Different Types of Real Estate Investments

For most investors, real estate investing is not optional unless you are Warren Buffet who “Puts all of his eggs in one basket and then watches the basket”! Most investors need diversification. Real estate is an important part of that diversification. This asset class has been in existence for 100s of years and the factors influencing real estate prices are different from stocks and bond prices. That’s why it is essential to understand different types of real estate investing options out there. This is by no means the exhaustive list of different kinds of real estate investment options. But it covers most of the important ones you will encounter or even participate in your life.

I would like to divide real estate investments in two main categories:

  1. Active Investments
  2. Passive Investments

Active Investments

Buying A Single Family Rental

This is a fairly straightforward asset class. People have been buying single family residences for the purpose of renting for a long time. I have been doing it for more than 11 years now. You can do some preliminary calculations to ensure that the rental income will provide a positive cashflow. Most of the home buying process is exactly the same as buying your own residence. Your real estate agent will provide you with rental comps which can help you estimate the rental income. Insurance and mortgage payment is fairly easy to estimate. If the property is nearby you can manage it yourself or if it is far away, you can hire a property manager. Hiring a property manager will definitely take some headache away from the process. The idea is to keep the property in good condition for 8 to 10 years and then sell it off to book the profit. This is a very well documented process and if you go to biggerpockets.com you will find many articles and videos that will help you learn how to do it. One potential issue with this is scaling up. If you want to make a bigger investment – let’s say you want to buy 5 properties, your effort will be 5x.  Also, in my experience, even if the property is cash flow positive, one big expense can wipe out your cash flow.

Building Accessory Dwelling Unit (ADU) and renting it

This is definitely a new popular way of earning money from rentals. Especially in California, many cities are encouraging people to do it to increase the housing supply. In California, many cities have made it easier to get approvals for ADUs. The only catch is that you need space in your house to build an ADU. I know some people who have built an ADU above their garages. Having a detached ADU is even better. It can have its own entrance and even its own property number. You can take a HELOC from the equity you have built in your own residence and use it for the construction expenses. In most cases, you don’t need any property management! It is your own house, so you are right there and you can fix the issues exactly the same way you fix your residence issues. I think It is easier than owning a single family rental somewhere far away. You may need more capital than buying a single family home in a smaller city far away though.

Buying a Vacation Rental

This has really become a popular way of investing in real estate lately, courtesy AirBnB! On the management side, this requires a lot of effort, but you can always hire a property management company. They will take a much bigger cut from the rental income than a long term rental – a 30% management fee is not uncommon. In many cases, this can give you better returns compared with a long term rental. Again, revenue here is dependent on the tourism industry and hence location becomes much more important. Also an event like COVID-19 can wipe out the cash flow for a year or two. Making realistic assumptions about occupancy is very important while running numbers for buying a vacation rental. This is definitely a growing industry and if you are lucky enough to get a house near a popular tourist attraction, this could be a lottery ticket and a free vacation home for you as well!

Passive Investments

Multifamily or Commercial Property Syndications

Here the word multifamily generally means 5 or more apartments in one building or apartment complex. Commercial property usually means strip malls, office spaces,  warehouse  spaces etc.  Each of the asset classes has their own peculiarities, but the syndication process is more or less the same. In a syndication two kinds of investors are involved. One is the syndicators (or General Partners) themselves who supposedly know what they are doing. These people will choose a property (aka ‘deal’), do their due diligence and present the property numbers to other kinds of investors – passive investors (aka Limited Partners).  These passive investors will evaluate the merits of the deal and decide to invest (or not invest). The syndicators form an LLC per property and then issue shares of the company in proportion of the investments. The syndicators then run the operations of this company and sell it when the price increases to a predetermined range. The profits are then divided in the proportion of investments. Because this involves issuing shares of a company, the syndicators are required to follow Securities and Exchange commission’s regulations. You may be required to have “accredited investor” status in order to invest in certain syndications, especially the ones that use regulations D’s 506(C) exemption. The good part about this kind of investment is that the investors pretty much don’t have to do anything but sign the documents and give their money. The syndicators take care of running the property and they are incentivized to get the best outcome for investors.

Note Investing

Note investing refers to the practice of investing in financial instruments such as mortgage notes, trust deeds, and other similar assets. The investor provides funds to finance real estate transactions or a refinance transaction and in return, receives regular payments with interest. One of the most popular online platforms for Note investing is PeerStreet. One advantage of note investing is the potential for higher returns compared to traditional fixed-income investments like bonds. Additionally, note investing can provide a more secure form of passive income, as the payments are backed by the underlying real estate. However, it is important to thoroughly research and understand the specific notes you are investing in, as well as the market conditions and potential risks involved in real estate investing. Note investing can also be complex and may require a higher level of expertise than other types of investments, so It is important to seek professional advice if necessary. Keep in mind that higher interest rates usually come with a higher risk note.  If you are interested in learning more about Note investing, you should read this book.

REITs (Real Estate Investment Trusts)

As per Nareit – a REIT  industry consortium, a real estate investment trust is a company that owns, operates or finances income-producing real estate. The easiest way to understand it is to compare it with a mutual fund. Mutual funds invest in many different company shares.  REIT’s own portfolios of real estate and a common investor can buy a piece of it. The idea is similar to multifamily syndication, but at a much larger scale where multiple properties and of  potentially different kinds are involved. The profits earned from the real estate can then be distributed to REIT shareholders in the form of dividends. You can buy REITs through individual company stocks or through a mutual fund or ETFs. One difference between REITs and multifamily syndication is that multifamily syndication comes with some of the tax advantages equivalent to owning a real estate. REIT doesn’t have those advantages. REITS are more like owning any other stocks. Not all REITs are publicly traded, there are private REITs as well which are more like multifamily syndications.

Real Estate Crowdfunding Sites

President Obama passed the JOBS act in 2012 that made real estate crowdfunding feasible. Since then many crowdfunding websites such as Fundrise, Yieldstreet, Realty Mogul, Equity Multiple have sprung up. They have online platforms where you can essentially sign up to invest in a real estate portfolio or a fund. The websites will give you the details about its past performance and fees.  You can make a decision to invest or not based on the information given. Websites like Fundrise give people an option to choose aggressive growth vs income producing funds. You can invest as little as $500 in these funds. One good aspect of this is it is completely passive – you never have to talk to a person. Everything is online – on a website.

Again, I want to repeat that there are many other ways of investing in real estate. But for most people, these are the prominent ways to get real estate exposure. Each of these has  its own pros and cons. Many savvy investors try out multiple of them to decide which one(s) are  best suited for their specific requirements.

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