There isn’t just one path to real estate investing — but whichever way you choose, you’ll be joining the ranks of the many Americans who increase their wealth each year through this strategy.
To decide which tactic is best for you, consider how much you have to invest upfront and how much time you’ll be able to give to your investment. You’ll also want to determine how much risk you’re willing to take on for a higher return.
Here, we’ll discuss five different ways to build wealth through real estate and the pros and cons of each.
Short-term rentals such as Airbnb and Vrbo have grown in popularity over the past decade. These are vacation rentals that can be rented anywhere from one night to several months and serve as an alternative to staying in a hotel.
If you want to remain flexible with your property, short-term rentals can be a great option. This is especially true if you own a vacation home in an area you frequently visit yourself. You can black out the dates you plan to use it and rent it out during other times of the year.
Plus, some investors can actually make more through short-term rentals than they would keeping the home under a one-year lease. This is because you may be able to charge more per night than with a long-term tenant but is dependent on the area and how popular it is as a tourist destination.
Short-term rentals tend to be more hands-on than long-term rentals. You’ll need to come up with an efficient system to correspond with guests and potentially hire a cleaning person to ensure the unit is ready for new guests — especially if you don’t live in the area.
The income stream from short-term rentals can also fluctuate quite a bit with the season and other factors. It may barely foot the bills during the off-season but make up for it during more vacation-friendly months. You may need to purchase additional insurance for a short-term rental — some landlord insurance coverage is voided with short-term stays.
Additionally, some areas have stricter laws disallowing the use of short-term rentals, greater regulations, or higher taxes. Make sure you know the rules in your community if you’re looking at using your property as a short-term rental.
Long-term rentals are typically rented for six months or longer and are secured through a lease.
The major benefit of a long-term rental is a dependable rent payment each month, which you can use to pay the bills and build equity in the property. It’s also easier to vet potential tenants of a long-term rental than it is for a short-term vacation home. Plus, you may go months without ever having to set foot on the property — unless you have a particularly high-maintenance tenant.
Another benefit of both short-term and long-term rentals is the ability to leverage your property — meaning you can use the equity you’ve built up as a down payment to purchase another property to increase your rental portfolio.
Although a long lease can be great for predictable income, it can also put you in a tough spot if your tenant stops paying rent or doesn’t hold up to the lease terms and needs to be evicted. Evictions can be a long, expensive process, and you may never realize the lost rent.
Landlords must also complete continual maintenance and upkeep to keep their property rentable and tenants happy. This takes time and money and could cut into profits. Also important to mention: Income with long-term rentals can be slow and steady, and your money is relatively illiquid. Investors may be able to realize gains more quickly with other investments but maybe not as easily.
Investors who use the “fix-and-flip” method purchase a distressed home for a rock-bottom price, renovate it, and sell quickly for a profit.
One of the biggest pros of doing a fix-and-flip is that you can realize your gains in just several months — and you have the potential to make a good return if you’re good at it. Then, you can turn around and use that initial investment and profit to purchase another property.
Fix-and-flips are more risky than other types of real estate investment strategies. While you may be able to find and purchase a home in need of repairs, the market may take a downturn by the time you’re ready to resell. This could result in less profit than you initially anticipated, especially after you pay for a realtor and pay all the costs associated with selling a property. There’s also a high level of expertise and market knowledge needed to accurately budget and complete a fix-and-flip while still making a profit.
Plus, fix-and-flip investors typically must borrow money in the short term at high interest rates — usually from private lenders. If all goes well and they’re able to sell for a profit, they can easily pay back the loan. But, if the home sits on the market and the investor has a hard time selling, they may not be able to pay back the loan on time — resulting in fees or even foreclosure.
REITs — short for real estate investment trusts — are companies that own commercial real estate. You can buy shares of these companies similarly to how you buy other stocks. This allows you to invest in real estate without having to be involved in its day-to-day management.
REITs must return 90% or more of their taxable income to their shareholders yearly — resulting in dividends paid to you if they do well. This means you can realize gains by barely having to lift a finger — and certainly without dealing with any problem tenants.
Another benefit is that REITs offer great liquidity — if you need some cash, simply sell off your shares in the stock exchange.
Unlike other real estate investments, you won’t build any equity through REITs because you’re not owning a physical property — only a portion of the overall business. In other ways of investing in real estate, you can get started with a small amount — a down payment — and build your portfolio by having your tenant pay the mortgage and bills. In a REIT, you only realize your return on the amount you put in, so you may not earn as much in the long-run.
Commercial real estate
Similar to long-term rentals, commercial real estate is held under a lease — although commercial leases are typically three years or longer and are rented by a business instead of a resident.
Commercial properties have longer leases and can generate more in rent — meaning higher and (usually) steadier income in the long-term.
Commercial tenants are also less likely to skip rent payments or cause issues, as they want their business to continue. You may also generally avoid the middle-of-the-night phone calls you may get with residential real estate.
Commercial real estate can have greater property management expenses, as retail tenants in particular expect the lawn to be mowed, snow and ice removed, and a more pristine look.
Additionally, any repairs needed will need done more immediately, as they can result in lost income for tenants. Commercial property loans may also require a higher down payment, so you’ll need more money upfront to get started.
One, some, or all
Although you may be more inclined to start with one of these investment strategies in particular, you can diversify your income (and your risk!) by trying out several. You may opt to have most of your investment in long-term rentals, but also try out REITs or short-term rentals as you get more comfortable.
Pros and Cons of 5 Real Estate Investment Strategies by Thomas O’Shaughnessy | Realty Biz News