A growing number of people are starting to see that adding real estate to their investment portfolios is a great way to diversify and mitigate risk away from more traditional stocks and bonds. However, even those who want to invest in real estate often become confused about where or how to start. The real estate sector is vast and can seem complicated for those who are unfamiliar. In turn, many would-be investors sit on the sidelines, stuck in a state of paralysis.
It doesn’t have to be that way!
There are many easy ways to invest in real estate. In this article, we look at the difference between active and passive real estate investing. In addition to looking at strategies for investing using either approach. You will find numerous ways to begin investing today, regardless of the amount of capital you have.
Active vs. Passive Real Estate Investing
Some people assume that investing in real estate is a guaranteed way to earn steady, passive income. A friend might convince them to purchase rental property. Then later to find out that owning real estate individually requires a lot more time and effort than they originally anticipated.
This is why it is important to distinguish between active and passive real estate investing.
Active investing, or purchasing real estate directly, can be incredibly time-consuming – especially for those working traditional 9-to-5 jobs.
It may be manageable with one or two rental properties. However, as investors grow their rental portfolios, self-managing real estate can prove difficult.
They will also be limited to certain property types. Simply as larger deals, like apartment complexes and office buildings, usually require more equity than any one individual can contribute on their own. In order to access these larger, higher-caliber deals, investors will generally have to utilize a passive real estate vehicle. For example like a real estate fund or syndication.
When investing in a real estate fund, individual investors are
putting significant faith in the fund operator to identify deals
that meet the fund’s investment criteria.
In this article, we look at seven different ways to invest in real estate as either an active or passive real estate investor.
1. Purchase Directly
Purchasing real estate directly is the quintessential type of real estate investment. It is how many individuals dip their toes into the real estate waters.
However, purchasing real estate directly is complicated. In order to be successful, the investor must know how to do significant due diligence on properties. This is including both the physical asset and its financials. These properties require ongoing repairs and maintenance, and often require property improvements and creative leasing efforts in order to stabilize.
There are many strategies for purchasing real estate directly as an individual, including:
Buy and Hold
Buy and hold investing is when a person purchases a property that they intend to own or (“hold”) for an extended period of time. The property may or may not need improvements. It might already be fully occupied and generating positive cash flow. In other cases, an investor will want to make property upgrades and/or lease to new tenants in order to maximize the property’s revenue-generating potential.
“House hacking” has become a popular way for individuals to own their first rental property. The concept is simple: purchase a small multifamily property (usually with 2-4 units) and then live in one unit while renting out the others. House hacking has many benefits, especially for those with limited capital.
For example, owner-occupied properties tend to qualify for better mortgage rates and terms than properties used solely for investment purposes. House hacking also allows the owner to self-manage the property more easily. They can use the rental income to offset their own housing payment. Sometimes, can live for free (and then some!)
Fix and Flip
House flipping is another way to invest in real estate. The “fix and flip” strategy is when an investor purchases a property, ideally below market rate. Then makes some degree of improvements before re-selling the property. The improvements may be cosmetic or more substantial, depending on the investor’s experience, timeline, availability of capital and end goals.
Investors are forewarned about house flipping in that these projects often have unknown risks and surprises that can quickly eat away at the project’s margins. A fix and flip strategy is generally best executed by an investor with construction experience.
Wholesaling is when a person purchases the rights to a property and then sells the property to another buyer for a larger sum. For example, an investor might canvas a neighborhood looking to purchase a property for cash. By finding off-market deals, they can purchase the property for less than it might sell for on an open market.
Once the investor has the property under agreement for that price, they will find another buyer to purchase the property at a higher price. Sometimes, wholesale transactions occur on the same day. Trading from the original seller to the wholesaler and then to the eventual buyer in consecutive fashion.
Other times, the agreements are written to allow the wholesaler to “assign” the contract to another buyer. In which this case the wholesaler never takes title to the property but collects an assignment fee for procuring the transaction. This approach allows people to “invest” in real estate without ever putting a penny of their own money into the actual deal.
2. Real Estate Investment Trusts
Directly purchasing real estate is the most intensive form of active real estate investing. At the other end of the spectrum is investing in something like a real estate investment trust, or REIT.
When investing in a REIT, an individual is purchasing the equivalent of stock in a company that owns various real estate assets. REITs can be publicly or privately traded. However, in both cases, are required by the federal government to return 90% of cash flow to investors on at least a quarterly basis.
The downside to investing in a REIT is that
investors do not actually own real estate.
The benefit to investing in a REIT is that it is a way for investors to preserve their liquidity. Unlike investments in a real estate fund, syndication or another passive vehicle in which investors’ equity may be tied up for years at a time. REIT shares can be easily purchased and sold with little notice.
The downside to investing in a REIT, though, is that investors do not actually own real estate. They are investing in the company that owns the real estate. Therefore, cannot take advantage of the many tax benefits (like depreciation) associated with direct ownership.
3. Real Estate Funds
Another way for individuals to passively invest in real estate is real estate funds. Real estate funds pool capital from investors and then deploy that capital into various real estate assets. The capital can be used to make either loans (i.e., debt funds) or equity investments (i.e., private equity funds) in real estate.
When investing in a real estate fund, individual investors are putting significant faith in the fund operator to identify deals that meet the fund’s investment criteria. This is because most are structured as “blind funds,”. This is where the actual assets that the fund will invest in have not yet been identified.
For example, a fund may raise $50 million to invest in value-add multifamily housing. However, the specific properties may not be identified yet.
Real estate syndications are a way of pooling capital for co-investment in a specific property. For example, the sponsor of a syndication may have an option to purchase a multifamily apartment building at 123 Honeysuckle Lane that they will only be able to move forward with if they raise enough capital through the syndication.
The benefit to investing in a syndication is that prospective investors have more specific information about the property. For example its operating history, its current revenues, etc. They can then evaluate the existing condition against the sponsor’s proposed business plan. Essentially to give themselves a better sense for whether they think the deal will be profitable.
5. Tenancy in Common (TICs)
TICs are another way for individuals to invest in real estate. TICs allow between two and 35 people to serve as co-owners of a property. Each TIC member holds separate legal title to the property based on the value of their original investment. Individuals can exchange or sell TIC interests to others, providing an opportunity for those who want to liquidate their investment in the asset.
One of the benefits to investing in a TIC is that, it allows each member, as the number of investors in capped at 35, to have more influence on decision making as they can be much more vocal. This is a great option for investors who would prefer to be more hands-on, however still wish to put the day-to-day operations in the hands of the sponsor who oversees the TIC on investors’ behalf.
Conversely, one downside to investing through a TIC is that all decisions (even the most mundane) require the consent of all participating members. This can prove challenging when the TIC has upwards of 35 participating co-owners.
6. Delaware Statutory Trusts (DSTs)
DSTs are another way for people to co-invest in real estate alongside a qualified sponsor. Typically, DSTs invest in stabilized, cash-flowing assets.
They will have already aggregated a portfolio of properties for investors’ benefit, so individuals have explicit information about the assets and their income-generating potential. After aggregating the portfolio, the DST then sells fractional shares to investors and collects a commission and/or management fee for overseeing the portfolio on investors’ behalf.
Active investors often use DSTs to defer paying capital gains taxes on profits earned from selling a property. One way to do so is by rolling the proceeds from the sale into a DST (using a 1031 exchange), and in doing so, will shift from being an active to a passive real estate investor.
However, DSTs are also open and available to cash investors. Some have requirements around needing to be an accredited investor; others have minimum investment amounts – which is similar to most real estate funds, syndications and TICs as well. One of the appeals to investing in a DST as a cash investor is that it opens the door to large-scale, professionally managed properties that individual investors would not have access to otherwise.
The Jobs Act f 2012 resulted in important changes to SEC regulations that, in turn, allowed real estate sponsors to begin soliciting investments from the general public.
This fueled the growth of online real estate crowdfunding platforms like RealtyMogul, CrowdStreet and Fundrise. Using platforms like these, sponsors can list both individual deals and/or real estate funds for investors to consider. This allows dozens, if not hundreds or thousands, of investors to participate in individual deals.
The ability to raise capital from so many people (even people located all over the world) means that these deals often have lower investment minimums. Some deals allow people to invest with as little as $500 or $1,000 – a much lower threshold than traditional real estate funds or syndications.
Moreover, crowdfunding platforms often feature deals for both accredited and non-accredited investors. This provides a great avenue for non-accredited investors to begin their foray into real estate without making a substantial capital contribution.
Another benefit to investing through a crowdfunding platform is that the low contribution requirements allow investors to diversify their portfolios. Someone may invest $1,000 apiece into ten different deals, with ten different sponsors and in ten different geographies. They can diversify into a range of product types (office, multifamily, retail, hospitality, industrial, etc.) and can invest in a combination of both debt and equity.
Real estate crowdfunding platforms are intended to provide user-friendly access to real estate deals and allow people to begin investing quickly and easily, which will appeal to those eager to begin investing immediately.
With so many easy ways to invest in real estate, it can be difficult for a first-time investor to determine which avenue is best for them. Ultimately, it will come down to how much time, capital and experience an investor has. Those with more time, capital or experience may pursue active real estate investment strategies. Those who’d prefer a more hands-off approach will want to consider the passive real estate investment vehicles shared here today.
Real estate funds pool capital from investors and then deploy that capital into various real estate assets.
There is no “right” or “wrong” way to invest in real estate. In fact, many investors utilize many of these vehicles simultaneously. The key is to simply get started one way or another.
Are you interested in Smartland’s real estate investing strategies? Connect with us today and find out if real estate is the right investment for you!