Five Easy Ways We’re Investing in Real Estate

Do you want to start investing in real estate?

I’m a little bit obsessed with it, myself. I spend way too much time searching for homes in cities that I don’t yet and may never live in (just planning for our future retirement). I was house-hacking before I knew that was a thing, have watched thousands of hours of home renovation shows, and even seriously considered leaving my lucrative accounting career at one point to pursue selling real estate. Of course, then the housing bubble burst and reality caused me to abandon this idea.

We’ve dipped our toes in a few passive ways to invest in real estate up to this point. However, we’re excited to expand into other ways as we enter the next phase of our lives: work optional! Although we can’t go losing money, we aren’t relying on the income either.

Since we’ve recently expanded into a new way of real estate investing, I put together this list of 5 easy ways to start investing in real estate, plus a bonus way that’s not so easy.

I’ve listed the strategies below in what I think the order of difficulty and involvement required is. As always, nothing within this post is intended to be investing advice.

HOW WE’RE INVESTING IN REAL ESTATE

1. Real Estate Investment Trusts (“REITs”)

Investing in publicly traded REITs is one of the easiest and least risky ways to start investing in real estate.

What are REITS?

A REIT is a company that owns, and often operates and/or finances, income-producing real estate. These companies invest in commercial properties, such as apartments, warehouses, or shopping centers. They are easy to buy and can be traded like any other stock.

When you invest in a REIT, you are effectively buying part of a diversified portfolio of properties, and the future income or value they will produce. The number of properties and how diversified the portfolio is will differ depending on the specific REIT you choose.

Either way, it’s a completely passive and fairly low risk way to dip your toes into real estate investing. Kiplinger recently published an article with their favorite individual REITs for 2021. If you want to diversify even further, you can invest in an REIT index fund, such as Vanguard’s Real Estate Investment Trust ETF (VNQ).

Things to consider when investing in REITs

You have a lot options when in comes to REIT investing, from large companies that invest in a diverse array of real estate to smaller ones that invest within a specific niche. The key is to do your research and make sure you understand the portfolio allocation of the company you’re considering. For example, we’re currently steering clear of REITs that have a significant exposure to shopping malls in their real estate portfolio.

You can earn higher dividend yields with REITs, since they have to distribute 90% of net income to shareholders. You’ll typically find yields between 3 – 5%, but they can be as high as 10%.

Before getting too excited about a high yield, check the payout ratio. REITs calculate this differently than most companies, using Funds from Operations (“FFO”), a measure of free-cash flow, rather than net income. A high payout ratio might indicate that a dividend is not sustainable in the long run. Luckily, this ratio is easy to find in a REIT’s quarterly report or investor presentation.

Finally, if you’re an American investor, dividends from REITs are generally taxed at ordinary income rates. You should consider this fact when deciding where to hold these investments. We hold our REIT investments primarily in our retirement accounts, though have a few individual REITs in our brokerage account.

2. Own your primary residence

Many people don’t view their primary residences as an investment, but it technically is one.

Purchasing a home is different than investing in the stock market, but both can go up or down in value. Home ownership is less passive and has more on-going costs. It’s still an asset. Buying a home is also a way to diversify your investment portfolio, investing in a particular real estate market. By investing in your home, you’re locking in the price, in hopes that it will appreciate in the future (or at least protect from inflation). This is where I think home ownership shines.

Historical returns

Over the last 30 years, U.S. home prices have increased 4.1% per year before inflation (nominal) and 1.7% after inflation (inflation-adjusted, or real). If you look over longer periods of time, the real return gets closer to 0%. The fact is, housing has only slightly outpaced inflation since 1891.

Renting: The Alternative

One of the arguments for your primary residence NOT being an investment is that you need somewhere to live. And that is true. But there is an alternative choice: renting.

Depending on your location, you may be able to rent a primary residence for cheaper than owning over the long term once other home-ownership costs are included. However, in other markets it might actually be cheaper to buy a home. You can do the math, but it will be better to base your ultimate decision on lifestyle factors.

If average monthly costs of renting are less than owning, you could invest the extra in the stock market. As we saw above and last week’s post, real estate returns have lagged stock market over the last 30 years. However, as mentioned above, investing in your home is a way of diversifying your investments. Diversification is good. There is no guarantee one investment will be better than the other over your time horizon. The stock market could hit a rough patch, or you could sell your home after a period of significant growth.

No matter where you rent, it’s VERY likely that rent will increase each year. In contrast, your mortgage payments will stay the same. And, after that’s paid off, you’ll only have to pay for ongoing maintenance, insurance, and taxes.

If we look at the same 30-year period as above, rent experienced an average inflation rate of 3.04% per year. For comparison, the overall inflation rate was 2.24% during this period (source BLS). This link includes data for other countries, as well.

I’m not trying to make an argument that renting is better or worse than homeownership. I’m merely pointing out that each is a choice with its own risks and benefits. We prefer home ownership at this stage in our lives.

3. Real Estate Crowdfunding

Next up, as it relates to risk and effort, is Real Estate Crowdfunding. Although real estate syndicates have been around for a long time, the evolution of real estate crowdfunding and availability to the broader population is fairly new.

With real estate crowdfunding, you can invest in commercial real estate projects without a significant amount of capital. These projects are attractive since they generally have higher potential returns, though they also carry higher risk.

There are several e-REITs to choose from, so you’ll have to do your due diligence. With most companies, you can invest in a portfolio of projects, which lowers the risk more than a single project. Some funds are limited to accredited investors, while others are open to most investors. Either way, it’s a passive and low cost way to add alternative real estate investments to your investment portfolio. Like traditional REITs, you’ll be taxed on any “dividends” at your ordinary income rates.

Our newest way to invest in real estate

After researching for two years, we finally took the plunge and invested $5,000 into Fundrise last week (referral link). We chose Fundrise because they have some of the best reviews for non-accredited investors and a low initial investment requirement. We weren’t comfortable investing the higher amount some funds required.

We’ll share updates of how this investment is going, and whether we add more money, in future posts.

4. House Hacking

House hacking is an investing strategy whereby an investor earns rental income by renting out part of their primary residence. You can do this by renting out a room, basement, or an accessory dwelling unit (ADU) on your property. Or you can purchase a duplex or other multi-family unit and live in one unit, while renting out the others.

In some cases, the rent you receive may be enough to cover your housing costs, letting you effectively live there for free!

Although it can be more challenging with kids, house hacking is a great strategy to get into real estate and build wealth for young couples and/or single people.

And in fact, I did a few small-scale house hacks when I was younger (before I even knew what house-hacking was). In my 20’s, I rented out a bedroom and bathroom in my house for a few months at a time. The money didn’t cover all my bills, since they paid the “family & friends” discount price, but it did offset 25% of the mortgage. I’d be open to this strategy again in the future when our daughter is older.

When you’re ready to trade up, you can rent out the rest of the property, and keep building your portfolio.

5. Become a landlord

Buying and renting out properties is a real estate investing strategy that we’re very interested in! Although the current hot real estate market and lack of free time has put this plan temporarily on hold.

You can buy single family properties or apartments and rent them out as either long-term or short-term (i.e. Airbnb) rentals, depending on the market you live in.

Your future vacation home is within reach

If you’ve been itching to buy a vacation property somewhere, but only plan to use if a few times a year, turning it into a rental property may make the purchase more economical. You can rent the property during the year when you’re not using it to offset the ownership costs. Each jurisdiction will have its own rules as to how many days you can stay in the home and classify it as a rental property (i.e. where you can deduct most ownership costs). However, even if you don’t qualify, you’ll still benefit by earning some extra income.

Run the numbers with a property manager

You can save money by managing a rental property yourself (we plan to do so). However, you should still make sure the numbers work with the costs of a property manager included. By doing so, you’ll leave yourself options if the business grows, you move, or just don’t want the hassle anymore. A good property manager can help you find and screen tenants, as well as handle maintenance issues, but it will cost you up to 10% of the rent.

Plus, 1 way that’s not as easy as it looks… Flipping houses

In my opinion, flipping homes is the riskiest way to start investing in real estate. Sure, there’s the potential for huge rewards. But there is also the potential for huge losses. And I think the slew of TV shows glamorizing flipping and only showing the wins has caused most investors to underestimate the risk related to this strategy. It’s not as easy as it looks.

A lower risk alternative: The “live-in flip”

I think a safer way to approach flipping is the “live-in flip”. This is where you buy a fixer upper and live in it while you renovate. Because the property also serves as your primary residence, the costs and risk are a bit lower (if you can deal with the chaos of a renovation). If the numbers don’t look as good as expected when you go to sell, you can always continue to live in the house until it’s more profitable, or rent it out.

This is basically what we’ve been doing with our own fixer upper. Although we intend to live in ours for a couple years after the renovation is complete before selling. However, because our intent is to eventually sell, we’ve been more mindful of the renovation budget, trying to strike a balance between our preferences and what makes sense when considering the financial returns and benefits.  

The other perk of this approach is that you can avoid paying any taxes on gains up to $250k ($500k if your married filing jointly) if you’ve lived in the home for 2 of the last 5 years. There are other ways to defer taxes on gains (though you’ll pay them eventually), such as “1031 exchanges.” However, these tax strategies are more complex, require immediate reinvestment in the next property, and are being threatened in current tax reform discussions.

Or, another way to limit risk

Another way to reduce the risk of flipping, is to make sure that you’re picking properties where the numbers make sense as both a flip and a rental property. It’s easy to blow the budget if you come across unexpected issues or the housing market quickly changes. Making sure the numbers work for multiple strategies is a great way to hedge your bets. That way, if the sale profits (or loss) don’t look great at the end of your renovation, you can change the strategy to hold and rent. Obviously, you’ll want to assess this before purchasing the house, and of course be willing to be a landlord. 

MY FAVORITE RESOURCES TO START INVESTING IN REAL ESTATE…

Books

These are some great books to help you start investing in real estate if you’re considering some of the less passive options in this post. I’m generally a big fan of utilizing the library first (FREE books!), but we actually ended up purchasing these first 2 books so that we could use them as resources in the future. The book links below are Amazon affiliate links.

Bigger Pockets Presents: The Book on Rental Property Investing

Bigger Pockets Presents: The Book on Estimating Rehab Costs

The Book on Managing Rental Properties: Find, Screen, and Manage Tenants with Fewer Headaches and Maximum Profits

Buy, Rehab, Rent, Refinance, Repeat: The BRRRR Rental Property Investment Strategy Made Simple

Blogs & podcasts

Bigger Pockets – This real estate focused site has tons of free resources, including educational articles, tools, community forums, videos, a great newsletter, and a podcast. It’s the one that got Mr. RFL really excited to start investing in real estate.

Coach Carson – Coach Carson writes about all topics real estate. He’s self-made and shows how to use real estate as a means to achieve financial independence and retire early.

Afford Anything – Paula Pant writes about a lot of finance topics, but most notably about real estate, and how she used real estate investing as a tool to obtain financial freedom at a young age.

Mashvisor – This site contains a plethora of real estate investing tools, tips and strategies, including great information about specific geographic markets and how to analyze deals.

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