REAL ESTATE INVESTING
Owning real estate is the base foundation for building wealth. There a numerous benefits to owning real estate, whether a personal residence or a rental property, such as value appreciation, consistent cash flows, as well as deductible interest expense. The equity in a property can be converted into cash to make more investments.
Simply stated, when investing in real estate, the goal is to put money to work today and allow it to increase so that you have more money in the future. The profit, or "return," you make on your real estate investments must be enough to cover the risk you take, taxes you pay, and the costs of owning the real estate investment such as utilities, regular maintenance, and insurance.
Real estate investing really can be as conceptually simple as playing monopoly when you understand the basic factors of the investment, economics, and risk.
To win, you buy properties, avoid bankruptcy, and generate rent so that you can buy even more properties. However, keep in mind that "simple" doesn't mean "easy." If you make a mistake, consequences can range from minor inconveniences to major disasters. You could even find yourself broke or worse.
The 4 Ways Real Estate Investors Make Money
When you invest in real estate, there are several ways you can make money:
- Real Estate Appreciation - This is when the property increases in value due to a change in the real estate market, the land around your property becoming scarcer or busier like when a major shopping center is built next door or upgrades you put into your real estate investment to make it more attractive to potential buyers or renters. Real estate appreciation is a tricky game. In fact, it is riskier than investing for cash flow income.
- Cash Flow Income - This type of real estate investment focuses on buying a real estate property, such as an apartment building, and operating it, so you collect a stream of cash from rent, which is the money a tenant pays you to use your property for a specific amount of time. Cash flow income can be generated from well-run storage units, car washes, apartment buildings, office buildings, rental houses, and more.
- Real Estate Related Income - This is income generated by "specialists" in the real estate industry such as real estate brokers, who make money through commissions from buying and selling property, or real estate management companies who get to keep a percentage of rents in exchange for running the day-to-day operations of a property. This type of real estate related income is easy to understand. For example, a hotel management company gets to keep 5 percent of a hotel's sales for taking care of the day-to-day operations such as hiring maids, running the front desk, mowing the lawn, and washing the towels.
- Ancillary Real Estate Investment Income
For some real estate investments, this can be a huge source of profit. Ancillary real estate investment income includes things like vending machines in office buildings or laundry facilities in low-rent apartments. In effect, they serve as mini-businesses within a bigger real estate investment, letting you make money from a semi-captive collection of customers.
Tips for Purchasing Real Estate Investment Properties
There are several ways to buy your first real estate investment. If you are purchasing a property, you can use debt by taking a mortgage out against a property. The use of leverage is what attracts many real estate investors because it lets them acquire properties they otherwise could not afford. However, using leverage to purchase real estate can be dangerous because, in a falling market, the interest expense and regular payments can drive the real estate investor into bankruptcy if they aren't careful.
You will almost NEVER purchase a real estate investment in your own name. Instead, for risk management reasons, consider holding real estate investments through special types of legal entities such as limited liability companies or limited partnerships (you should consult with a qualified attorney for his or her opinion as to which ownership method is best for you and your circumstances).
That way, if the real estate investment goes bust or someone slips and falls, resulting in a lawsuit, you can protect your personal assets because the worst that can happen in some circumstances is you lose the money you've invested. It lets you sleep at night because unless you've screwed up somewhere, your 401(k) planassets, Roth IRA investment, and other retirement accounts should be out-of-reach.
HOW TO INVEST IN REAL ESTATE WITH LITTLE MONEY
If you want to get into real estate investing but don’t have enough capital, REITs are your chance.
REITs, or Real Estate Investment Trusts, run like a mutual fund would. They buy bundles of real estate, and you get a chance to buy the fund.
Just as a mutual fund buys a portfolio of companies, an REIT buys a portfolio of real estate.
hey buy commercial, industrial, or residential real estate. The owners of the REIT are then paid part of the profits from these investments in dividends.
There are 2 distinct advantages to REITs.
1. By law, an REIT must pay 90% of its earnings to shareholders in a dividend
2. Investing in REITs gives you an additional layer of diversification
REIT Advantage #1
What a great feature to have. Instead of having to worry about management pissing away earnings, the shareholder gets money in hand.
This is how companies should be run. With the shareholder in mind.
Of course, an REIT isn’t a company and doesn’t have to deal with the types of liabilities that companies need to run. So this will never happen.
But it does happen in REITs. And it’s up to shareholders to take advantage.
Keep in mind is that dividends from an REIT are taxed differently than dividends from a corporation. REIT dividends are taxed as income, not as capital gains.
Therefore, you should hold REITs in a tax deferred IRA or 401k.
The only exception to this is if the REIT dividend becomes a qualified dividend, which must be held throughout a set holding period.
REIT Advantage #2
Because an REIT is invested in real estate instead of a company, it provides diversification through a different asset class.
This is important because equities (stocks) tend to generally move in the same direction. Equities tend to rise and fall during the same time.
So, a portfolio of only stocks will lose value quickly during a market crisis. The investor would then have no choice but to wait out the storm.
But if you diversify your asset classes (stocks, bonds, real estate) so that you aren’t all in stocks, then you can shift money in and out of these asset classes as you need to.
In fact, the investing legend Benjamin Graham emphasized the importance of always holding both stocks and bonds. His teachings on how to balance these holdings were absolutely brilliant.
Graham urged his readers to carry more bonds when stocks were up, and carry more stocks when they were down. They may seem counterintuitive, but bear with me and listen up. This is important to understand.
The worst time to buy a stock is when it has already seen massive gains. A stock that has performed extremely well will no longer be undervalued, and so it won’t have the margin of safety you need.
This is the foundation of value investing, and you can learn more about it in Benjamin Graham’s book The Intelligent Investor.
When a stock is beaten down, then at that time you can purchase shares at a discount. It’s like a clearance sale. Once you know how to calculate what the stock is worth, you can find the stocks that are trading at extreme discounts, and purchase assets for less than what they are worth.
This is exactly how to make money in the stock market, and do it successfully.
So what does this have to do with REITs?
Well if you remember what I was saying about asset class diversification… You want to shift money in and out of stocks and bonds depending on how stocks are valued.
When most stocks are overvalued, then this is the time you want more of your portfolio to be bonds and REITs instead of stocks.
Then when stocks crash and trade at discount, bargain prices– you’ll have the cash to be able to buy many of them. That’s when you want to transfer the money out of your bonds and REITs and into stocks.
REITs maximize gains if you use them this way.
REITs: Great Inflation Hedge
REITs are also a great inflation hedge. Historically, real estate prices have risen with inflation. Since their inception in the 1970s, REITs have done fantastically well amidst federal deficits and government debt.
Many residential real estate properties have increased substantially in the past 20 years. You saw it with the real estate bubble, and it’s recovering again. REITs are great for giving you peace of mind against the fear of unlimited money printing.
But don’t think that all REITs are without risk. Many of them use a ton of debt to purchase their properties.
Some of the REITs that are most heavily leveraged will get absolutely devastated when interest rates finally rise. Many of them are heavily dependent on interest rates, and operate with low spreads.
You don’t want to be invested in those kind of REITs when interest rates rise.
These type of REITs are known as Mortgage REITs. Be extra careful when investigating those. You might also hear of Hybrid REITs. These are a mix of Equity REITs (just real estate) and Mortgage REITS.
So when you invest in a REIT, pick one that is more conservative than its peers. Especially about debt. They should have a solid balance sheet.
If you don’t know how to figure this out or don’t want to, then invest in an REIT ETF like VNQ. These ETFs hold a bundle of REITs and keep you safe through diversification.
This will limit your gains, but I understand that some don’t have the desire to research. That would then be the best option for you.
If you are interested in learning how to research an REIT, well you’re in luck because it’s no different than researching a company.
Definitely check out all of those, especially #2.
You’ll learn how to research a company. It will directly relate to helping you research a REIT. The methodology and even websites used are exactly the same.
Having the power to understand the balance sheet of a REIT is so critically important. You’ll never have to worry about your investments ever again. And best of all, you only have to learn it once.
It’s a skill that will pay you dividends for life. Do it.
**A Simple REITs Guide for Beginners**
**All Rights Reserved. Investing for Beginners 2013**