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Real Estate Investment Basics

There was a time when real estate was primarily a functional investment. If you needed a home to live in or a building to conduct business from, you purchased real estate. In today’s complex economy, real estate can also function as a purely financial investment and a means of generating income. Real estate investments are both potentially more lucrative and more complicated than more traditional investments like stocks and bonds. If you are considering expanding your investment portfolio to include real estate, it is important to understand some of the ways that real estate investments can function.

Renting your property

One of the most effective ways to earn money from a real estate investment is by renting it. The property owner/landlord is responsible for paying the mortgage, property taxes, and any maintenance and upkeep. In a perfect scenario, the monthly rent fees are enough to cover the landlord expenses, and would even allow for a profit. However, a rental property can still be a lucrative investment, even if operating at a temporary loss while the mortgage is being paid off. If your property value goes up over the life of the mortgage, your investment return is compounded.

What are the downsides to renting?

As with any investment, there are no guarantees of easy money from a rental. Your real estate investment may be more lucrative than a stock purchase, but you’ll have to work for it. Managing tenants can be difficult, and you may be left with damage to the property. You’ll also be responsible for repairs and maintenance, which means when there’s a problem with the plumbing, you’ll be the one dealing with it. You could hire a property manager, but that means an additional expense.

Investment Groups

A Real Estate investment group works similarly to a traditional investment fund, except instead of being backed by financial instruments like stocks and bonds, the group assets are in real estate. Each investor buys shares of a property through an investment company. The company handles the property management duties, tenant relationships, and advertising and renting out vacant units, and the shareholders split profits after expenses. Some funds are also usually held in an emergency account, to protect against vacancies and other unexpected costs. An investment group is a very good way to enjoy the financial benefits of real estate while avoiding the hassles of property management.

Real Estate Trading

Offering a much greater reward, and a much greater risk, is the practice of Real Estate Trading. With this approach, real estate investments are intended to be very short term, typically only a few months, before the property is sold at a profit. The investor leverages knowledge of the local market to find undervalued properties. In its purest form, real estate trading (also known as ‘flipping’ a property) is strictly a buy and sell proposition.

A subset of this group takes a modified approach, and adds value to the home or property through upgrades and renovations before selling for a profit. This is a valid investment strategy, but is arguably best suited for someone skilled in construction and who enjoys the process of home improvements. The danger to real estate trading is that investors tend to be single proprietors with limited financial resources. Once this investment train is moving, it’s not uncommon to use the proceeds of one house sale to finance the next one. The obvious problem is the risk of being spread too thin is a deal falls through for whatever reason.

Real Estate Investment Trust

A Real Estate Investment Trust, (or REIT), has passing similarities to an Investment group. Under an REIT, a corporation is created for the purpose of owning and operating investment properties. Legally, an REIT is structured differently than an investment group, and 90% of all taxable profits are paid to shareholders in the form of dividends. In this way the corporation is not subject to corporate income taxes on profits earned. REITs offer investors more flexibility, and opportunities to invest in commercial as well as residential properties. REITs also offer the lowest barriers to entry in terms of required real estate knowledge and experience.

Leveraging your investment

A significant advantage that real estate ownership has over a more traditional investment like stocks is the idea of leverage. To have controlling interest in a share of company stock, you have to purchase the share at the full market value. However, you can have controlling interest in a property for as little as 5% of the total value. That is a somewhat extreme example, and more typically you would have to pay up to 25% down on an investment property, but even at that you are gaining considerable leverage on a proportionally smaller outlay.

This also amplifies the inherent risk in spreading yourself too thin when investing in real estate. When rental profits fund the purchase of new properties, any interruption in income resulting from vacancies or other issues can be disastrous.

Making real estate investments work for you

We’ve taken a brief, high level look at some varying approaches to real estate investments. These strategies offer different risk/reward ratios but are all effective, proven plans that have been successful for people from all walks of life. While no investment is a guaranteed money maker, real estate has provided stable earnings over the long haul. Before embarking on a real estate investment, be sure to consult with your local Realtor for expert advice.>

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