Real estate can be a fantastic way to invest. Property investments have tremendous return potential and diversify your portfolio to protect you from recessions and other adverse financial conditions. But what’s the best way to invest in real estate?
There’s no single right answer. You have to look at the best options and decide which will work for you. There are several ways to invest in real estate, each with different capital requirements, risk levels, and investment dynamics. Here’s a rundown of the 9 Ways to Invest in Real Estate and Create Multiple Streams of Income
1. Real estate limited partnerships
A real estate limited partnership (RELP) provides investors with a diversified portfolio of real estate investment opportunities, allowing you to merge your funds with other investors to buy, lease, develop, and sell properties that would be hard to manage or afford independently.
Like REITs, RELPs usually own a pool of properties, but they differ in their structure and organization. Primarily: RELPs are a form of private equity – that is, they are not traded on public exchanges
Instead, they exist for a set term, which typically lasts between seven and 12 years. During this term, RELPs function like small companies, forming a business plan and identifying properties to purchase and/or develop, manage, and finally sell-off, with profits distributed along the way. After the holdings are all dispatched, the partnership dissolves.
They’re generally more suitable for high-net-worth investors: Most RELPs have an investment minimum of generally $2,000 or above, and often substantially more – some set minimum “buy-ins” anywhere from $100,000 to a few million, depending on the number and size of the property purchases.
2. Use an online real estate investing platform
If you’re familiar with companies such as Prosper and LendingClub — which connect borrowers to investors willing to lend them money for various personal needs, such as a wedding or home renovation — you’ll understand online real estate investing.
These platforms connect real estate developers to investors who want to finance projects, either through debt or equity. Investors hope to receive monthly or quarterly distributions in exchange for taking on a significant amount of risk and paying a fee to the platform. Like many real estate investments, these are speculative and illiquid — you can’t easily unload them the way you can trade a stock.
The rub is that you may need money to make money. Many of these platforms are open only to accredited investors, defined by the Securities and Exchange Commission as people who’ve earned income of more than $200,000 ($300,000 with a spouse) in each of the last two years or have a net worth of $1 million or more, not including a primary residence. Alternatives for those who can’t meet that requirement include Fundrise and RealtyMogul.
3. Build a new home on spec
This is like fixing and flipping houses in terms of investment dynamics, but with the obvious additional step of building a house from scratch. Building a spec home can be an especially lucrative investment strategy in markets with a limited supply of new homes to choose from.
In several ways, building a spec home can actually be less risky than fixing and flipping an existing house. You generally know what new construction is going to cost — you don’t have as much potential to run into unexpected repairs as you would with fixing and flipping.
On the downside, spec houses are more time-consuming. It generally takes a couple of months to fix up an existing home, but it can take a year or more to build a house from scratch. Be sure your returns justify the increased time commitment, as you can potentially complete several fix-and-flip projects in the time it takes to build one house from the ground up. The longer timeframe also creates the additional risk factor of market fluctuations. Your real estate market might be hot right now, things can change quite a bit in the year it takes you to build a house.
4. Syndications and Silent Partnerships
In real estate syndications and silent partnerships, you put up money but don’t actually do any of the work of finding deals or managing properties. Instead, the principal partner or “sponsor” does the work and gets an extra cut of the profits for their trouble.
Syndications typically involve large commercial properties. The sponsor finds a good deal, then raises money from investors to fund it. As part of the deal, the investors surrender all decision-making power and oversight to the sponsor.
For that reason, syndications would fall under SEC scrutiny — if they opened investment to the public. So they almost never do, instead only allowing accredited investors to participate.
The rest of us non-accredited investors can instead invest the money as silent partners with friends, family members, and other people we know personally. If your brother-in-law flips properties on the side of his full-time job, you can form your own LLC with him with whatever rules you like.
But entering a silent partnership does require you to know and trust the real estate investor. Otherwise, don’t expect to sleep soundly at night with few safeguards in place to protect your money.
5. Real estate crowdfunding
Real estate crowdfunding is a strategy that allows enterprises to raise capital from large groups of individuals. It’s done via online platforms that provide a meeting ground/marketplace between real estate developers and interested investors. In exchange for their money, investors receive debt or equity in a development project and, in successful cases, monthly or quarterly distributions.
Not all real estate crowdfunding platforms are available to everyone: Many are reserved for accredited investors – that is, high-net-worth, and/or highly experienced individuals. Still, there are several less exclusive platforms like Fundrise and RealtyMogul that allow newbies to invest as little as $500.
Through these sites, you create an account and either select a portfolio strategy based on your goals, with brokers diversifying your money across a series of investment funds, or browse and select investments yourself, keeping up with their progress a 24/7 online dashboard.
Despite their convenience, crowdfunding offerings come along with considerable risk. As private investments, they’re not as liquid (easily sold) as other publicly traded securities, like stocks. Think of your funds as being tied up over the long term. Fundraise recommends investors have a time horizon of at least five years, for example.
Wholesaling properties is often misunderstood by people new to the world of real estate investing. It involves finding a great deal, putting it under contract, and then selling that contract to another investor with a profit margin. You never take title to the property; you merely connect an eager seller with a willing real estate investor.
For example, say you find a property worth $150,000 and you get it under contract for $110,000. You reach out to your network of investors and offer them the property for $125,000. When you find a taker, you assign the contract to them.
The investor gets a $150,000 property for $125,000, and you get a $15,000 fee — all without having to hassle with financing, closing costs, renovations, tenants, or real estate agents.
Sound too good to be true? It’s not. Finding deals this good takes a lot of work, and so does building a network of real estate investors who trust you not to sell them bad deals. And then there’s the risk of failing to find a buyer, which leaves you stuck between breaking your contract or buying the property yourself.
Still, it offers a great side gig to earn money while you learn some of the fundamentals of real estate investing before you’re ready to start buying properties yourself.
7. Buy a vacation rental
A vacation rental is different than a long-term rental property in a few key ways. On the positive side, you may be able to use the home when it isn’t occupied. It can also be significantly easier to finance a vacation rental, especially if it meets your lender’s definition of a second home and you don’t use the rental income to qualify. Finally, a vacation rental tends to bring in more income per rented day than a comparable long-term rental property.
However, there are some potential drawbacks to owning a vacation rental. Marketing and managing a vacation rental is more involved than a long-term rental. As such, property management is far more expensive — expect to pay a property manager about 25% of the rent on a vacation rental. That’s more than double the 10% industry standard for properties with long-term tenants.
Furthermore, you might not be allowed to rent out properties in your preferred locations — or you might need a special license, which can be very expensive. And it can be easier to get second home financing, but you’ll need to qualify for it based on your existing income, not your anticipated rental revenue.
8. Opportunity Zone Funds
At the obscure end of the real estate investing spectrum lie Opportunity Zone Funds. These funds were introduced by the Tax Cuts and Jobs Act of 2017, which specified roughly 8,700 Qualified Opportunity Zones to target for economic stimulation. The idea is simple: encourage investment in struggling areas by offering tax breaks to invest money in them.
Opportunity Zone Funds are private equity funds. An experienced commercial real estate investor raises money from accredited investors, then uses the money to buy real estate in Qualified Opportunity Zones. Because these zones are impoverished, it raises the risk of investing in them. In return for that heightened risk, investors get preferential tax treatment, including deferral of some or all capital gains tax through 2026.
Only accredited investors qualify, and besides, the tax breaks only really justify the higher risk for wealthy investors with higher tax liability. Mom-and-pop investors need not apply.
9. Invest in a REIT or other real estate stock
Real estate investment trusts, or REITs, can be an excellent way to invest in real estate. If you’re not familiar, check out our introductory guide to REITs. But here’s the quick version: REITs are specialized companies that own, operate, manage, or otherwise derive their income from real estate assets. Many REITs trade on stock exchanges, so you can buy them with the click of a mouse and very little capital.
I’d also put real estate mutual funds and real estate ETFs in this category. If you don’t want to choose just one REIT, you can invest in a ready-made portfolio of them. The Vanguard Real Estate ETF (NYSEMKT: VNQ) is one excellent example of a real estate ETF that can help you get real estate exposure.
It’s also important to mention that some real estate stocks aren’t classified as REITs. Land developers and homebuilders are two other ways to invest in real estate through the stock market.
Conclusion: Like all investment decisions, the best real estate investments are the ones that best serve you, the investor. Think about how much time you have, how much capital you’re willing to invest and whether you want to be the one who deals with household issues when they inevitably come up. So whenever you think of real estate, you almost always have to think of it as a long-term investment.