For some, investing in real estate can translate to thousands of dollars in additional income each year. And experts say that in todays inflationary environment, doing so could prove to be a strategic move.
A real estate investment provides a hedge against inflation if rents keep pace with, or outpace, the rate of inflation, says Derek Graham, principal and founder of Odyssey Properties Group. Property types such as multifamily (apartment buildings) that are able to adjust rents more rapidly tend to be the most inflation resistant. He adds that the typical lease term on an apartment is 12 months, after which point the rent amount can be readjusted to reflect the current market.
In fact, about 70% of rental properties in the U.S. are owned by individual investors, according to the U.S. Department of Housing and Urban Development (HUD). But even if youre not looking to add landlord duties to your list of responsibilities, there are other ways to buy into real estate and generate investment income.
Heres how to know if this type of investment is right for you, and how to get started.
Pros and cons of investing in real estate
If youre thinking about investing in real estate, its important to weigh the pros and cons carefully and ensure this type of investment fits your lifestyle and financial goals.
There are a number of benefits to investing in real estate:
It can provide an additional stream of income. Putting your money toward a rental property (or even renting a room in your home or a portion of your property) can help you earn enough money to cover the cost of that property, and even pad your monthly income. Whether its a single-family home, a shopping center, an industrial warehouse, or a myriad of other real estate assets, individuals can generate a steady stream of cash flow from the rental income of their real estate investments, says Graham. The level of income generated is dependent on both the location and type of real estate asset.
Investing in real estate can help diversify your investment portfolio. Graham notes that real estate investments generally have a low correlation to the stock market, so you can use them to hedge against losses during market downturns. Having a diverse mix of assets in your portfolio also spreads your risk out across asset types, meaning youll have a higher chance of coming out on top when some of your other assets arent doing as well.
Real estate investments may reduce your tax bill. Another perk of real estate investing is potential savings during tax time. Some of the most common benefits include deductions for mortgage interest and property taxes, says Graham. You may also be able to lower your annual taxable income through depreciation, he says. Lastly, the 1031 exchange allows investors to defer capital gains taxes by using the sales proceeds from one property to purchase another like-kind property.
Despite these benefits, there are some drawbacks you should carefully consider, too:
Real estate investments can be more involved than other asset classes. Unlike the money you invest in stocks or bonds and monitor from time to time, your real estate investments may require more time and attention. Real estate investments typically require significant upfront capital and are burdened by additional and ongoing operational and maintenance expenses, says Graham. Owning and managing a property can be time-consuming and require a lot of effort, especially if you have multiple properties.
Your money could be tied up. Real estate is considered an illiquid investment because in order to access your money, you have to go through the process of selling your property, which can take a considerable amount of time. However, you can get around this challenge by investing in real estate funds instead.
Pros
- Additional source of income
- Portfolio diversification
- Tax breaks
Cons
- Potentially more hands-on
- Direct property investments are illiquid
How to invest in real estate
There are several ways to invest in real estate, either directly or indirectly. Depending on the route you take, not all types of real estate investments will require a ton of time or capital. The amount of money needed to invest in real estate varies depending on the property, location, market conditions, and investment avenue, says Graham. In some cases, investors might need as little as a few thousand dollars to get started.
A few common ways to get in on the real estate game, include:
- Direct purchase: This is when you buy all or a stake in a specific property such as an apartment, home, housing complex, shopping center, or commercial office building.
- REIT: Real estate investment trusts (REITs) are companies that own, operate, or finance income-producing real estate and then collect rent, operating expenses, or interest payments from the properties in its portfolio and use those funds to pay dividends to shareholders. You can buy shares of a REIT in a taxable brokerage account, as well as a tax-advantaged retirement account such as an IRA or employer-sponsored 401(k) (if the plan allows it).
- Real estate sponsor: A sponsor is an individual or company in charge of finding, acquiring, and managing a property on behalf of investors. Sponsors will typically invest in the property as well, but wont have to invest as much capital as the other investors involved. For investors seeking to reap the benefits of owning real estate without enduring the obligations of operating the property, partnering with an experienced real estate sponsor is an ideal choice, says Graham.
- Investing apps: There are also brokerages and investing apps that offer fractional investment options, which allow you to buy small shares of an individual property or real estate fund at a relatively low cost, and even earn monthly dividends. Of course, this route likely wont generate the same amount of revenue that youd earn by owning 100% of a property or piece of land, but its an easy way to get your foot in the door of real estate investing.
The takeaway
Investing in real estate can be lucrative. And it doesnt have to be an expensive undertaking. You have lots of options for investing in real estate, from buying an actual piece of property and renting it out, to purchasing small shares of real estate funds. Not matter which route you take, diversifying your portfolio with real estate investments can help you ride out short-term market volatility and grow your wealth over time.
Even so, putting your money into real estate could make it more difficult to access than with liquid assets such as stocks or bonds. So before you invest, think carefully about your investment time horizon and what type of investment structure aligns with your personal goals.
