There’s big appeal in the idea of investing in real estate right now. And it’s not just because of all the attention these days on President Donald Trump, who made his fortune in the industry.
Many real estate-related investments have done quite well in the last decade or so. The median sales price of single-family homes hit $315,700 at the end of the third quarter, up 23 percent from the prior peak for values in 2007 before the financial crisis hit.
At the same time, a low-interest rate environment has depressed yields in typical safe-haven investments like bonds and certificates of deposit. That has made income-generating real estate assets even more attractive.
And, of course, there’s the basic value of real estate as part of any well-balanced investment portfolio.
“Without alternative assets, a portfolio is limited to stocks and bonds. That means the portfolio is not fully diversified,” says Craig Cecilio, founder and president of real estate investment firm DiversyFund. “The other big advantage of real estate investing is that your investment is backed by real assets.”
Yes, real estate values do fluctuate – and sometimes drop significantly. But since properties are physical assets, they will always be worth something whereas other investments can go all the way to zero.
So if you like the appeal of real estate, how should you start investing?
Buy rental homes. This is the most direct way to invest in real estate – however, this approach does comes with a few drawbacks.
The first is the initial investment that’s required, since buying a house can require a big one-time payment or taking on significant debt. Then, of course, there is the hassle of being a landlord to fix leaky faucets or dealing with tenants.
That said, in many markets where rental rates are higher than mortgage payments on a similar property, a shrewd landlord can easily wind up ahead at the end of every month – and more importantly, have a reliable income stream that is independent of any appreciation in the underlying real estate.
Of course, renting versus house flipping is very different, and this latter strategy can be fraught with risks, Cecilio says.
“Investors need to ask whether the incentives of the investment issuer are the same as their own incentives,” he says.
For instance, if a company benefits by selling you advice or issuing loans instead of sharing in the ups and downs of your investment portfolio, that’s a sign that they may not care much whether you ever make any money.
Buy into publicly traded REITs. A special class of companies known as real estate investment trusts, or REITs, are specifically designed to make public investment accessible for regular investors.
In fact, thanks to all the attention, the Standard & Poor’s 500 index added real estate as its 11th industry group in 2016 to show the importance of this segment on Wall Street.
The biggest appeal for income-oriented investors is that REITs are a special class of investment with the mandate for big dividends. These companies are granted special tax breaks to allow them to more easily invest in the capital-intensive real estate sector, but in exchange, they must deliver 90 percent of their taxable income directly back to shareholders.
As a result, the yield of many REITs is significantly higher than what you’ll find in other dividend stocks. Mall operator Simon Property Group (NYSE: SPG) yields about 4.8 percent. Residential housing developer AvalonBay Communities (AVB) yields about 3.1 percent.
And, of course, investors can purchase a diversified group of these stocks via an exchange-traded fund if they prefer. For example, the Vanguard REIT Index Fund (VNQ), yields about 3.9 percent at present and has a portfolio of 155 of the biggest real estate names on Wall Street. The VNQ has an expense ratio of 0.11 percent, or $11 per $10,000 invested.
Crowdfunding. A fast-growing form of real estate investment for the digital age is via “crowdfunded” properties. The concept involves pooling together the investments of individuals to purchase properties, and share in those properties’ successes.
DiversyFund is one provider of these crowdsourced investments, as is Fundrise, a Washington, D.C.-based firm that owns properties from South Carolina to Seattle.
“We allow investors to very simply invest in private real estate instead of public real estate, with much lower fees and greater transparency, through the internet,” says Fundrise co-founder and CEO Ben Miller.
Private real estate can offer much bigger yields than publicly traded REITs, Miller says, to the tune of 8 to 10 percent annually. But the challenge in the past was the burden of big upfront fees and a lack of liquidity or access to your initial investment after you buy in.
Miller says REITs offer low barriers to entry for investors and the ability to buy or sell stocks on a daily basis, but investors pay a steep “liquidity premium” for the ability to trade – and subsequently, suffer a lower return.
“That liquidity premium is theoretically a benefit, but it’s invisible for most people and it’s not free,” he says. “If you’re investing in the long-term for income, why would you pay that premium?”
Crowdfunding platforms like Fundrise, DiversyFund, Realty Shares and RealtyMogul all look to take the best of both private and public worlds. For instance, Fundrise has a minimum investment of just $500 in its “starter portfolio” and charges significantly lower fees thanks to the cost-saving benefits of technology and a lack of middlemen.