Real estate is often a rewarding investment, with the potential for passive income and long-term appreciation. It can also be a smart way to diversify your portfolio beyond the traditional lineup of stocks, bonds, and mutual funds.
While a home might be your first foray into real estate investing, there are numerous other avenues for tapping the market, from rental properties and house flipping to real estate investment trusts (REITs) and online real estate platforms. Here are six investments to consider to diversify your portfolio with real estate.
Buy a rental property
Buying and leasing out a rental property to short- or long-term tenants is a classic way to invest in real estate. A huge perk of being a landlord is that you can deduct many of the costs associated with the property, including maintenance, repairs, insurance premiums, utilities, administrative fees, mortgage interest, and depreciation.
Of course, the downside is that rental property can be a time-consuming investment with high start-up costs, You might have to deal with late payments, property damage, and unruly tenants. Still, you can enjoy positive cash flow and long-term appreciation with the right property. What’s more, if you sell the home and swap it for a “like-kind” property, you can use a 1031 exchange to defer capital gains taxes.
Rent out a room
House hacking can be an excellent way to dabble in real estate investing. The strategy involves renting out part of the home you live in, such as a single room, the basem*nt, an attic, or an accessory dwelling unit (ADU). The start-up costs can be minimal, depending on the condition of the space. And the extra income can help offset your monthly housing expenses while you pay down the mortgage and build equity.
A more advanced house hack is to invest in a multifamily property: living in one unit and renting out the rest. Whether renting out a room or half of a duplex, you can find long-term tenants or—where permitted—open the space to short-term rentals using an online platform such as Airbnb.
Use an online real estate investing platform
Online real estate investing platforms (aka “crowdfunding websites”) are the new kids on the block in the real estate investment world. These platforms match developers with interested investors who pool their capital to fund real estate projects with as little as $500. In exchange, investors get debt or equity in a project, as well as monthly or quarterly distributions if all goes well. While these investments offer higher potential returns than publicly traded REITs, they carry more risk and are generally illiquid, so you may not be able to sell your shares quickly.
Some platforms are open only to accredited investors, while others, including RealtyMogul, offer opportunities for accredited and nonaccredited investors alike. Investors typically pay an annual management fee ranging from about 0.25% to 2.50% (depending on the platform), and other fees may apply.
Flip a house
House flipping involves buying a discounted property, fixing it up, and selling it for a profit. With the right property you can turn a quicker profit than from managing a property, but it’s not as easy as it looks on TV. To be a successful flipper, you need to see a property’s potential and have a vision for bringing it to life. You also need sufficient cash, a reliable team of contractors, and accurate cost-estimating skills to ensure that you earn a profit.
Strong project organization skills are also a plus. The sooner you can sell the property, the less you’ll spend on holding costs, including mortgage payments, utilities, property taxes, homeowners’ association (HOA) fees, and insurance.
Buy a REIT
A REIT can be an excellent option if you want exposure to real estate without the responsibility and headaches of managing rentals. A REIT is a company that owns and operates income-generating properties, such as apartment buildings, offices, warehouses, medical facilities, hotels, and retail centers. Like mutual funds, a REIT pools the capital of multiple investors and owns a portfolio of assets. Investors buy shares of the REIT and earn a proportionate share of the income.
A key selling point is that most REITs are publicly traded on stock exchanges, making them an easy and highly liquid way to gain exposure to real estate. A REIT makes money leasing space and collecting rent on its real estate holdings. In turn, investors earn money through dividends. By law, REITs must pay out at least 90% of their taxable income as shareholder dividends each year.
Invest in a real estate investment group (REIG)
A real estate investment group (REIG) is a club of private investors who pool their money and expertise to buy income-generating properties. They can be a good option if you want to own rental properties but don’t want sole responsibility for managing them. REIGs leverage the buying power (and experience) of the entire group to invest in various types of properties, including apartment blocks, condominiums, and commercial buildings.
On the plus side, REIGs allow you to learn from other, more experienced real estate investors while participating in deals that can expand your wheelhouse. However, the downside is that membership fees could erode your profits, and the investment could flop if you partner with an inexperienced or unskilled group. Still, if you do your research and find a group that aligns with your goals and risk tolerance, a REIG could be a worthwhile venture.
Time Stamp: Investing in real estate has plenty of potential
Real estate investments can offer numerous benefits, including stable cash flow, long-term appreciation, portfolio diversification, tax breaks, and the ability to leverage your funds. Of course, there are also drawbacks—among them lack of liquidity, high start-up costs, and the reality that real estate investing can be a long grind.
Still, it’s helpful to remember that there are multiple ways to invest in real estate, and some options might be a better fit than others. For example, rental property might be a good option if you’re looking for an investment that offers hands-on control and money-saving tax breaks. You might opt for a REIT if you prefer a hands-off approach and a more liquid asset. If you want the best of both worlds, you might invest in rental properties and REITs. After all, you don’t have to pick just one type of investment.
Ultimately, investing in real estate depends on your goals, risk tolerance, and time horizon. Working with a financial advisor and researching your options can help you find an investment that works for you.
Frequently asked questions (FAQs)
How much do real estate investors make?
There’s no limit to how much a real estate investor can earn. For example, Donald Bren, the founder of the Irvine Company, has reportedly amassed a $15.5 billion fortune investing in commercial real estate. Of course, most real estate investors don’t enjoy this level of success.
If you invest in equity REITs, you might expect a total annual return of about 6% to 11%, based on their performance over the past 50 years, according to data from Nareit (the National Association of Real Estate Investment Trusts). The YTD return as of July 31 was 5.03%.
You can also get a job in the field. According to ZipRecruiter, the average salary for real estate investors is $139,851 per year. Ultimately, your earnings potential depends your location, the investment(s) you choose, the number of deals you make, your time commitment, your risk tolerance, how well capitalized you are, and sometimes a little luck.
What are the pros and cons of investing in real estate?
Like all investments, real estate investing has pros and cons to consider. On the plus side, real estate investments can offer portfolio diversification, passive cash flow, long-term appreciation, and tax advantages, including deductions, depreciation, and tax-deferred capital gains. On the negative side, real estate investing can be time-consuming, property values can decline, the income can be variable, and it can be difficult to sell quickly.
Of course, different types of real estate investments come with various risks and rewards. Do your homework before deciding whether a particular investment makes sense for your goals, risk tolerance, and financial situation.
What are the top tax benefits of real estate investing?
The tax treatment of real estate investments varies, depending on how you invest.
Rental property ownership comes with the most tax breaks. For example, you may be able to deduct:
- Mortgage interest.
- Property taxes and occupancy taxes.
- Insurance premiums.
- Maintenance and repairs (improvements must be depreciated).
- Utilities.
- Advertising.
- Legal and professional fees.
- Travel costs related to managing the property.
- Home office expenses.
- Depreciation.
- Wages and salaries for employees and independent contractors.
- Losses not covered by insurance.
- Deferred capital gains taxes (through 1031 exchanges).
- Up to 20% of your net rental income (this deduction is scheduled to last through 2025).
The same rules apply when you rent out a room in your house, but you can only deduct expenses related to the actual rented space, not the entire home (similar to how the home office deduction works). For example, if you have a 1,200-square-foot house and rent out a room that’s 300 square feet, you can deduct 25% (300 ÷ 1,200) of your home expenses.
The tax treatment of house-flipping is complicated and hinges on whether the Internal Revenue Service (IRS) considers you an investor or dealer (working with an advisor is recommended). Forming a limited liability company (LLC) may allow you to deduct certain house-flipping expenses, including home improvement costs on sold properties, property taxes, and building permits. However, the costs of capital improvements generally aren’t deductible. Instead, they’re usually added to the property’s basis, which can help lower your capital gains burden when you sell.
Other types of real estate investments don’t offer the same tax breaks as rental property, but you still owe taxes on income, dividends, and capital gains. A financial advisor or tax specialist can optimize your tax strategy to make the most of your real estate investments.
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