If you do it right, real estate can be one of the best investments you can make with your money. It can offer passive income and long-term wealth and even become a full-time career if you're really dedicated to your craft. It's especially advantageous when compared to (and done in tandem with) other investment options.
Are you considering putting money into real estate? Use this guide to understand the benefits and drawbacks of investing in real estate, as well as how to get started.
What is real estate investing?
You can invest in real estate in many ways. Buying, fixing up, and selling properties -- also called flipping -- is one common method of real estate investing.
Other investment strategy options include:
- Buying properties and renting them out to long-term tenants.
- Buying and renting out vacation homes or short-term rentals.
- Real estate stocks and real estate investment trusts (REITs).
- Crowdfunding real estate deals and developments.
You can also rent out your existing residential property (either a room or the whole thing) using platforms like Airbnb. There are many considerations to take into account before going this route, though.
Benefits of investing in real estate
When done right, investing in real estate can offer some serious perks. From equity and passive income to a more diversified portfolio, there are lots of ways real estate can benefit your household -- both financially and over the long haul.
Here are some of the biggest benefits that come with real estate investing.
You get to build equity for the future
As you pay down your mortgage loan or the home's property value rises, you build up equity -- which you can cash in on later. That might mean selling the property for a sizable retirement infusion, tapping the equity in a cash-out refinance or a HELOC, or even leveraging it to buy another property and grow your portfolio.
You get protection against inflation
Unlike most other types of investments, real estate can offer a hedge against future inflation. That's because as prices rise (and the value of the dollar decreases), so does the cash flow you get from the property. If home prices rise in your market, for example, rents naturally do, too -- meaning you're basically keeping pace with inflation.
You can create regular income and cash flow
Real estate can also provide consistent, reliable income -- especially rental properties (both residential and commercial). If you're still working a 9-to-5 job, that can mean additional cash to use toward vacations and nice-to-haves. And if you really build out your portfolio, it could equal an entirely new career.
Real estate investments are also great options once you've retired, helping supplement Social Security payments and other retirement funds you might already have in place.
You can impact your larger community
There are a lot of benefits for the markets you invest in, too. You can help provide much-needed housing and stability for families, increase city tax revenues, support the local economy, and more.
The best part? The more your community flourishes, the more your assets appreciate. It's a self-feeding circle that can really help you build wealth and long-term financial security.
You can diversify your portfolio
If you're already invested in stocks, bonds, gold, and other securities, real estate offers a good way to diversify that investment portfolio and mitigate risk. By spreading your funds across a number of different vehicles, you can more effectively offset losses, should they occur. (Hint: They usually do.)
In the long run, this means standing up to market swings better and, in many cases, coming out with more cash as a result.
It qualifies you for valuable tax advantages
When you invest in real estate, you open yourself up to countless tax benefits. Many of your costs become deductible business expenses, you can write off your mortgage interest, and you may even get to avoid paying self-employment income tax on your rental income, depending on how you run your business.
You also get to take advantage of depreciation recapture -- another tax benefit that can save you money on your annual liabilities.
You might get a new house or vacation home out of it
Ultimately, real estate investing typically gives you some sort of asset. If you invest in a vacation rental property, your family also gets to use that home next time you need a getaway. If you purchase a longer-term rental or fix-and-flip property, you could even find yourself with a new primary residence down the line.
Drawbacks and risks of real estate investing
Obviously, there are some big benefits to investing in real estate. But what are the drawbacks? What should you be wary of before diving in?
Here are a few of the most notable disadvantages to real estate investing.
It requires a lot of upfront capital
Buying an investment property isn't cheap. You'll either need plenty of cash or a costly mortgage loan. If you do finance the home, you'll also need a down payment, money for closing costs, and cash reserves (most loan programs require at least 6 to 12 months of mortgage payments on hand for investors).
On top of all this, if you're flipping the property or renting it out, you'll also need the funds to fix up the place and market it.
It can be time-consuming
Buying, selling, and fixing up real estate requires lots of time and dedication. And if you're a landlord on top of that? That's even more time you'll be putting in. Though you could hire out a property management company to take over some of the work, that's an added cost -- and it will definitely cut into your bottom line.
It's highly localized
Your returns will depend on the specific real estate market you buy, sell, and rent out your properties in. If you don't choose carefully, you could end up with serious losses. It requires a lot of research and on-the-ground knowledge to ensure you're picking the right property in the right place.
Properties require regular maintenance and upkeep
If you're going to hold your properties and rent them out, you'll need ongoing funds to keep them afloat. That means repairing anything that goes wrong with the property or its systems, doing seasonal maintenance on the home and yard, and cleaning and fixing the home up between tenants.
There's added liability
There's lots of liability that comes with renting out properties, both short- and long-term. You could be held responsible if accidents occur in the home or if you fail to follow rental laws in your area. And if you're a solo landlord -- meaning you're not doing business as an LLC or corporation -- these liabilities could even threaten your personal wealth and assets.
You lose liquidity
When you put your money into a property, it becomes harder to access. You have to fix up the home, list it, market it, sell it, and wait for the mortgage to close before you ever see a penny of equity. While that's not a big deal under normal circumstances, if you find yourself in a financial bind and need quick cash, your real estate holdings could make getting that money difficult.
How to minimize risk in real estate investing
Real estate investing comes with some risks, but there are lots of ways to lessen that risk and make sure you (and your money) are protected. You can:
- Get a thorough home inspection of every property you buy: When touring the property, you might also consider bringing in an experienced contractor, who can help you gauge what repairs might be necessary and how much they'll cost.
- Consult with a real estate attorney on each deal: This can help you minimize liability and ensure you're in accordance with local laws.
- Secure landlord insurance if you're renting out a property: This can protect you from liability should something happen at the home.
- Have an exit strategy: Know what you'll do with the property if the market turns or you need quick cash. Could you turn it into a short-term rental? Move into it yourself? Having a backup plan is critical.
You should also choose your properties carefully. Work with an experienced real estate agent, pull comparable sales (comps) in the area, and make sure you're making the right choice for the long haul.
Getting started in real estate investing
Ready to get started as a real estate investor? Check out our guide to the basics first. Then see our strategy-specific guides for house flipping, house hacking, real estate investment trust (REIT) investing, and crowdfunding.