Real estate investment strategies every investor should consider

Real estate strategies overview

There are a lot of options when it comes to investing in real estate. Flipping houses is a very active form of real estate investing. On the other hand, buying shares of a mutual fund that holds real estate is very passive. And there are many strategies in between. Are you looking for a particular strategy to fit your investing needs? Consider the pros and cons of these eight most popular strategies.

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1. Rental property investing

Rental property investing involves finding, acquiring, and managing residential dwellings — single-family homes, duplexes, townhouses, and condominiums — for a profit. The majority of investors own rental units that have “cash-flow,” meaning that the monthly rental income exceeds the monthly rental expenses. This isn't always possible in an expensive and rapidly growing market. And investors may choose to break even or even fund part of the monthly cost in anticipation of holding and selling the property for more money down the road.

Rental property investing is best suited for those with the skills and interest in taking a very active role — including researching, selecting and acquiring homes, property management, maintenance, and handling tenants. If you need help finding a good rental property, you can use a free service like HomeLight to find a real estate agent in your area who can help you find the best deal for you.

Pros of rental property investing

• Once set up, you can benefit from passive monthly cash flow
• You can benefit from powerful tax benefits including depreciation
• Capital appreciation potential — If bought and managed wisely, rental properties generally appreciate in value over time while your cost of ownership decreases typically
• Rents go up with inflation, increasing monthly cash flow over time
• Tenants pay down your mortgage for you
• You maintain control over your investments
• You can use leverage (debt) to create a portfolio of rental properties quickly
• As a direct form of real estate investing, rental properties are not directly correlated to the stock market
• You can buy a distressed property, do some or all of the work yourself and benefit from instant equity
• Unique tax benefits such as depreciation

Cons of rental property investing

• You are a landlord dealing with tenants (or you'll need to find and pay a qualified property manager)
• It's a long-term investment (expect to hold on to the property for at least ten years)
• High transaction fees
• Takes time, knowledge and active participation to be successful
• Your funds are not liquid if you have a financial emergency
• Can take 30–45 days to close on a property
• Harder to achieve investment diversification because of the high cost of each property
• Capital intensive — You need lots of cash

2. Real Estate Investment Trusts (REITs)

REITs (real estate investment trusts) are a way to own commercial real estate without owning physical office buildings, retail spaces, apartments, or hotels. REITs are companies that own and operate properties to generate income. You purchase shares that represent ownership of an individual real estate company that holds the properties, and you share in the rental income and profits from property sales.

Investing in REITs is a very passive way to add real estate to an investment portfolio. REITs by law must distribute 90% of their annual profits, which can make them an excellent strategy for investors looking for both regular rental income and the potential for appreciation. Just be aware that some investing fees can be quite high and eat into your gains.

Pros of REITs

• Easy to buy and sell shares on stock market exchanges — very liquid
• Easy diversification across this type of asset
• Lower minimum investment than flipping or rental property investing
• Regular dividend distributions that can be reinvested
• Lower risk than owning properties
• Exposure to real estate without being a landlord

Cons of REITs

• While public REITs are easily bought and sold, private non-traded REITs can be complex, illiquid, have limited transparency and carry high fees
• No control — you are dependent on the integrity and competency of the REIT management
• Distributions are not guaranteed

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3. Real Estate Exchange-traded Funds (ETFs)

Real estate exchange-traded funds (ETFs) invest the majority of their assets in equity REIT securities and related derivatives. These securities are passively managed around an index of publicly traded real estate assets and often have low expense ratios.

Similar to REITs, this strategy is ideal for the passive investor who wants a convenient way to add the diversity of real estate holdings to a portfolio without owning real properties directly.

Pros of real estate ETFs

• Easy to buy and sell shares — these trade on stock market exchanges — high liquidity
• Broad diversification across asset classes and property types is possible
• Lower minimum investment than flipping or rental property investing
• Regular dividend distributions that can be reinvested
• Lower costs than buying, selling and owning individual properties
• Lower risk than owning properties yourself

Cons of real estate ETFs

• More susceptible to stock market volatility
• No control over asset management
• No property appreciation potential

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4. Real estate mutual funds

A straightforward and very common way to add real estate investments to your portfolio is to buy shares of a mutual fund that invests in commercial properties, giving you real estate exposure without the need to own, operate or finance properties yourself.

This is perhaps the most passive and easiest strategy to invest in real estate. You can buy shares on major stock market exchanges. And there are typically a very low minimum number of shares that you need to buy.

Pros of real estate mutual funds

• Very liquid — easy to buy and sell shares on stock market exchanges
• Easier to calculate total investing costs
• Wide diversification is possible
• No hassle of direct ownership of real estate assets
• The very low minimum investment needed
• Low fees in general

Cons of real estate mutual funds

• More susceptible to stock market volatility (higher correlation to stocks)
• No property appreciation potential
• No control — you are dependent on the integrity and competency of asset managers

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5. Online real estate investment platforms

Crowdfunding companies provide online platforms where real estate developers who need funding to finance projects can connect with individual investors looking for a return from real estate investing without getting their hands dirty. As part of the “crowd,” you can choose to participate in either debt or equity investments.

Real estate crowdfunding platforms are plentiful; there are many to choose from. And each has its own niche. Many require you to be an accredited investor to participate. But even if they don't require it, this is a strategy best suited for investors with enough real estate knowledge to do proper due diligence on platforms, sponsors, properties, markets, and opportunities.

Pros of online real estate investment platforms

• Passive investing
• Potential for high returns
• Opportunities to invest in residential or commercial projects
• Quarterly payouts are provided on most platforms
• Some crowdfunding platforms offer very low minimum investments
• Low correlation to stocks
• Easy to invest in either residential or commercial real estate using crowdfunding platforms
• And most offer the opportunity to participate in capital appreciation (as well as regular dividends)

Cons of online real estate investment platforms

• Investments are not liquid. And there is often no secondary market
• Investments offered via real estate crowdfunding platforms are, in general, more speculative than other real estate investing strategies
• Many platforms require you to be an accredited investor
• Many investments have high minimums
• Investors may have to pay platform fees
• Crowdfunded real estate is a fairly new, untested industry with lots of startups (it's likely some platforms will go out of business)
• You need to have the knowledge and skills to do proper due diligence

6. Real estate investment partnership

A real estate limited partnership (RELP) is an entity consisting of individual investors who pool their money to invest in real estate assets.

RELPs are run by a general partner, which is usually a corporation, an experienced property manager, or a real estate development firm. The general partner is responsible for property purchasing, leasing, and development. And it shoulders the liability. Most investors contribute funds as limited partners and are liable only up to the amount they contribute. In essence, the limited partners simply provide financing in exchange for an investment return.

This strategy is for passive investors looking to add income-producing buy-and-hold real estate to their investment portfolio without direct ownership of properties.

Pros of real estate partnerships

• As a limited partner, you share in both income generated from the holdings and longer-term appreciation when properties are sold
• Lower minimum investment than rental property ownership or flipping
• Low correlation to stocks
• Potential for higher returns

Cons of real estate partnerships

• Not liquid
• Due diligence is crucial
• May be difficult to find because these are private deals, not sold on stock market exchanges
• Higher minimum investment than exchange-traded funds (ETFs) or mutual funds (typically)

7. Real estate investment groups

As an investor, or member, of a real estate investment group, you acquire ownership of one or more units of an apartment building that's owned by a large company that buys and manages large apartment complexes. Real estate investment groups commonly buy out a property and sell units to investors while taking on the responsibility of administration and maintenance.

This strategy is best for investors who want the benefits of owning rental units — including monthly income, tax benefits, and potential appreciation — without the responsibility of managing the property. The company takes care of all maintenance, advertising, tenant placement, rent collection, and management in exchange for a percentage of the rent.

Pros of real estate investment groups

• No hassles of being a landlord
• Protection against vacancy expenses, since all owners pool a portion of the rent to pay the mortgage if your unit is empty
• Lower minimums than direct real estate ownership

Cons of real estate investment groups

• Possible high fees
• High level of due diligence needed
• No control over investment decisions

8. House flipping (a.k.a. real estate trading)

Flipping has recently been made popular by reality TV shows. But it has been a real estate investment strategy for decades. This is when an experienced real estate investor purchases a distressed or outdated property at a discount price and improves the property to sell it at a higher price a few months later.

This is not a strategy for real estate investing beginners, as it's very easy to lose money flipping houses. But it's a great way to make short-term profits if you're an experienced real estate investor with access to deals and a well-chosen team of tradespeople like contractors, plumbers, and electricians. And you need an investor-friendly agent.

Pros of house flipping

• Possible to make a large profit in a short timeframe
• Highly localized
• The exciting sense of accomplishment from active involvement
• No correlation to the stock market
• You maintain a high level of control over investment outcome

Cons of house flipping

• Requires a high level of knowledge, skill, and competent help to be successful
• Transaction time can take months to close on purchase and resale
• High transaction costs
• Capital intensive — You need cash to get the best deals and cash to rehab
• High-risk potential from many angles (market change risk, underestimating costs, unexpected problems)
• Short-term financing costs are higher — the longer you hold a property, the less money you make
• Hard to do long distances, and there may be no deals where you live

It's easier than ever to invest in real estate

Adding real estate to your investment portfolio is a sound financial decision. According to a study by Morgan Stanley, real estate has turned more people into millionaires than any other investment class. The barriers that once excluded small investors from participating in large real estate deals have largely been removed thanks to advances in technology and relaxed government regulation.

It's never been easier to invest in real estate. I've been investing in real estate since 2015 using several of these strategies and have more than doubled my portfolio value in less than five years. By all means, jump in once you choose a real estate investment strategy that fits your experience and comfort level.