How to Create Wealth Investing in Real Estate
We are entering nearly a decade of sustained economic growth in the real estate sector. Markets across the country, from Dallas to Portland, have seen high single- and even double-digit annual growth over the past few years. To an outsider looking in, it may seem like most real estate investments involve flipping and selling homes for a profit- however, this is far from the case. Investors create wealth with real estate through commercial leases, multifamily rentals, property appreciation, and through many other income streams.
Real Estate Investments: What You Need to Know
Real estate (RE) as an asset class offers many advantages over traditional investments like stocks, bonds, and other types of securities that trade on exchanges. Investors flock to RE due to its stable cash flow, tax advantages, property appreciation, and other financial rewards that make real estate an excellent addition to a portfolio that is diversified across multiple asset classes.
Real Estate Asset Advantages
-Average 20-year returns for real estate properties range between 9 and 11 percent per year, for commercial real estate and REITs, respectively. Both numbers are higher than the S&P 500’s average return.
-The majority of returns from real estate investments come from cash flow, not appreciation. Rental properties generate stable cash flow, which can be leveraged to acquire more properties, used for personal expenses, or to invest in other asset classes.
-Real estate is among the most tax-advantaged asset classes. If you choose to finance RE investments, you will be able to deduct any mortgage interest from the property. Since real estate improvements depreciate over time, you also get those deductions.
-Diversification is another major plus for real estate investments. The RE market has historically had an inverse relationship with equities markets, and many investors use real estate as a hedge against inflation and down markets for securities.
Diversity in Real Estate Assets
When most people think of real estate, they think of buying and selling residential properties. While this is a substantial portion of the RE market, there are a myriad of other options that are available to astute investors. These include:
Commercial Buildings (Retail, Office)
Multifamily Apartment Buildings
Real Estate Investment Trusts
Real Estate Mutual Funds and Stocks
Real Estate Crowdfunding
Real estate is a fantastic tool for generating cash flow, reducing market volatility, and growing your wealth through property appreciation.
When most people think of investments, they think of equities, aka stocks. Equities are just one of many asset classes you can use to generate returns. Real estate is an alternative to traditional stocks and bonds. RE assets possess positive qualities that cannot be found in any other asset class, but they do have a few drawbacks when compared to stocks, bonds, and mutual funds.
Why Choose Stocks
Stocks are by no means “bad investments.” While there are outliers, the stock market has consistently risen over time to the present day. As investment assets, they edge out real estate in a few different ways.
-Low Transaction Fees
Stock sale and purchase transactions are lower than most RE transaction fees. If you are buying a lot of properties, or even one expensive property, these fees can add up to quite a bit of your capital paid to lenders and RE professionals.
Liquidity is another major plus for equities- you can buy or sell them relatively painlessly compared to real estate assets.
-Less Complex Transactions
Shares of stocks can be easier to research and to buy and sell. Real estate transactions can be relatively complex and may require the assistance of a real estate attorney, broker, or other type of specialized professional.
-Better and Easier Diversification
Diversification can also be much easier with a portfolio of stocks. You may have a 50-stock portfolio that is invested in a number of different industries: Retail, Technology, Utilities, etc. While real estate is slowly changing to provide more diversification, stocks still have the upper hand right now.
Why Choose Real Estate
-Lower Asset Risk/Stability
Historically, the stock market has been more volatile than the RE market. Company earnings rise and fall all the time, but it is incredibly rare that the value of real estate can decline to zero. The land the building sits on has value and the building can always be modified for a higher and better use.
Out of all the major asset classes, real estate is arguably the most tax-advantaged. Investors can write off property depreciation and maintenance, mortgage interest, and can take advantage of numerous local, state, and federal tax breaks.
-Actively Managed RE Beats Stock Returns
Dalbar, a leading independent financial auditing and data firm reported that over the past four decades, actively managed real estate returns beat stock market returns by more than one full percentage point. Passive real estate investments have roughly the same ROI as the equities market.
Real Estate Crowdfunding is a relatively new RE financing method, which uses crowdfunding to raise capital for real estate projects. By taking advantage of crowdfunding to raise funds, investors can invest directly in a range of properties, without having to work with real estate agents, contractors, or mortgage brokers. Crowdfunding projects are typically hosted on online platforms, reminiscent of Kickstarter or GoFundMe.
Benefits of RE Crowdfunding
-Access to Capital
Along with the increased opportunity for investors, crowdfunding allows greater access to capital for developers. Instead of going to a bank or lender, developers can go straight to individual accredited investors to raise capital funds.
-Combines Fundraising and Marketing
Crowdfunding allows developers to use technology to more effectively reach accredited investors. This can help raise a developer’s profile and connect them with investors for development projects, even those that are not listed on the crowdfunding platform. The share-able nature of crowdfunding also means that developers do not have to spend an arm and a leg on marketing expenses- the viewers and users share that expense with them.
Types of Crowdfunding Investments
Just like securities are stocks and bonds, there are two types of crowdfunding investments- equity (ownership position) and mortgages (lender position).
These investments have returns that can top 25 percent or more, depending on property appreciation. Fees are typically lower than other similar RE assets. Equity investors also benefit from many of the tax benefits that come with owning real estate, like property depreciation, mortgage interest, etc.
A crowdfunding debt investment is when an investor lends capital to the current property owner. They typically provide a fixed return based on the property’s mortgage rate. Debt investments offer regular returns, lower risk, and shorter holding periods when compared to CF equity investments.
One benefit of living in such a large and economically diverse country is the ability to find real estate opportunities in any niche, geographic location, or price point. There are a multitude of factors that make an area optimal for investing – for example, job growth, rising population, planned developments, crime rates, and other characteristics.
Dallas combines robust population and job growth, alongside relatively low acquisition costs to rank number one in many RE investment surveys, including Mashvisor, Forbes, and NORAD Real Estate.
This Disney World adjacent city is bouncing back from the 2008 crisis, which hit Florida particularly hard. A diverse employment base, ample housing stock, and solid economic growth make Orlando an excellent choice for picking up RE assets.
Charlotte, North Carolina
Charlotte has long been the financial center of the South, and despite long-term year on year growth, the area still remains affordable for many investors, especially when compared to other finance-oriented coastal cities like NYC or the SF Bay Area.
This eclectic city is considered by many to be the cultural heart of Texas. Aside from its culinary and musical reputation, Austin is home to numerous tech companies, which has led to rising annual incomes and an increase in home values.
Tampa has one of the lowest property acquisition costs in the country, somewhere around 136k. This, combined with excellent job growth and population growth makes Tampa an excellent place for beginner investors to dip their toes into the water.
Other metro areas to check out include:
There are many different ways you can add real estate assets to your investment portfolio. You can purchase and sell a home, aka a flip. Many investors also buy and rent properties to tenants. Others invest in REITs and Crowdfunding platforms.
Direct Real Estate Investments
Direct investing in real estate occurs when you put capital directly into a property. You either purchase a share of the property, like in a crowdfunding deal, or buy it outright with or without a mortgage.
Residential Rental Properties
You can generate cash flow and benefit from appreciation by investing in rental properties. Common rental properties include duplexes, single-family homes, and multifamily apartment buildings. Residential properties generate income through tenant leases, related services, and property appreciation.
Many investors purchase properties to “flip” them to new buyers. Often these properties are dilapidated or in less than stellar shape. Investors will buy the property, invest some capital, and resell the property at a profit. This can be a very lucrative way to generate returns with real estate, but also risky, due to the hazards and potential cost overruns of construction/rehab projects.
In areas that have significant tourist traffic, investors may purchase homes to rent out. Airbnb and other homeshare platforms have led to a substantial increase in the vacation rental market over the past decade.
Commercial properties include retail, hotel, self-storage, manufacturing, and any other type of property used for commercial or business purposes. Commercial leases are longer than traditional residential leases, and this can lead to long-term, stable rental income from a commercial property.
Indirect Real Estate Investments
There are ways you can invest in real estate without purchasing a property. Instead of buying an individual property, you can buy a share in a portfolio of properties, or shares in a real estate-oriented company. These include Real Estate Investment Trusts, Real Estate Mutual Funds, Real Estate ETFs, and other RE aligned investment assets.
Some IRAs, or Individual Retirement Accounts, limit investment choices with restrictions on what types of assets you can buy- you may be limited to stocks, bonds, and mutual funds. A Self-Directed IRA (SDIRA) allows retirement savers to have more control over their portfolio to invest in alternative assets, like real estate.
How Do Self-Directed Real Estate Investments Work?
With a standard IRA, you are not allowed to invest in alternative asset classes like real estate, precious metals, promissory notes, and others. If you want to invest in those asset classes, you can change your standard IRA to a Self-Directed IRA. Here is how it works:
Find a Self-Directed IRA Custodian.
This is a financial advisor that handles the management and administrative tasks related to Self-Directed IRAs. They do not provide any sort of financial guidance, as a standard IRA manager might – their job is strictly to ensure your compliance with the relevant SDIRA regulations.
Contact Your Current Financial Institution to Transfer Your Account
After hiring a custodian, you then request a wire transfer from your old IRA to your new SDIRA. Your custodian can help with all the details, and the process should not take more than a few weeks.
Start Investing the Way You Want
Now that you have opened your Self-Directed IRA, you can choose to deploy your capital in any number of real estate projects, as well as other asset classes. All of the tax-deferral benefits that come with an IRA are available to SDIRA holders.