Investing in real estate is one of the best ways to build wealth and generate consistent cash flow over time. Although rising home prices and above-average mortgage rates have made it challenging for investors to find investment properties that are profitable, investing in real estate is still a smart decision for investors interested in long-term asset appreciation.
Acting as a hedge against inflation, the real estate market is less vulnerable in times of economic uncertainty. This causes investment properties to outperform other forms of investment even when the economy is not as strong. Let's discuss the pros and cons of investing in real estate, as well as the difference between active and passive real estate investing.
The pros and cons of investing in real estate
Property investors often enjoy consistent cash flow, long-term asset appreciation, and the ability to grow equity. However, like any investor, they face a certain amount of risk. Real estate investments are often more stable than stocks or bonds in times of economic uncertainty — but they’re not immune to market fluctuations or state laws. Unexpected changes in the market or local regulations can cause real estate investors to lose money or reduce the profitability of their investments.
Take a closer look at the pros and cons of investing in real estate below:
Pros
Consistent cash flow
Investing in rental properties can boost your monthly income by generating positive cash flow through rental payments. Although it costs money to invest in and maintain a property, rents grow over time, allowing you to capitalize on the difference every year.
Long-term appreciation
Investing in real estate usually results in asset appreciation over time. So long as you purchase a property in a strategic location, at a fair price, and at the right time, your property value should naturally grow. You can also force property appreciation through value-adding home renovations such as room additions, bathroom remodels, and kitchen revamps. For investors looking to fix and flip, forced appreciation can significantly boost home sales prices, resulting in a greater return on investment.
Equity gains
Building equity is crucial for accumulating wealth and creating future financial opportunities. Once you’ve built up enough equity, you can leverage it to invest in other ventures, such as purchasing an investment property.
Using your home as collateral can result in more favorable rates, larger funding amounts, and better terms than other financing options.
Portfolio diversification
All investments are subject to market volatility. However, real estate is considered less volatile because it deals with physical spaces needed to either live or work. Even in times of economic uncertainty, tenants will prioritize paying their rent on their residential or commercial properties to secure housing for themselves or their businesses. As a result, investors with a real estate portfolio tend to do better than those with non-essential assets during economic downturns.
Cons
Market volatility
Real estate markets experience cycles of growth and decline at the national and local levels. Economic downturns, such as the one witnessed during the pandemic, can negatively impact investor cash flows. It can lead to financial losses if investors don’t time their investments carefully.
Different types of real estate investments carry varying levels of risk. A fix-and-flip investor, for example, can incur a major and immediate loss if they can't recoup what they invested to renovate the home.
Even when investors are diligent about predicting property values and generating rental income, financial losses can still occur. It’s important to have enough cash reserves to weather difficult times in the market.
Liquidity challenge
Real estate investments aren’t easy to liquidate. Selling property is a lengthy, time-consuming process that can take several months to complete. Unless you’re dealing with an all-cash buyer, it can be difficult to convert a property into cash. This lack of liquidity in real estate limits an investor’s ability to access funds when needed. This isn’t the case with stock or bonds, which can easily be sold for cash.
Homeownership costs
As a property owner, you’re responsible for keeping your investment property in good condition. Ideally, you’ll find reliable tenants who care to keep the home clean and functional. However, property maintenance ultimately falls on you. You’ll need to regularly pay for landscaping, HVAC, and plumbing services, to name a few.
According to Wells Fargo, homeowners spend 1% to 2% of their home’s purchase price on routine maintenance every year. Some homeowners abide by the square footage rule, which states that homeowners should spend $1 per square foot per year on their rental property’s regular maintenance.
Property expenses can become especially burdensome if critical areas, such as the roof or foundation, are compromised. Not all home repairs are created equally. Some will quickly put you in the red before you even begin to see a return on your investment. That's why it's important to get thorough home and pest inspections before investing in any property.
Unexpected expenses
In addition to regular maintenance costs, property owners can run into unexpected expenses that significantly impact their rental income. Legislative changes, such as the stringent Airbnb regulations recently implemented in NYC, can dismantle entire rental businesses, forcing investors to switch over to less profitable models.
If you own a rental property, experiencing vacancies is a possibility. Unfortunately, you’re responsible for maintaining monthly mortgage payments even when your rental properties aren't generating rental income. Make sure to factor these contingencies into your real estate investment strategies.
How to make money in real estate
In addition to being a stable investment opportunity, real estate investing is quite versatile. There are several ways to make money as a real estate investor—and they don’t always involve owning a piece of property. Real estate investors can invest in real estate actively or passively. Both forms generate passive income streams. However, they differ in risk tolerance, upfront investment, and time commitment. Take a closer look at both forms of real estate investing below.
Active real estate investment strategies
Active real estate investing involves hands-on property management that demands time and attention from an investor. It offers the potential for higher returns but also comes with higher risk.
Investing in residential real estate
Purchasing a multi-family home and renting out multiple units within the property is a great way to generate rental income. The longer an investor holds onto the residence, the better their chances of selling the property at a higher price. Owners of multi-family residential properties benefit from economies of scale, given that maintenance and management costs tend to be lower per unit in multi-families than in single-families.
Obtaining a single-family home is a simple and reliable form of investing in residential real estate. While multi-family homes often yield higher returns, they usually require greater capital for purchase and involve more complicated transactions. A single-family home, on the other hand, is cost-effective and easier to manage. This type of rental property also tends to appreciate faster than a multi-family home. Investing in residential real estate could generate an annual ROI between 14% and 18%.
House-hacking
Getting started as a real estate investor can be difficult if you lack the capital to purchase an investment property. Investment properties usually require a down payment of 20-25%, which can be a large sum of money for a first-time investor — especially if the home they're purchasing is a multi-unit property. One way investors get around this is by house-hacking.
House-hacking is when a homeowner converts their primary residence into an investment property by renting out multiple units or rooms within the home. This strategy can be applied in single-family homes as long as you have enough space and are comfortable living with roommates. Savvy investors often use this method to accumulate funds for acquiring a second investment property. House-hackers can expect an annual cap rate of 3%-4%, although it’s possible to achieve a higher cap rate depending on how you manage your property expenses.
Fix-and-flip
Investors who prefer to see more immediate returns and have considerable cash to invest upfront can fix and flip a property. House flipping is when an investor purchases a distressed or undervalued property to renovate and sell it immediately after repairs are complete. House flippers enhance the property's value and curb appeal through structural and aesthetic repairs. The ROI on the average house flip was 26.9%, with a gross profit of $67,900.
Hosting short and mid-term rentals
A relatively new form of real estate investing with low barriers to entry is hosting short-term and mid-term rentals on Airbnb, VRBO, and other booking platforms. Also referred to as Airbnb investing, hosting is considered an active real estate investment strategy because it requires frequent maintenance through property maintenance and marketing. Airbnb investors can either own the properties they manage or operate a property management company that manages the properties for the owner. Short and mid-term rentals typically generate an ROI of 15% or more.
Passive real estate investment strategies
Passive real estate investing requires limited involvement on the investor's behalf and less time commitment.
REITs (Real Estate Investment Trusts)
A real estate investment trust is an investment vehicle that pools funds from multiple parties to invest in a diverse range of real estate assets. As publicly traded entities, REITs allow investors to buy and sell real estate shares on stock exchanges. By law, REITs are mandated to distribute a significant portion of their income to shareholders through dividends on at least an annual basis.
REITs are appealing investments because they provide investors with regular financial returns. They also allow investors to tap into the real estate market without the responsibilities of direct property ownership. When compared to investing in physical real estate, REITs offer greater liquidity and require less capital to get started. On average, REITs generate an annual ROI of 11.8%.
Crowdfunding
Real estate crowdfunding works similarly to online funding platforms such as GoFundMe — but is tailored for real estate investments. Crowdfunding investors combine their funds to invest directly into a real estate project or property. Investors receive a portion of the property’s rental income as cash flow, which is proportional to their investment.
Crowdfunding is similar to REITs in that investors can receive a return on their investment regularly. However, crowdfunding offers less liquidity and more involvement. REITs are managed similarly to stocks. Crowdfunding real estate projects, on the other hand, are managed collectively among various investors. If one investor would like to exit, they would first have to consult with the other investors involved in the project.
The perk is that investors share direct ownership and have greater control over the real estate project or property. Crowdfunding real estate projects yield varying returns. The average annual ROI for real estate crowdfunding platforms ranges from 2% to 20%.
REIGs (Real Estate Investment Groups)
Similar to REITs and crowdfunding platforms, REIGs are collaborative . However, real estate investment groups offer greater flexibility in that they bring together a variety of real estate investors who pursue communal real estate ventures based on their interests.
In an REIG, investors can access better deals and collaborate on larger investments than they could alone. Investors pool funds for long-term residential and commercial properties, short-term vacation rentals, fix-and-flip properties, and other real estate ventures. Given the diverse nature of REIGs, the ROI for each real estate project varies.
Final thoughts on investing in real estate
As you can see from the options mentioned above, there are quite a few investment vehicles to choose from if you’re interested in real estate. Whether you prefer to take a hands-on or hands-off approach to real estate investing, there’s enough flexibility in the market for all kinds of investors.
If you’re interested in investing in the real estate market but don’t have the necessary funds to get started, consider Point’s Home Equity Investment product as a funding source. An HEI allows you to tap into your home’s equity without monthly payments, or taking on debt. Visit Point to find out if you qualify for an HEI and embark on your real estate investment journey today.
