Real estate can be a great way to make money as an investor. Not only do real estate investments have the potential to produce excellent long-term results but also tax advantages, and they can add diversification to your overall investment strategy. Real estate has set millions of people on the path to financial freedom and could do the same for you.
However, there are several ways you could choose to invest in real estate -- ranging from simple stock investments to fixing and flipping houses and everything in between -- and there are some big differences among the various methods. So, here's a quick guide that can help you get started on the path to making money in real estate.
5 ways to make money in real estate
Here are five of the most common ways to put money to work in real estate, as well as some information about each method.
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Investment properties (rental real estate)
The most obvious way to make money in real estate is to buy an investment property (or several). You could buy a home and rent it out to long-term tenants or purchase a multi-unit rental property or small apartment building. You could look into buying a vacation rental or a property you intend to otherwise rent short term. Or you could buy a commercial property (any type of property that is not residential real estate), such as a retail or office building, and lease it to tenants to generate rental income.
Buying an investment property can be a great way to make money in real estate, but it isn't without its drawbacks, and there's quite a bit to learn before you get started.
Real Estate Investment Trusts (REITs)
A real estate investment trust, or REIT (pronounced "reet"), is a special type of company designed to invest in real estate assets. Think of a REIT as sort of a mutual fund for real estate investment: Investors' money is pooled to buy a portfolio of commercial properties or other real estate assets. Many REITs are traded on the stock market and are very easy to buy and sell, making them excellent choices for beginner investors and those with limited capital to invest. And, many pay consistent dividends, making them good options for investors who want steady income.
There are REITs specializing in just about any type of real estate you can think of, as well as exchange-traded funds and mutual funds that will allow you to invest in a diverse portfolio of REITs. You can learn more about REIT investing with our guide to the basics of investing in REITs.
Fix-and-flips
If you've watched HGTV in the past few years, you probably know what it means to flip houses. This potentially lucrative form of real estate investing essentially involves taking a rundown residential property, completing repairs and/or renovations on it, and then selling it at a profit. While the popular fix-and-flip shows make it look easy, flipping houses successfully requires a lot of effort and knowledge of your local real estate market, among other things.
Wholesaling
A real estate wholesaler serves as a middleman between motivated home sellers and real estate investors. A wholesaler finds cheap property investment opportunities (if you've ever seen those "we buy ugly houses" signs, those are typically put there by wholesalers). The wholesaler will enter into a contract to buy the property but then find a real estate investor who is willing to pay a bit more, the difference being the wholesaler's profit margin.
Unlike many other forms of real estate investing, wholesaling can be a very time-consuming job, and there are lots of rules and other things to know.
Crowdfunding
Real estate crowdfunding is a relatively new form of real estate investing, but there is certainly money to be made. When a developer or professional investor identifies an opportunity to build or buy a commercial real estate asset, they may choose to raise some of the project's capital from individual investors. For example, a crowdfunding deal might aim to purchase a hotel, spend a few years gradually renovating the rooms, and ultimately sell it at a profit. There are several reputable crowdfunding marketplaces, but it's important to point out that most of the best deals are limited to accredited investors only.
Other avenues
In addition to the choices mentioned above, you can lend money to other real estate investors, become a real estate agent, become a property manager or start your own property management company, begin another type of real estate business, invest in unpaid property taxes or tax liens, or buy the stocks of companies in real estate-related businesses (e.g., homebuilding companies) -- just to name a few examples.
Things to consider
When deciding the best way or ways for you to put your money to work in real estate, there are a few factors you need to consider:
- Risk tolerance: Before you decide to pursue any investment opportunity, determine whether the investment is appropriate for your level of risk tolerance. For example, for a retired investor who relies on their investment portfolio for consistent cash flow, fixing and flipping houses probably would not be the best fit. On the other hand, owning a portfolio of rental properties could be a smart addition to their asset allocation strategy.
- Your local housing market: It's important to consider your local real estate market, especially if you plan to buy rental real estate or flip houses. Local regulations, market conditions, and prices can vary dramatically, and a licensed real estate professional can help you decide whether your local market is a good fit for you as an investor.
- Liquidity: This is a factor you don't really need to consider when investing in stocks or mutual funds, but it can be a major consideration when investing in real estate. Liquidity refers to how quickly you're able to sell an investment at a price that's reasonably close to full market value. A publicly traded REIT is a highly liquid investment. An investment property isn't.
- Capital: Unlike buying and selling stocks, some real estate investments require significant amounts of capital. For example, if you're buying an investment property, you should anticipate needing at least 20% of the purchase price as a down payment, plus money for closing costs, and reserves to make sure you can cover the mortgage payment if the property is vacant. And most crowdfunding deals have minimum investment amounts, usually around $25,000.
- Knowledge: You don't need a ton of real estate knowledge to effectively invest in REITs. And you can buy your first investment property without much knowledge beyond the basics. However, flipping houses and wholesaling are highly competitive, and you really should know what you're doing before putting serious money at risk. I'd strongly recommend learning all you can and getting started with a relatively small project or investment amount if you want to pursue one of these.
- Passive versus active investments: Another major consideration is how much time you want to spend on your real estate investment activities. If you buy shares of a REIT or invest in a crowdfunded real estate deal, you won't have any day-to-day involvement in the investment and can generate a reliable income stream. On the other hand, buying rental properties (even if you don't manage the property yourself) or fixing and flipping houses can feel like a part-time job. Some of the best returns in real estate investment can be made with these active types of investments, but it's important to decide whether you're prepared for the time commitment.
The bottom line
There are many different ways to make money in real estate. From an investment perspective, the choices range from extremely passive and liquid options, such as buying an exchange-traded fund that invests in REITs, to skilled and time-consuming investment strategies like flipping houses and wholesaling.
The best way for you to invest in real estate and make money depends on a few things such as your risk tolerance, skill and knowledge levels, liquidity requirements, and amount of time you want to spend.
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