4 questions to ask before investing in real estate

Investing in real estate is a good way to add some diversity to your portfolio and make a decent profit at the same time. But the rewards don't come without certain risks. Before you start putting big bucks into real estate investments and different rental properties, it's a good idea to ask yourself the following four questions to make sure it's the right choice.

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1. What Kind of Investment Am I Looking for?

There are a few different ways to break into the real estate investing market. Real estate crowdfunding, for example, allows you to invest in private residential and commercial properties with a relatively small amount of money. This is a very passive form of investing that doesn't require you to do anything other than choose a property and provide funding.

Flipping homes or renting out an investment property, on the other hand, are much more hands-on. If you're flipping a property, you'll have to worry about things like hiring contractors and overseeing renovations. If you're doing the work yourself, that'll tie up even more of your time.

With a rental property, you're assuming all of the responsibilities (and headaches) that go along with being a landlord. You could hire a property manager to handle things for you, but you're still going to have to play a more active role in managing your investment compared to crowdfunding or a real estate investment trust (REIT). Ultimately, it's best to make investment decisions based on whether you'd prefer to be an active investor or a passive one.

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2. When Will I Start Seeing Returns?

Real estate investing isn't like trading stocks or buying mutual funds. You're probably going to have to wait a while to see investment returns. For example, if you're putting money into equity investments through a crowdfunding platform, it could take five or even 10 years for your investment to pay off. If you're trying to get rich quick, real estate investing might not be your best bet.

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3. How Liquid Will My Investment Be?

Another factor to consider before investing in real estate is the fact that real estate assets tend to be less liquid than other kinds of investments. With a stock or mutual fund, for example, you can buy or sell your securities within the same day. With real estate, it's harder to unload your assets once you've invested in them.

Putting money into a REIT can offer you more liquidity. But it might take time for you to see the kinds of returns that you want. Bottom line: You'll need to be sure that you don't mind tying your money up in a long-term investment before venturing into the real estate arena.

4. What's My Risk Tolerance?

A certain degree of risk is inherent in any investment and you need to know exactly how much risk you're willing to take on before diving in. With real estate, it's important to recognize that risk levels can vary.

For example, if you're interested in flipping properties, you'll be taking a pretty big gamble. You're assuming that you're going to be able to sell the home at a price that's high enough to recoup your initial investment and make the kind of profit you're looking for. If the market takes a nose dive or you go over budget, your profit margin could shrink or disappear completely.

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In the worst-case scenario, you might not be able to sell the home at all. If you can't find a buyer and you can't afford the mortgage payments, then you could lose the home to foreclosure, along with all the money you put into it.

The Bottom Line

Investing in real estate isn't for the faint of heart. Before taking the plunge, it's a good idea to evaluate individual investment opportunities and take stock of your goals. That way you can figure out where you can afford to invest your money.

Photo credit: ©iStock.com/Kokkai Ng, ©iStock.com/fastfun23, ©iStock.com/MichaelSvoboda

The post 4 Questions to Ask Before Investing in Real Estate appeared first on SmartAsset Blog.

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