ABankrate survey finds that 31% of Americans think that real estate investment is the best investment over 10 years, compared with 20% who believe stocks are best.Data also shows that more than 70% of Americans are interested in real estate investing, with 55% of Millennials interested, which may explain the surge in the popularity of real estate investment books and podcasts. However,data still show that two-thirds of Americans believe that real estate investing is too hard, too costly, or beyond their expertise.
Real estate investing is popular and potentially very lucrative, but how does one get started without a large initial investment? Let’s review the variety of ways to start investing with a low-cost initial investment. (Full disclosure: As the founder and CEO of Invown, I strive to answer this very question. Invown’s vision is to democratize real estate finance for everyday homeowners and investors to provide a low-risk and low-cost start into real estate.)
Before we begin, let’s start by analyzing the different types, and pros and cons, of each real estate investment.
Types of Real Estate Investments
Residential real estate is property developed for people to live in. City or town ordinances zone areas to develop housing for single-family homes, condos, or vacation homes and not commercial or industrial purposes. Residential real estate is a low-risk investment with historical appreciation trends of about 3.8%.
What Are the Pros and Cons of Residential Real Estate Investments?
The Pros of Residential Real Estate Investments
Easy long-term financing: Financing residential real estate is a big business, and banks are more than happy to provide long-term loans (aka mortgages) that they can count on.
Low volatility: A low-risk investment that has historically always trended in one direction: up. Cha-ching!
Fantastic tax benefits: Owning a home has its advantages. Aside from realizing the American dream, owning a home can also help your financial life. Mortgage interest, property taxes, and operating expenses are all tax-deductible.
High appreciation potential: With average appreciation at almost 4%, real estate investors are very likely to make some dough, especially since 4% on a large investment like residential real estate can really give you a high return.
The Cons of Residential Real Estate Investments
High barrier to entry: Buying a house typically means working with a bank to get a mortgage and a mortgage typically requires 20% down. If you’re investing in cities like San Francisco, Washington DC, or Honolulu, where house prices average about one million dollars, you will need to have $200,000 lying around.
High operating costs: Once you purchase residential real estate, it’s all yours, the good AND the bad. If you plan on living there, then there is no landlord to pay for a new water heater, roof, or foundation. You’re on your own. Even if you’re not living there, prepare for the same renovation costs + the added expense of a property management company. If you’re planning to flip the house, then get ready to pay for a realtor and general contractor to manage that same renovation.
Labor intensive: Owning residential real estate can be a labor of love, whether that’s your labor or someone else’s. You’ll always hope the property inspection or appraisal has already uncovered all of the necessary work to be done but there are times when it won’t.
Commercial Real Estate
Now let’s talk about a different property type: commercial real estate. Commercial real estate often refers to buildings built for other purposes beyond residence. Typical examples include retail buildings, office buildings, warehouses, industrial buildings, rental properties like apartment buildings, and mixed-use buildings.
What Are the Pros and Cons of Commercial Real Estate Investments?
The Pros of Commercial Real Estate Investments
Income potential: Commercial properties have an average annual return of 6–12%, compared to residential of less than 4%.
Limited hours of operation: Most commercial properties operate during business hours, extending the building’s life with less wear and tear. For owners, it also means fewer calls in the middle of the night for fixes or lost keys.
Objective price evaluations: Property prices are easier to evaluate because they can be based on operating income and other local factors. Knowing the anticipated generated revenue can make doing math much more manageable.
Triple net leases: A triple net lease is ‘a lease agreement on a property where the tenant or lessee agrees to pay all real estate taxes, building insurance, and maintenance (the three “nets”) on the property, in addition to any normal fees that are expected under the agreement (rent, utilities, etc.).’ Removing the headache of regular monthly bills for all of your tenants is going to help offset the cons below.
Flexible lease terms: Security deposits, term lengths, and other facets of lease agreements are subject to less regulation for commercial properties, making agreements more customizable to suit your needs.
The Cons of Commercial Real Estate Investments
Time commitment: Real estate investors and owners should be prepared, and resourced, to juggle multiple tenants, contracts, and much more. With more tenants, more flexible terms, and more transparent pricing, there’s a lot more management involved, which brings us to our next point.
Professional help required: This business is complex, so be prepared to hire professionals, especially if you have multiple buildings with many tenants.
Bigger initial investment: Bigger building, typically in more metro areas, means more expense and larger initial investments. Further, getting a foot in the door on a first investment can be difficult. This is why real estate investment options typically start with residential properties, before graduating to commercial.
Now that we’re familiar with the two types of real estate investments, let’s discuss the different WAYS to invest: buying and not buying. I think we’re all familiar with the buying options, so let’s focus on the ways to invest without buying.
Type of Real Estate Investments that Don’t Require Buying
Let’s walk through a few non-buying options: investment trusts, mutual funds, wholesaling, and crowdfunding platforms (Invown).
What Are Real Estate Investment Trusts (REITs)?
A real estate investment trust is a company that invests in income-producing real estate. Investors can buy a share of the real estate investment trust for a relatively small sum. Typically, a REIT will own commercial real estate that they then lease out to others to generate income. They are legally obligated to pay 90% of their profits to shareholders. REITs allow retail investors to invest in real estate without purchasing or managing any real estate themselves.
How to Invest in REITs?
If you have a broker account with companies such as Fidelity or Charles Schwab, or even Robinhood, you can invest in REITs just the same way you would invest in stocks.
What Are the Pros and Cons of REITs?
The main benefit of investing in a REIT is the exposure to the upside and potentially attractive returns without owning or managing any actual real estate yourself. However, that is also the disadvantage of a REIT. With a REIT, the management fees and overhead costs associated with managing the real estate are taken out of the profit. This means less money for you as an investor compared with owning and managing real estate yourself.
Let’s dig in.
The Pros of Real Estate Investment Trusts
Easy to buy and sell: REITs trade on public exchanges and can be bought and sold quickly.
Highly liquid: Unlike actual property, REITs, being easy to buy and sell, are highly liquid.
Low risk: REITs include thousands of properties, so the diversification is enormous, creating a steady stream of income.
Better diversification: See above.
Flexible lease terms: Unlike traditional real estate investment options, REITs have flexible terms.
The Cons of Real Estate Investment Trusts
Taxation: REIT income is taxed as ordinary income and does not enjoy the same tax benefits as property owned directly by its tenants.
Real Estate Mutual Funds
Real estate mutual funds are similar to REITs, but, instead of investing in a specific company, the mutual fund pools companies like these together and are managed by the investor.
Real Estate Wholesaling
Real estate wholesaling is the process of finding an undervalued property whose sellers are underpricing their property and ALSO finding a buyer to scoop it up. Wholesalers facilitate that transaction. As you can imagine, this can be hard to do. The timing and conditions all have to align for the perfect match.
Real Estate Crowdfunding Platforms
Like REITs, real estate crowdfunding allows you to invest in real estate without actually having to buy or manage real estate yourself. Many of the platforms offering a crowdfunded investment in real estate allow you to invest small amounts of money, and some of them are open to retail investors.
What Are the Pros and Cons of Real Estate Crowdfunding Platforms?
Real estate crowdfunding benefits are that you can invest in individual real estate projects for a relatively low financial outlay without having to purchase real estate and manage it. On the other hand, you pay for this in the form of management fees and other overheads. Also, most real estate crowdfunding projects, commercial or residential, are leased to tenants. A further drawback is that these projects mostly use debt as leverage. Before any income can be returned to investors, debt repayments, including interest and management and carry costs, need to be subtracted. Just as with REITs, this means less profit for the investor.
The Pros of Crowdfunding Platforms
Portfolio diversification: Investors can invest in different types of properties and owners.
Accessibility: Properties at your fingertips improve ease of access.
Geographic diversification: View properties outside of your local markets to take advantage of hotter markets.
Small investment size: Invest with just 100s or 1000s of dollars, not the typical 20%, which is an enormous barrier to entry for investors just starting. Investors will also gain a higher return on investment, as operating expenses are significantly lower.
The Cons of Crowdfunding Platforms
Lower relative returns: Most crowdfunding platforms take a 30–40% cut of any equity appreciation, removing much of their benefit. Not when you Invown. Investors’ appreciation mirrors that of the homeowner.
Illiquid investment: Today’s crowdfunding platforms require equity events for investors to cash out, which typically happens every seven years. At Invown, we hope to solve this problem by creating a secondary market that shortens the time window to invest.
Lack of control: Our competitors will tell you what the terms are, just like banks do. When you Invown, homeowners set the terms, and investors will decide to agree or not, giving you as the homeowner ultimate control over your most precious asset.
REITs vs. Real Estate Crowdfunding Platforms
The main difference between real estate crowdfunding platforms and REITs is that crowdfunding is usually a real estate investor or developer looking to raise capital for a project from a pool of other investors. In contrast, a REIT is a company that owns or finances real estate and offers investors a dividend in return for their investment. Therefore, the practical difference is that, with a real estate crowdfunding investment, you often get to review the project and underlying asset you will be investing in.
Real estate crowdfunding platforms will often post pictures and detailed financial information about the office or apartment building for which they are raising capital from investors to either purchase or develop. With REITs, primarily publicly traded REITs, this information is not advertised in the same way. In a sense, real estate crowdfunding platforms get the investor one step closer to the actual real estate investment as compared to REITs. This likely allows the investor to make more informed and educated investment decisions.
Invowning—Crowdfund Investing in Owner-occupied Residential Real Estate
Invown is a platform that allows homeowners to crowdfund investment for their own homes. This type of investment eliminates major drawbacks of REITs and real estate crowdfunding by allowing retail investors to invest directly into owner-occupied residential real estate. With Invown, because its owner occupies the property, the owner is also the best steward of the property and there are no management fees or maintenance costs that eat into the investor’s profits.
Pros and Cons of Invowning Your Real Estate Investment
The benefit of using a crowdsourcing platform like Invown is that you can review detailed information about the property you’d like to invest in, as well as about its owner. The investment is open to retail investors at a low financial cost, and there are no management fees that would otherwise eat into your profits.
At the time of writing, beyond the normal risks associated with any type of investments, we cannot see any real cons associated with Invowning … but of course, we may just be biased.