so you find a reputable one.
Types of Real Estate Investment for Passive Income
Now that you understand the different types of real estate investment, you know there’s no best type to pursue. It all depends on your experience with real estate, your expectations, how hands-on you want to be during the process, and whether you need your investments to be liquid or not.
For instance, if you need frequent access to your cash, then a real estate investment trust would make more sense than managing a rental property. However, if you have experience in your local housing market and are willing to roll-up your sleeves, then flipping homes or operating long-term rentals could earn you a good chunk of change.