Is Real Estate a Good Investment?
If there is one question we hear from new investors all the time, it is: “Is real estate a good investment?” These investors want to know whether it is really possible to make money in real estate or whether they should just stay on the stock market. We did our best to answer that question below. Read each section to get a better idea of whether real estate investments are the right choice to add to your portfolio.
What are the different ways to invest in real estate?
Before we dive into the specific benefits of investing in real estate, it is important to clarify that real estate investments are more than just becoming a landlord and generating rental income. In practice, there are six different ways you can add real estate to your portfolio:
- Buy and hold strategy: This is the classic real estate investment strategy where you buy an investment property, find a tenant, and earn regular rental income.
- Short-Term Rental Strategy: A short-term rental strategy is similar to a buy-and-hold strategy, except that you are renting out your investment property for a short time rather than finding a long-term tenant. Investors often use platforms such as Airbnb or VBRO to market their properties.
- Fix-and-flip strategy: A fix-and-flip strategy, also known as “flip houses”, involves buying a property that is undervalued for the market, repairing it, and selling it for a profit.
- Real Estate Wholesale Strategy: A wholesale strategy also involves buying a property that is undervalued for the real estate market. But in this case you turn around and sell it to an end buyer very quickly at a higher margin instead of fixing it first.
- Real Estate Investment Trusts (REITs): If you enjoy playing the stock market, you might be interested in investing in a real estate investment trust. REITs are listed companies that own, operate or finance real estate. Investors can buy shares in these companies and receive dividends in return. Alternatively, you can also invest in a real estate mutual fund such as a mutual fund or real estate ETF.
- Crowdfunding: Similar to REIT investments, crowdfunding is a great way to generate passive income. In this case, a seasoned real estate professional will usually identify a good investment opportunity but will not have the income to finance it. Instead, they use a platform to pool funds from interested investors, who then receive a share of the profits in return for their capital.
What are the pros and cons of investing in real estate?
As with any major investment, it is important to consider the pros and cons before you start investing in real estate. We have listed some of these for you below so that you can have a better idea of what to expect when you decide to invest in the real estate market.
When you decide to add real estate to your investment portfolio, there are several ways you can make a profit first. As mentioned above, if you want to generate a regular cash flow, you can use a buy and hold strategy. In this case, you would also have the opportunity to benefit from long-term appreciation. If you prefer a flat payout, you can opt for a fix-and-flip strategy or a wholesale strategy. However, if you want more passive income, you can go for REIT investing or crowdfunding.
In addition, real estate investment offers a tax advantage. For example, you could use depreciation to significantly lower tax rates on long-term profits, or you could use a 1031 stock market to defer capital gains from the sale of your rental property. While you need to speak to a tax professional to ensure that you can take advantage of all of the tax breaks that are available to you, it is important to know that they exist.
Finally, with real estate, you can build up equity that you can ultimately use as leverage to expand your investment portfolio. For example, a real estate investor often opens a HELOC for one of their investment properties to fund the down payment for a new purchase.
The biggest downside is that the initial investment for investing in real estate is usually larger than that of any other investment option, especially if you want to undertake either a buy-and-hold strategy or a fix-and-flip strategy. Put simply, when you get a mortgage to cover the purchase price, you need to be willing to pay the down payment and closing costs and have adequate cash in the bank.
Many forms of real estate investment are also a lot of work. While crowdfunding and REIT investing allow you to generate passive income, other forms of real estate investing take a lot of effort. For example, with a fix-and-flip strategy, you need to put a lot of equity into improving your home before you can increase the property’s value enough to sell at a profit.
What is the long-term growth rate of real estate investments?
The truth is, it is difficult to compare apples when you look at different asset classes. In this case, stocks tend to appreciate much faster than real estate. However, they don’t offer the same level of leverage, making it difficult to pinpoint exactly which investment option is ultimately more valuable.
Even so, in an article titled “The Return on Everything 1870-2015,” researchers at the Federal Reserve Bank of San Francisco examined the average return for each major asset class in 16 global economies. Her research goes back to 1870. However, in order to keep the data manageable, we decided to only look at the returns in the US from 1980 to 2015.
They found the following:
- Bills: 1.71
- Bonds: 5.71
- Shares: 9.09
- Real estate: 5.66