Real estate investing is a great way to build long-term wealth. While the old saying "It takes money to make money" applies to real estate, beginning investors can start small and grow their real estate investing wealth over time. Here are several smaller ways to start building your real estate empire.
Real estate stocks
Many publicly-traded companies focus on the real estate sector, including homebuilders, developers, brokers, property managers, home improvement retailers, and real estate investment trusts (REITs).
REITs are one of the easiest ways to get started in commercial real estate. They typically own a portfolio of income-producing properties, with some specializing in specific segments like office or residential, while others take a more diversified approach. These entities must distribute 90% of their taxable income to investors, which is why most REITs pay high dividend yields.
Why real estate stocks make a good starting real estate investment
All an investor needs to do to get started in investing in a real estate stock is open an online brokerage account. Thanks to $0 commissions at most sites, investors only have to purchase one share, which typically costs less than $100. After that, they become a truly passive real estate investment. The only work investors need to do is to monitor the company's financial progress, such as by reading through the quarterly REIT report.
Why real estate stocks might not be right for you
The main drawback of buying shares of a real estate company is the exposure to stock market volatility. The company might be performing well, but if the stock market is tumbling, shares of the real estate stock will likely follow it downward.
Another issue with real estate stocks is that the market might be doing well, but the company might underperform due to poor management oversight.
Real estate-focused exchange-traded funds (ETFs)
An ETF is a fund that holds a basket of stocks. Several ETFs focus on owning shares of real estate companies and REITs.
Why ETFs make a good starting real estate investment
Much like owning shares of a REIT or real estate company, ETFs are an easy and low-cost way to get started investing in real estate since most are available at an online broker for $0 commissions.
A benefit of owning a REIT over those other options is the diversification, since many real estate ETFs hold more than 100 stocks. That enables an investor to participate in the sector's upside without the risk of picking the wrong stock.
Why a real estate ETF might not be right for you
Like any investment in the stock market, an ETF exposes an investor to volatility. Meanwhile, another pitfall of an ETF is that an investor limits their upside to the sector's performance, whereas some real estate stocks could significantly outperform. Finally, ETFs charge investors a fee to manage the investment, which eats into their returns.
Real estate crowdfunding
Real estate crowdfunding enables investors to contribute money toward a real estate deal. Several platforms have popped up in recent years that allow individuals to invest in a variety of opportunities, including specific properties, public non-traded REITs, and real estate-focused peer-to-peer lending.
Why crowdfunding makes a good starting real estate investment
Many online real estate crowdfunding platforms enable an investor to start small (from as low as $100). They can then add to their investment over time as they have additional funds.
Several sites offer investors the ability to buy shares of a public non-traded REIT. However, instead of trading on a stock exchange, these REITs don't trade, which eliminates the risk that stock market volatility will impact the investment.
Why real estate crowdfunding might not be for you
Some crowdfunding sites or deals are only open to accredited investors, which are those meeting at least one of two criteria:
- A high income ($200,000 annually for the past two years)
- A high net worth ($1 million, excluding the value of their primary residence)
Given the newness of many crowdfunding platforms, there aren't very many options available to starting investors. Many deals fund quickly, while some REITs and funds will close themselves to new investments until they put the capital they already raised to good use. Meanwhile, most crowdfunded investments aren't very liquid, meaning an investor can't sell as quickly since there isn't a secondary market.
Many crowdfunding platforms aren't yet profitable. As such, there's an increased bankruptcy risk in a real estate market downturn, which could cause an investor to lose their investment.
House hacking is one way that many investors get started in buying physical real estate. What an investor does is purchase a small multifamily property (two to four units) and live in one of the units while renting out the rest.
Why house hacking makes a good starting real estate investment
House hacking can potentially enable an investor to live for free. That's because the rental income from the tenants can, in some cases, cover the entire mortgage payment. Alternatively, an investor can continue paying the mortgage out of pocket while using the rental income to build equity faster by making additional principal payments or investing that money elsewhere.
Because the property will be a primary residence, an investor can qualify for cheaper financing compared to buying an investment property as long as they plan on living in it for at least one year. Further, in many cases, they can buy it with a low down payment. Whereas most investment properties require at least 20% down, those who qualify for FHA financing only have to put 3.5% down while a veteran or active-duty military can get a no-money-down VA mortgage. Meanwhile, even those who don't qualify for those options can put less than 20% down if they pay private mortgage insurance (PMI).
Why house hacking might not be right for you
Living in a multifamily property isn't for everyone. If you have a large family, you might not find a property that has enough available space. Meanwhile, those who like their privacy, or a quieter setting, might not do well with noisy tenants.
Being a landlord is also far from passive. Tenants often don't treat a property as they would their own home, which could cause additional maintenance. Further, as the landlord, you're responsible for the repairs in your home as well as the other units. These tasks will likely eat up a considerable amount of time and money. On top of keeping up with repairs, you also have to make sure your tenants pay their rent on time. If they fall too far behind, you might have to have them evicted.
Another potential pitfall with house hacking is vacancies. Whether due to an eviction or a move-out, you'll need to move quickly to find and screen a new tenant to keep the rent checks flowing. The longer your other units remain vacant, the greater the potential for the property to become a financial burden.
Finally, there are tax implications involved with rental real estate. Because of that, you'll likely need to hire a tax professional.
Investing in a parking spot
Buying a parking spot in a densely populated area or tourist destination is a lower-cost way for an investor to get started in commercial real estate. In many cases, an investor can purchase a spot for less than $25,000 and potentially rent it out for a couple hundred dollars a month. Further, it often involves less work than other commercial real estate property opportunities.
Why a parking spot makes a good starting real estate investment
A parking spot is a potentially low-cost, high-yielding way to invest in real estate. It's also usually more passive than owning a multifamily property. While there is some maintenance involved, as the parking spot's pavement will eventually deteriorate and need repair, an investor likely won't get a pre-dawn wake-up call from a tenant with a maintenance emergency.
Why buying a parking spot might not be right for you
While a parking space can be a high-yielding investment, a real estate investor needs to factor things like taxes, insurance, and maintenance into the equation before buying a spot. Repair costs can run thousands of dollars, especially if the space is in an older parking garage.
Meanwhile, there's uncertain appreciation potential with parking. Whereas many commercial property values rise at least with the pace of inflation, the investment market for parking spaces isn't very developed. As such, an investor could lose money on the spot if they need to sell it quickly, especially in a weak economy.
Single-family home investments
There are several ways to start small by investing in single-family real estate:
- If you already own a home, instead of selling it, consider renting it out when you buy a new one.
- Another house-hacking method is to rent out a room in your home to a long-term tenant or via Airbnb.
- An investor can also consider purchasing a vacation home to rent out when it's not in use.
- Purchase an additional single-family home to rent out in your current market or a different one through a website like Roofstock.com.
- Buy a house to fix and flip.
Why a single-family home makes a good starting real estate investment
One reason a single-family home is a good way for an investor to get started in real estate is that the initial investment is often much less than a multifamily or commercial property. Further, a single property is easier to manage than multiple units, making it a better way to ease into the business. It can also be a lucrative investment as rental properties often generate more than enough income to pay the mortgage. Meanwhile, flipping a house can produce big profits if you buy for the right price, make high-return investments, and don't run into too many challenges.
Why a single-family home investment might not be right for you
A single-family home investment has a much higher upfront cost than most other beginning options. Investors will likely need to come up with a down payment of at least 20% for most real estate loans as well as for any needed repairs, especially for a fix-and-flip.
Meanwhile, as with other house-hacking options, there are several potential pitfalls, including vacancies, issues with tenants, costly maintenance, and taxes. The combination of financial costs and time requirements can make a single-family home investment quite a burden for a beginning investor if they are juggling several other commitments, such as a full-time job, family, or school. Because of that, they might need to hire property management, which would eat into their returns.
Small steps can still take you a long way
Beginning real estate investors often make the mistake of biting off more than they can chew. That's why it's best to start small. Once you've mastered one investment option, such as owning REITs, you can then expand your real estate empire into other larger opportunities, building your wealth over time.