There are several reasons why you might invest in real estate: tax benefits, a passive income stream, and the potential for higher returns than the stock market.
You may already know someone that is living entirely off of their passive real estate income, and wonder how on earth they manage to do it. While real estate is one of the most common investments, there are many different ways to invest in real estate beyond the traditional option of becoming a landlord and managing tenants.
Choosing the right real estate option for you is like choosing a college major. You have to identify your strengths (are you organized and mentally prepared to take on tenants?
Or are you better equipped to invest cash in a trust?) and weigh out your options while considering what path might be best for your future. Just like a college major, no two options will be exactly the same, but some options can align better with your situation and investing goals.
To reap the benefits of passive real estate investing, it’s a good idea to learn about the advantages and drawbacks of each investment.
Here are 15 different ways that you can invest in real estate, including pros and cons to help steer you in the right decision.
Direct ownership of a property can be held by an individual owner or a group of owners. The group can be a few owners that are structured as a partnership or syndication (where a sponsor puts together and buys the deal and you invest as a limited partner).
Direct ownership is the most common way of owning real estate. It’s the most straightforward way to get into the real estate game if you’re just starting out with your investments.
Single Family Homes
A single family home is constructed on a single lot with no shared walls.
Pros: This type of property attracts more financially-stable and responsible tenants that tend to stay long term. It also typically has more square footage and privacy than a condo or townhome.
Cons: As the owner, you are responsible for all maintenance costs. Also, you’ll have to cover the mortgage payments if the property is vacant.
A duplex/triplex/quad or any building with 4 units or less.
Pros of Multi-Family Buildings
These buildings tend to have the best potential to generate positive cash flow because if one sits empty, you’ll still be collecting rent from the other units.
Cons of Multi-Family Buildings
You have to deal with more tenants and potentially higher maintenance costs.
Buildings with 5 or more units are considered a commercial loan. These have a totally different set of lending standards and qualifications compared to the previous options. This option is popular with syndications as the investors work with a professional operator to ensure the building is well managed, eventually selling the building to collect a tidy profit at the end of the term.
Pros of Apartments and Condos
There is a greater income potential than residential properties because you are generating rent from a lot more units.
Cons of Apartments and Condos
This requires robust building management, so hiring professionals is a must for this type of property.
Investing in Retail
The city can zone commercial real estate property for business uses such as offices, restaurants, hotels, gas stations, and even hospitals. A triple net lease may be in place. A triple net lease (NNN) is where you own the building and the land, and the business pays all real estate taxes, building insurance, and maintenance fees.
Pros to Retail Properties
Leases are typically at least 3 years long and can go up to 25 years under a triple net lease.
Cons to Retail Properties
Finding tenants can be difficult if the retail property is in a less-than-ideal area.
Zoning for commercial use can allow the owner to have a mix of residential and commercial uses such as offices, restaurants, and warehouses.
Pros to Mixed Use Real Estate
You can enjoy having a variety of property uses as they might come with longer leases and higher rental income.
Cons to Mixed Use Real Estate
Trying to understand each commercial use may prove to be more troublesome than its worth, so it’s likely you’ll have to find management to help maintain the property.
These properties are typically used as warehouses for storage or manufacturing.
Pros to Industrial Properties
Industrial properties usually need very little management and have proved to be a steady source of income.
Cons to Industrial Properties
It’s not always easy to find a tenant for this type of property, so you might find it empty for a while after a move-out.
Self Storage Units
People have a lot of stuff with very little storage space in their homes, so self-storage units have been cropping up in cities everywhere.
Pros of Self Storage Units
You don’t have to deal with standard tenant complaints like a noisy neighbor or plumbing problems.
Cons of Self Storage Units
The business is built solely around customer service, so prepare to take on some customer management duties or hire someone to deal with it on your behalf.
Mobile Home Parks
Affordable housing options like mobile home parks are a popular investment during economic downturns. These types of properties are usually funded with crowdfunding or pooled investors.
Pros of Mobile Home Parks
Mobile home parks don’t experience a high tenant turnover, so you won’t have to deal with constant move-ins and move-outs.
Cons of Mobile Home Parks
These can be quite expensive to obtain and securing a loan can be difficult for these types of properties.
Depending on your local laws, you can rent out your property (or even just a room) for a short-term while you’re away on vacation or a business trip. Services like Airbnb make it easy to run a profitable short-term rental business.
Pros of Short-Term Rentals
The rate per night is often higher than a long-term stay, so you’d make a pretty penny if you can rent it out for the majority of the month.
Cons of Short-Term Rentals
Running a short-rental business is very hands-on - having to deal with several renters moving in and out each month can be stressful, so many owners hire a property manager to deal with their rentals.
Investing in Land
Some people like to buy land in areas that hold future potential, so when the area gets popular, they can sell off the land for a profit.
Pros of Investing in Land
You won’t have any tenants (and headaches that come with it) to deal with.
Cons of Investing in Land
Land often doesn’t appreciate, and land won’t provide any positive cash flow unless you set up a billboard or some other way of collecting income.
Real Estate Investment Trust (REIT)
A real estate investment trust, or REIT, is created when a corporation uses an investor’s money to buy and maintain investment properties. REITs allow investors to buy into investments such as shopping malls or office buildings, that are generally not available to individual investors to buy directly. Most importantly, REITs are highly liquid because they are bought and sold on the major exchanges (just like any other stock), so you won’t need a real estate agent or broker to help you cash out your investment. They are considered a safe approach for a new investor to gain exposure to the real estate market.
Like a mutual fund, a public REIT is a good investment for someone who wants a completely passive investment while still learning about the real estate market.
Pros of Public REITs
You can invest in high-end commercial properties with the help of trained professionals.
Cons of Public REITs
A public REIT can ebb and flow with the stock market, so it may not be the best investment for someone who wants to diversify their portfolio.
These are not publicly traded but are like public REITs in the sense that you are able to buy shares and receive dividends.
Pros of Private REITs
Private REITs can potentially offer higher returns.
Cons of Private REITS
They may only be available to a select group of accredited investors.
Other Ways to Invest
Besides direct ownership and REITs, there are other ways to earn passive income for your passive income real estate venture.
A lien can be placed on a property by the government if the owner doesn’t pay their taxes. The government has the right to keep possession of the property until they pay off the debt. If the taxes aren’t paid, the lien can potentially get auctioned off and the owner of the lien would can take possession of the property. This often ends up a win for lien owner, who receives a massively discounted price to buy the property.
Pros of Tax Liens
You’ll likely pay a deeply discounted price to get the property.
Cons of Tax Liens
You’ll need a seasoned expert in tax liens to help navigate through the process and steps that you must take to get a property in this way.
Real Estate Notes
When you’re investing in real estate notes through a bank, you’re typically buying debt below the price of a retail investor. If you want to invest in real estate but don’t want to deal with a physical rental building, investing in notes can be a good option. Some people specialize in buying notes with late payments and are willing to sell them at a deep discount. This gives the buyer of the note the ability to get the borrower to pay again, or the buyer can take ownership of the property.
Pros of Real Estate Notes
A well-performing note can be an easy way to collect a check at the end of every month.
Cons of Real Estate Notes
Understanding this type of investing is often tricky, so those who are just starting out with investments should proceed with caution.
Hard Money Lending
You can also consider giving a hard money loan if you have the cash to lend. A hard money loan is essentially a loan to a real estate investor. The term is typically shorter at 6-18 months and at a notably higher interest rate. This is attractive to property investors who “fix and flip” properties and don’t want to go through the fuss of a standard lending process. Since the goal is to flip houses as quickly as possible, the lure of a quick way to finance a home renovation is very appealing.
Pros of Hard Money Lending
Hard money lending can possibly be a large and steady way to generate passive income.
Cons of Hard Money Lending
You might deal with borrowers who default.
Fix and Flip
A fix and flip property is what you typically see on TV; a couple finds a house to completely renovate from top to bottom, only to put it back on the market to hopefully sell for a huge profit. Flipping a house isn’t quite as easy and quick as it looks on TV - you need enough capital and resources to ensure that your renovations are on time and on budget.
Your house might want to sell after months of renovations, but even a beautifully finished home is at the mercy of the current market. It is a real possibility that the house may sit vacant a few months after renovating.
Pros of Fix and Flip
You can control the final product when working on a fixer-upper.
Cons of Fix and Flip
You’ll need a significant amount of captial and resources during the renovations.
As you can see, investing in real estate can be much more than owning a house and managing tenants. We put a lot of time and thought into purchasing our homes, so why not put the same care and consideration into your real estate investments?
There are many paths that you can take as a real estate investor, but maintaining a few niche investments in your real estate portfolio can help you focus on understanding the nuances of each option. While this list doesn’t cover every single investment option out there (such as real estate crowdfunding), it might give you the nudge in the right direction when you make your next big investment decision. From what we’ve learned, that decision can be as involved as running your own short-term rental business or as passive as investing a few REITs. Choosing which investments are best for your portfolio is up to you, so arm yourself with as much information as possible to help you make an informed decision.