How Does Real Estate Investing Work?
Real estate is one of the world's oldest investment
activities. Ever since humans have lived on the earth, they've
needed shelter, and ever since the idea of making a profit came
about, people have been renting homes and houses to others for a
monthly rental payment.
Real estate rentals are very beneficial
to both the investor and the tenant. First, those seeking a home
in which to live can find one for only the period in which they
want to live there. Where buying a house is a process that may
last many decades (think of a 30-year mortgage), rental homes can
be found for terms of two years or less. Thus, those who rent have
ultimate flexibility in where they choose to live.
For the real estate investor, there is a significant amount of
money to make in
real estate investing. An investor can buy a home with cash or
on credit, and then rent it out to a tenant for an income. With a
loan, the investor may need to put up only 10-20% of the purchase
price, and thus the tenant essentially buys the home for the
investor! A spectacular deal, indeed!
Buying Real Estate for Investment
One of the most profitable ways to get into real estate business
is to buy a home and rent it out yourself. There are any number of
ways to purchase a home, but ideally it is best for the investor
to purchase the home with a loan. Doing so allows them to free up
their own cash, and limit their own risk in the property. Also, by
purchasing on credit, the investor can purchase more than one home
and grow their business quickly.
Unfortunately, buying a home to start your own real estate
investing business is time consuming. Not only will you need to
purchase the home, but you'll also have to ensure the tenant pays
on time, and that all of their needs are met. Likewise, you'll
have to find a tenant to occupy the home.
Besides the income from the investment property, there is an
opportunity to profit from appreciation of the home, as well.
Let's assume that you were going to buy a $100,000 home and put up
$10,000 of the purchase price. You would then borrow the other
$90,000. You find a tenant, and after all expenses, the tenants
rental payment brings the house to "breakeven." That is, all your
costs are afforded by the rental payment, and only a modest level
of monthly cashflow is achieved.
Now imagine that in the next two years the tenant moves out
after the lease expires, and the home has appreciated now to
$110,000. If you were to sell now, you'd bring in $110,000, pay
roughly $89,000 on the outstanding loan balance, and have $21,000
left over. Because you invested only $10,000, your profit is
$11,000, for a return of 110% in two years. That is just one
example of the insane power of leverage in real estate
Such a hands-on investing strategy doesn't work for everyone,
however. Most find that working a full-time job and balancing a
rental home portfolio is simply too much work. Luckily for them,
though, there are opportunities to invest in other forms of real
estate that require less work, and less hassle.
Real Estate Investment Trusts
Real estate investment trusts were popularized with the boom of
exchange-traded funds and have been popular ever since. A real
estate investment trust works very much like a mutual fund, except
it holds rental properties instead of stocks.
The REIT must pay out 90% of all earnings to investors to
maintain its status as a "trust." Thus, the earnings of a REIT are
not reinvested, instead they are paid out to investors monthly,
semi-annually or annually just like any other rental property. The
benefit here, of course, is that a professional team manages the
portfolio and an investor need put up only a very small amount of
money to get started. In fact, individual shares of a REIT can be
had for $10-50 per share, making it a perfect way to invest in
real estate on the cheap.
Unlike owning your own rental properties, though, REITs are not
as profitable. They are, however, extremely consistent and have
been seen as one of the best long-term investments for generating
an income. While you won't make $20,000 in two years flipping a
home for a profit, you won't have to deal with common problems
like repairing a leaky sink, or mowing a lawn while your home is
unoccupied. Nor will you have to deal with tenants that do not
pay, either. REITs practically define what "hands off" investing
is all about!