How To Invest In Real Estate: Your Guide to Getting Started

On the surface, real estate investing seems fairly straightforward. You buy a house, sit back and wait for the market to increase its value. Or you rent it out and wait for the rent checks to roll in. In practice, however, neither is as simple as it sounds, but those aren’t the only ways to invest.

See: 3 Things You Must Do When Your Savings Reach $50,000

Before jumping into real estate, it helps to know more about your options and what to do before you invest.

How To Invest In Real Estate

You invest in real estate when you purchase a property or a security derived from property to generate returns. How you proceed depends on how you want to invest, how much money you have to invest and your risk tolerance.

Some of the more popular ways to invest include:

• Buying physical real estate

• Investing in real estate securities

• Joining real estate investment groups

• Crowdfunding

• Wholesaling

Physical real estate investing entails purchasing property and using it to generate income and/or allowing it to appreciate so that it’s worth more than you paid for it. Physical real estate is a direct investment — you own the property, with no third party between you and it other than the lender, if you have one.

However, real estate investments can also be indirect — rather than own the property itself, you can buy shares of a company that owns real estate. Indirect investments are truly passive, and you can start at a much lower cost.

1. Residential Rental Properties

Buying a home and renting it to tenants is one of the most common ways to invest in physical real estate. One reason is that you can earn a return on your investment in two ways: by collecting rents now and, over the long term, through appreciation of the property’s value.

Rental property owners have two choices for how to rent: long-term, to residential tenants, or short-term, to transient guests such as vacationers or business travelers. It’s important to check your local zoning laws before you buy to make sure the property is zoned for your intended use.

You can manage the property yourself or hire a property management company to manage it for you. A property manager’s fees will eat into your cash flow, but turning over day-to-day operations greatly reduces the amount of time you have to spend maintaining the property and the relationship with your tenant.

2. Commercial Real Estate

With more money, and more risk in exchange for potentially bigger profits, you can buy and rent commercial real estate instead of residential properties. Commercial properties are those that businesses use — retail stores, offices and storage facilities, for example — as well as apartment buildings.

Commercial properties tend to generate higher returns than residential properties do, and because your tenants are other business owners, the relationships can be easier to manage than with residential tenants.

Another benefit is that commercial tenants typically pay the property tax and other expenses related to the property.

On the downside, managing a commercial property is more complicated than managing a residential one. Whereas basic handyman and bookkeeping skills keep you on track with a residential rental, administrative duties and maintenance tasks that keep commercial properties operating smoothly require specialized knowledge and expertise, which means you’ll likely have to hire it out.

A real estate agent with experience in commercial real estate is an invaluable partner when it comes to choosing commercial properties.

3. Property Flipping

Property flippers buy distressed homes, fix them up and attempt to sell them for more than they’ve invested.

The biggest challenge of property flipping is finding suitable properties priced low enough to be profitable — and correctly determining what work they need before you buy. The ideal flip is a house that is available for well under the after-sale value and that you can renovate quickly and inexpensively before listing it for sale. For that, flippers look to invest no more than 70% of the property’s after-repair value, which means they have to buy properties at bargain-basement prices.

Your success as a novice flipper depends on assembling a strong team of professionals who can help you find, evaluate and renovate the properties. They typically include a buyer’s agent, a mortgage lender, if you’re planning to finance the purchase, and an experienced contractor who can identify the home’s defects, accurately estimate repair costs and resolve the issues. Mistakes can be costly, both in terms of the renovation and the carrying costs of holding the property — loan payments, taxes and utilities, for example.

4. House Hacking

The term house hacking means generating income from your own home while you’re living in it at least part time. Some forms of house hacking, such as renting out a spare bedroom to a roommate, are not investments. Other types do require an outlay of cash that you hope will generate a profit.

Here are some examples of house hacking:

• Multifamily housing: Purchase a multifamily property or, if local zoning and codes allow, convert your single-family home to one with two or more individual living units. You live in one unit and rent out the rest so that your tenants pay the expenses while your home appreciates.

• Accessory dwelling unit: If your property is zoned for it, you can build a small, separate home, sometimes called a tiny house or granny flat, in your yard and rent it to a tenant or short-term guests.

• Live-in flip: Investors who don’t mind living in a construction zone, and with little in the way of personal belongings, can increase their projects’ profitability by living in their flips. That way, you save the cost of owning and maintaining one home while you’re flipping others.

5. Real Estate Investment Trusts

Real estate investment trusts, or REITs, are companies that own portfolios of income-generating real estate and related assets. A REIT can own just about any type of real estate that produces income, including multifamily dwellings, shopping centers, commercial office space, or debt instruments like mortgages and loans. Investors can purchase shares in REITs in the same way they purchase stocks and receive a portion of the trust’s income as a dividend.

The safest REITs to invest in are publicly traded REITs, which are registered with the Securities and Exchange Commission and traded on stock exchanges. Non-traded REITs may be SEC-registered, but they don’t trade on an exchange and may be hard to sell if you want to get out of the investment. Private REITs are neither SEC-registered nor traded on a stock exchange.

REITs return at least 90% of their taxable income as dividends to shareholders and often produce higher yields than dividend stocks.

6. REIT Mutual Funds

Mutual funds pool money from many investors and invest it in a basket of securities — in this case, REITs. Fund managers select which REITs the mutual fund will invest in, and they buy and sell shares to meet the fund’s objectives.

REIT mutual fund prices are not set until after the markets close, so mutual funds are generally traded outside of market hours. These real estate investments are excellent for investors who don’t have time during the week to trade. They can work with buy-and-hold strategies as well.

7. REIT Exchange-Traded Funds

REIT exchange-traded funds are similar to mutual funds in that they also pool investor money to purchase shares. Traded electronically through an exchange on trading days, the same way stocks do, REIT ETFs provide an easily accessible and affordable way for you to invest in real estate.

REIT ETFs trade using real-time pricing, so they’re a better choice than mutual funds for investors who actively trade during the day.

8. International/Global REITs

A type of real estate investment with more risk, global REITs let you invest in foreign real estate. The risks of global REITs are numerous — in addition to the normal risks of real estate investing and investing in general, you’d need to understand the foreign policies, economic factors, taxes and global influencers of the countries that can be invested in.

Global REITs aren’t necessarily invested in physical real estate in emerging economies or foreign countries. Many are heavily invested in retail, development, residential and industrial properties, while others are invested in lodging and resorts.

9. Real Estate Investment Groups

You can find real estate investment groups or partnerships for investing. Although they require a significant buy-in, time and maintenance funds, they also give you the opportunity to network with other investors.

A real estate investment group is a private group of investors who pool their funds to buy and manage real estate. The REIG’s managers, who typically are real estate professionals or experienced investors, are responsible for finding investment-worthy properties, negotiating the sales, managing the properties and, perhaps, ultimately selling them.

There are no set requirements for how a REIG must be structured — group members might choose to form a limited liability company or partnership, for example.

REIGs offer a passive way to invest while learning from the experienced professionals who manage the group. However, you likely won’t have much say in the properties managers select, nor will you be able to immediately cash out your investment like you can with REITs that trade on a stock exchange. In addition, the minimum investment might be steep compared to a REIT.

Investors interested in REIGs might benefit from exploring their local chapter of the National Real Estate Investors Association, an advocacy group. Local REIA chapters provide educational resources and events as well as networking opportunities for new and experienced investors.

10. Real Estate Crowdfunding

Online real estate crowdfunding platforms let you join in on the investing game — in some cases, for much less than you might need with one of the other investment types.

With crowdfunding, money is pooled together for usually out-of-reach investment types like commercial or larger residential properties. Buy-ins can be low and fees modest.

Crowdfunding platforms structure opportunities in different ways. The investments might consist of notes, where your investment is a loan to a developer, property flipper or other investor looking to raise funds for a project. Others are private REITs that purchase income-producing properties.

The primary thing crowdfunding platforms have in common is that they provide access to private market investments not usually available to the everyday investor. However, some do require that investors be accredited, which means you have a net worth of at least $1 million and income of at least $200,000 ($300,000 for married or married-equivalent couples) over the last two years and at least that amount anticipated for the current year.

11. Real Estate Wholesaling

Some investors earn profits by selling purchase agreements for real estate instead of the real estate itself. The wholesaler acts like a buyer would going into the sale, submitting an offer and, after the offer has been accepted, making an earnest money deposit. But rather than follow through to closing, they sell the sales agreement to a buyer who then closes on the sale. The wholesaler never owns the property. They make their money by adding a fee to the contracted price of the home.

Successful wholesaling requires only a modest amount of cash to make the earnest money deposit. More importantly, the wholesaler should have a buyer waiting in the wings or else risk having to back out of the sale and forfeiting their earnest money. And, of course, they have to put the home under contract for less than it’s worth to leave themselves room to add their fee.

Steps To Take Before Investing In Physical Real Estate

There are several ways to get your hands on real estate for investing purposes. How you do it depends on the type of investment, your risk tolerance, your investing strategy and how much available capital you have. However, there are some steps that you should take before you invest a significant amount of money in physical real estate.

1. Know What You’re Getting Into

You’ll need at least a basic understanding of how to evaluate investment properties for cash flow potential and profitability. It’ll also be up to you to make sure a property is zoned for your intended use. If you’re planning to rent to tenants, you’ll need to know landlord-tenant and fair housing laws as well.

2. Review Your Finances

Take a close look at your finances to make sure you’re ready to invest. You should have ample cash reserves above the amount you plan to invest in case you are stuck with a property longer than you expect, have to do more extensive renovations than you intended or have periods of vacancy.

3. Build a Team

Find an experienced real estate agent to serve as your buyer’s agent, and also connect with lenders — banks and/or credit unions as well as private money lenders — that can help you explore financing options. If you’re flipping properties or planning to buy a distressed property to renovate and rent, you’ll also need a reliable contractor.

What To Consider Before Investing In Real Estate

If used wisely, real estate investments can diversify your portfolio, generate gains and hedge your other investment risks. However, real estate is never a sure thing, as the world learned during the financial crisis of 2008. The crisis was caused, in part, by real estate investors who became greedy. Mortgages were given on a widespread scale to people who didn’t have the means to pay them back, and financial institutions created securities from these mortgages, which had a very high risk of defaulting — and many of them did.

With that in mind, find real estate investments you can trust from reliable sources like licensed real estate brokerages and licensed securities brokers who are vetted and approved by the Securities and Exchange Commission.

Scott Nevil contributed to the reporting for this article.

This article originally appeared on GOBankingRates.com: How To Invest In Real Estate: Your Guide to Getting Started