Real Estate Investment: Understanding the Basics
Updated: Aug 30
Real estate investment has long been a popular way for individuals to grow their wealth and secure their financial future. With the rise of the internet and new technologies, investing in real estate has become easier and more accessible than ever before. But despite its popularity, many people still don't understand the basics of real estate investment and how it works.
Let's take a closer look at the fundamentals of real estate investment and provide some tips for those who are new to this type of investment.
What is Real Estate Investment? Real estate investment refers to the purchase, ownership, and management of income-generating properties for the purpose of generating returns and appreciating in value over time. This can include buying and renting out residential properties, investing in commercial properties, or buying and holding land for development. The most common forms of real estate investment are residential and commercial properties. Residential properties can be apartments, single-family homes, or condominiums, while commercial properties can include retail spaces, office buildings, hotel and industrial properties.
Why Invest in Real Estate? Real estate investment has many benefits, including:
Potential for high returns: Real estate has the potential to generate high returns, especially when compared to traditional investments like stocks and bonds.
Appreciation: Real estate typically appreciates in value over time, which can result in long-term wealth creation.
Cash flow: Renting out properties can generate a steady stream of passive income, making it a great investment for those looking to supplement their income or build wealth over time.
Tangibility: Real estate is a tangible asset that can be seen and touched, making it a more tangible investment than stocks or bonds.
Diversification: Investing in real estate can help diversify your investment portfolio, reducing your exposure to market volatility and risk.
The Case Shiller U.S. National Home Price Index grew on average 3.4% from 2000 to 2019, while the S & P index grew by 4.3% during the same period. However, that comparison is not quite accurate. S&P companies use debt to boost their returns, which gets reflected through S&P index appreciation. In the same way, if a real estate investor uses a loan to buy a rental home, his or her real return can be higher than the home price appreciation because of cheap debt. Historically CAP rates (real estate profitability ratio) in the United States have been higher compared to the mortgage interest. As an example, if your mortgage is 4% and the projected income ratio or CAP rate from your rental is 5%, you will make an extra 1% return from every dollar you borrowed from a bank and invested into your rental. As an example let’s assume that you could have bought a rental house for $100,000 with a $20,000 (20%) down payment in 1990. Based on the average annual 3% price growth of your investment you would be fully paid off in 2020 and would be worth $220,000. In the same example if you would have invested $20,000 in the stock market in 1990 your portfolio would be worth only $169,700 in 2020.
What are some of the Disadvantages of Real Estate Investing?
Less Liquidity. It can take anywhere from 3 to 6 months to sell your investment property. So if you need money quickly you should think about other alternatives such as an equity line of credit that will give you access to quick cash.
Operational Risk. Real estate management might seem very simple, but before considering a self-management option, the investor should make sure they have the time and the knowledge to deal with leasing, rent collection, tenant communication, maintenance and etc.
Risk of additional capital for repairs, renovation, or other issues. Real Estate is like a living organism that needs constant care. To maximize your rents you should always fix deteriorating physical structures and update building systems to keep your tenants happy and be in compliance with evolving building codes. If you are planning to invest in commercial real estate, you should always plan for sizable leasing commissions and a tenant improvement budget for new leases and lease renewals.
Tips for Successful Real Estate Investment If you're new to real estate investment, here are some tips to help you get started:
Do your research: Before investing in real estate, it's important to research the market and understand the local economy, real estate trends, and property values.
Develop a strategy: Determine your investment goals, risk tolerance, and time horizon. This will help you develop a strategy that is tailored to your specific needs.
Get the right team: Surround yourself with experienced professionals, such as real estate agents, attorneys, and accountants, who can help you navigate the investment process and make informed decisions.
Be patient: Real estate investment is a long-term strategy and requires patience. Don't expect to make a fortune overnight, and be prepared to ride out market fluctuations.
Diversify: Diversification is key to successful real estate investment. Consider investing in a variety of properties, both residential and commercial, in different geographic locations.
Real estate investment has the potential to be a lucrative and rewarding way to build wealth over time. By understanding the basics, developing a strategy, and working with the right team, you can increase your chances of success and achieve your investment goals. If you're considering investing in real estate, it's important to do your research, take the time to understand the market, and consult with experienced professionals who can help you make informed decisions.