What is real estate investing?
Real estate investing is familiar to most of us. It involves buying actual physical properties in one way or another. It can seem like an attractive way to make money, but while some properties do appreciate rapidly, much depends on location and timing, and plenty of properties grow very slowly in value.
Indeed, according to real estate researcher Robert Schiller, national housing prices averaged an annual growth rate of around 0.6% between 1890 and 2019. That number is adjusted for inflation, so if we add back an annual 3% inflation rate, the overall growth rate would be around 3.6% -- still well below the stock market's average of close to 10%.
As with stocks, there are various ways to invest in real estate
The most familiar way of investing in real estate is buying an actual physical building, such as a home, often with the help of a loan -- a mortgage. Home ownership is the classic American dream, and out of all of the housing units in America, nearly 57% were recently occupied by owners -- those who owned the homes outright or had borrowed to do so -- while about 31% were rented.
Beyond the homes we buy for ourselves and our families to live in, many people buy additional property as an investment to rent out to others. Some investors own many properties and make a living from renting them out
Another way that you can invest in real estate, typically with far less money, is via real estate investment trusts (REITs). They're companies that own real-estate-related assets, such as apartments, office buildings, shopping centers, medical buildings, and storage units. REITs are required to pay out at least 90% of their earnings as dividends. They aim to keep occupancy rates high, collect rents from tenants, and reward shareholders with much of that income.
With REITs, you can buy as little as a single share, often for less than $100, and have your money instantly diversified across a range of buildings. There's far less commitment than buying the property yourself.
Real estate mutual funds
Finally, you might invest in real estate through mutual funds focused on real estate. Each fund will differ in properties it invests in, but many own shares of REITs as well as shares of various real estate-related companies, such as homebuilders, home improvement retailers, and mortgage providers.
There are plenty of real estate ETFs as well. You may be able to get into a real-estate ETF you like more easily than some real-estate mutual funds, because some mutual funds may have steep minimum initial investments or may even be closed to new investors, whereas you can just invest in the ETF through your brokerage account and buy as little as one share.
Real estate investing: Pros and cons
Here are some of the key upsides to investing in real estate:
- The properties you buy or invest in can rise in value, making you wealthier.
- There are some tax breaks associated with real estate investing, such as deductions for mortgage interest on your home.
- If you invest in real estate, you may enjoy an income stream from collected rents.
And here are some of the downsides:
- Some forms of real estate investing require large sums of money and mortgages.
- It can be hard to get out of real estate quickly, as sometimes some properties don't sell immediately. This means it's an illiquid asset class.
- There's no guaranteed return, and plenty of properties fall in value in the first few years after purchase, with some staying underwater for a long time. (In real estate lingo, your mortgage is underwater if you owe more on your home than it's worth. In such a situation, you won't generate enough money when selling it to pay off the mortgage.)
- Being a landlord can be taxing, as you may have to deal with troublesome tenants and have unoccupied property at times.
- If you own properties, you'll be on the hook for maintaining and repairing them, and for paying property taxes and insurance.
Stocks or real estate -- what's right for you?
Given all of the above, between investing in stocks and investing in real estate, what's right for you? Well, for most people, the stock market will offer the best growth prospects over many years. That doesn't mean you shouldn't own or pursue owning your own home to live in, and it doesn't mean you can't also try investing in real estate. But remember that you can include plenty of real estate in your overall stock portfolio if you want to via REITs or real estate mutual funds.
Once you decide to invest in the stock market, what's the best way to start? If you have the time, interest, and ability to study investing, you might try investing in some carefully chosen individual stocks. But there's really no need to do so, because you can do very well with low-fee, broad-market index funds -- and you'll likely outperform most managed mutual funds while you're at it, too.
Even super investor Warren Buffett has recommended index funds for most people. He said he offers these instructions in his will for the money left to his wife: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)"
Fund companies offer many index funds, so choose one with the lowest fees. A particularly easy way to invest in the S&P 500 is via an exchange-traded fund such as the aforementioned SPDR S&P 500 ETF Trust. A SPY share recently traded for about $297, sported a dividend yield of around 1.85%, and charged just 0.09% in annual fees. Meanwhile, the Vanguard Total Stock Market ETF (NYSEMKT:VTI) and Vanguard Total World Stock ETF(NYSEMKT:VT) will have you invested in, respectively, the entire U.S. market or just about all of the world's stock market.
If you're not already saving and investing for your retirement, now is a great time to start. Perhaps begin with a few shares of an index fund -- and then keep going. Most of us will need to have amassed a sizable nest egg on our own in order to retire comfortably.