In 2007, two-thirds of Americans were investing in the stock market. However, over the last decade, this number has dropped to 50%, and the other half of investors have shifted their eyes to real estate.
There are numerous advantages to investing in the real estate market. Real estate assets are a great way to diversify your investment portfolio and hedge for inflation. Depending on how you invest in real estate, you can also enjoy tax advantages, increased leverage, and a form of passive income.
However, there are also some risks and downsides to real estate investment.
It is essential that you thoroughly evaluate your options and pick a real estate investment type that suits your needs. Continue reading to find out how to build a real estate portfolio that works for you, not you for it.
Identify Your Wealth Management Goals
The first thing to do before getting started with real estate investment is to identify your wealth management goals.
Ideally, you should do this with an experienced financial planner who can guide you on how to build a strong investment portfolio that’s tailored to your personal situation.
However, before you sit down with your financial advisor, ask yourself the following questions:
- How much diversification do I need?
- What is my level of risk tolerance?
- Do I want a hands-free real estate investment or something I can actively manage?
- Can I afford to lose liquidity?
These are all important areas to think about. For instance, if you don’t have the time or desire to oversee a rental property, then buying directly into the real estate market is probably not a wise move.
If you’re in a situation where you might need quick liquidity, then buying a property is also not the best choice, as you’ll need to lock up a lot of capital in a non-liquid asset.
Fortunately, there are ways you can invest in real estate and still retain liquidity and build passive income.
Direct Real Estate Investment
Once you have decided what your wealth management and investment goals are, the next step is to compare the different ways you can build your real estate portfolio.
One of the most common ways retail investors get into the real estate market is through directly buying one or more properties. These could be rental properties, fixer-uppers, second homes, primary homes, commercial spaces, etc.
Pros
One of the primary pros to directly buying property is that there is the potential for good returns. If you are familiar with the real estate market in your area, you might be able to spot a good opportunity and snatch it up.
Even if prices drop, real estate can still be a more sure investment than things like stocks. Because real estate has inherent, tangible value, it’s just about impossible for a property’s value to drop to zero.
Buying property can also increase your leverage. Once you build up a certain amount of equity in a property, you can use it as collateral to finance another investment property.
This kind of real estate investment also comes with some attractive tax advantages. For instance, you can write off things like property taxes and maintenance costs as expenses.
Cons
If you want to put your wealth management on auto-pilot, then buying a property is probably not the answer. Buying and selling individual real estate properties can be time-consuming. You have to organize evaluations, inspections, financing, staging, etc.
If you rent out property, then you’ll also need to spend time managing it. Even if you engage a property management company, there will still be some work involved.
Buying property can also come with a lot of unforeseen costs. According to statistics, costly maintenance fees and expenses is the biggest regret real estate buyers have.
REITs
If you want a more hands-free way to invest in real estate, then you can also consider buying into a REIT. REIT stands for real estate investment trust.
REITs own and operate real estate properties and allow investors to buy shares in their real estate portfolios.
Pros
By buying REIT stocks, you can enjoy some of the benefits of real estate investing, without having to actively manage property. REIT stocks typically offer above-average returns and usually out-perform the S&P 500.
REIT stocks also come with lower barriers to entry. Instead of having to produce the capital to buy an entire property, you can buy as few or as many REIT stocks as you want. REITs also gives private individuals a chance to invest in commercial properties that would usually be out of their reach.
If publicly traded, REIT stocks also offer enhanced liquidity. You can sell your REIT stocks in a matter of minutes or hours, whereas a real estate property can take months to list and successfully sell.
Cons
One of the main drawbacks of REITs is that they are taxed higher than “qualified dividends”. REIT stocks are also sensitive to interest rates, usually perform best over the long term, and can have some property-specific risks.
For instance, hotel REITs are vulnerable to recessions.
Real Estate Funds
Another way to passively invest in real estate is through real estate funds such as real estate ETFs or real estate mutual funds.
These types of real estate funds invest in securities from public real estate companies, including REITs.
Pros
Real estate funds offer one of the easiest, most diversified ways to invest in real estate. One real estate fund might have shares in multiple REITs spanning various sectors of the real estate market, which means you automatically get more diversification.
Because they are more diversified, real estate funds usually have more stable performance and require less intensive research than REITs.
Cons
Unlike REITs, real estate funds don’t pay out dividends. Instead, they provide value through appreciation. Because of this, real estate funds aren’t a source of short-term passive income.
They also don’t offer the same tax advantages as direct real estate investment.
Are You Looking for Real Estate Investment Assistance?
Real estate investment is an important part of wealth management and portfolio diversification.
However, there are a lot of factors to consider before you start putting money into the real estate market.
Do you feel like you need some independent advice before you get started?
Contact Bogart Wealth today and we’ll be happy to help.
