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 investments!

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!