How To Invest In Real Estate And Build Your Portfolio

Real estate has long been one of the best ways for Americans to build wealth. In fact, a 2022 Gallup poll showed that an impressive 45% of Americans believe real estate is the best long-term investment, beating out stocks, gold and other assets.

Real estate has several advantages for investors. Not only does it rise in value over the long term, as other assets do, but it can also provide a source of monthly income.

However, building wealth from real estate can also be more complex than other means of investing. Keep reading to learn how to invest in real estate and why it might be worth it.

How Does Real Estate Investing Work?

Just as with any other type of investing, the primary reason someone might want to get into real estate investing is to grow their income and wealth. There are two key ways real estate can help you do this: appreciation and rental income.

When you purchase a property, you hope to see the value rise (appreciate) over time. According to data from the Federal Housing Finance Agency, homes have increased by an average annual rate of 4.3% since 1991. While that number isn’t as high as the stock market’s growth during the same time, it is growth, nonetheless.

Of course, as with any other asset, there are years where real estate rises in value far more than 4.3%, as well as years where it rises more slowly (or even loses value).

The other major source of income from real estate investing is rental income. When you purchase a home and rent it out, you collect rent payments each month. While appreciation on a home is only realized when you choose to sell the property, rental income is realized every month you have a tenant in your home.

Similarly, making home improvements could increase the value of your property all around, allowing you to increase your rental income.

How To Invest In Real Estate

Investing in real estate isn’t a one-size-fits-all process. There are many routes you can go to start making money in both the short- and long term.

1. Rent Out A Room

The simplest way to make money with real estate is by renting out a property — or at least a part of one — that you already own. In fact, there’s a popular trend in real estate investing known as house-hacking, where investors find a way to make money from their residence, either by renting out a room or by owning a multi-unit property and renting out the other unit(s).

Renting out a room in your home can eventually turn into you renting or purchasing a new residence for yourself and then fully renting out your first home.

Pros

• If you already own the property, you’ll have lower upfront costs than other forms of real estate investing.
• Renting out a part of your home to someone else could mean they end up paying the full mortgage, leaving you with free housing.
• House hacking can serve as a launch pad to help you save money for your next property.

Cons

• This method only works if you have a property large enough to house both yourself and a tenant (or tenants).
• If you have a single-family home, renting out a room means living with a roommate, which not everyone wants to do.
• If you ever want to sell the home, you could have a hard time doing so with tenants living there.

2. Purchase A Rental Property

The next option for real estate investing is buying a rental property. You can buy a single-family home and rent the entire thing to one tenant. On the other hand, you could buy a multifamily home and rent it to several tenants.

The primary goal of any rental property is to collect rent every month that’s greater than the monthly expenses on the home. Ideally, the value of the home will also appreciate over time and you’ll eventually be able to sell it for more than you paid.

Owning a rental property isn’t going to be for everyone. It requires much more than just collecting a rent check. You need to find quality tenants, handle any issues that might arise and manage all of the bookkeeping. You can choose to hire a management company that will take on most of the work, making this a passive income investment, but doing so will cut into your profits.

Buying a rental property can have the potential for huge profits. If you find a house that needs a little bit of work, you have the chance to put in some sweat equity. Not only will the upgrades help you increase rent, but they will also boost the value of the home.

Pros

• A rental income can provide an ongoing source of monthly income.
• A rental property is likely to appreciate over the long term, meaning you’ll eventually be able to sell it for more than you paid for it.
• Owning a rental property comes with tax investments since you’ll be able to deduct many of your expenses, including depreciation.

Cons

• There’s a large upfront cost since you’ll have to buy (or, more likely, finance) a property to rent out.
• Managing a rental property requires a significant amount of either time or money since you’ll have to either manage the property yourself or eat into your profits to hire someone to do it for you.
• There’s some risk involved with owning a rental property since you may not always be able to find tenants and will be on the hook for the mortgage payments when you can’t.

3. Buy A Real Estate Investment Trust (REIT)

REITs are popular because they allow individuals to invest in real estate without actually owning physical property. A REIT is a company that owns a large group of properties. It could be apartment buildings, shopping malls or even commercial office buildings. REITs typically pay high dividends, which makes them great for income investors.

REITs can be great investments, but they also come with risks. Most REITs don’t have much correlation to the broader stock market, but that’s not always the case. There are some funds that can move in unison with the markets they’re traded on. REITs are also highly affected by housing prices. When housing prices decline significantly — as they did between 2007 and 2009 — REIT values will also suffer.

Unlike investing in rental properties or flips, REITs require very few resources (besides cash) to get started. Most REITs are traded on an exchange, just like individual stocks. This means you can use your existing brokerage account to buy and sell REITs. However, there are other REITs that are not listed on public exchanges. These have quite a bit more risk since they tend to be less liquid.

Pros

• Investing in REITs requires a lower upfront cost since you don’t have to buy an investment property yourself — you can simply buy shares in the company.
• REITs pay dividends to their investors and are required to distribute at least 90% of their profits. As a result, most of the profit is going to shareholders like you.
• REITs are far more liquid than actual real estate since you can generally sell your shares at any time (whereas you wouldn’t be able to sell a house at the drop of a hat).
• REITs give you access to ownership in commercial buildings, which wouldn’t otherwise be feasible for most investors.

Cons

• Some REITs charge high transaction and management fees, which means less money goes to the shareholders.
• REITs can be correlated to both the stock market and the real estate market, meaning if either of those markets declines, so may your REIT’s value.
• REITs can be sensitive to interest rate fluctuations due to the debt that’s used to finance the properties.

4. Use Real Estate Crowdfunding

You’re probably familiar with the concept of crowdfunding, thanks to sites like GoFundMe, where many people pool their money together for a single cause. Real estate crowdfunding is similar, but instead of pooling money for charitable purposes, investors are pooling their money to buy properties.

Real estate crowdfunding is generally done through a platform — Fundrise is an example — where you can make your investment, often by choosing a specific property to put your money toward. The company then pools your money with many other investors to fund the property.

Similar to REITs, real estate crowdfunding is more affordable and accessible than traditional real estate investing. Rather than having to buy an entire property yourself, you can contribute as much or as little as you want (though platforms generally have a minimum investment).

Then, as the properties make money, so do the investors.

Pros

• Real estate crowdfunding requires a lower upfront cost since you’re funding a property with many other people instead of buying it yourself.
• This type of investing gives you access to types of properties you may not have access to otherwise, either for financial reasons or because of your location.
• Real estate crowdfunding limits your losses in a way that traditional real estate investing doesn’t.
• Real estate crowdfunding platforms often pay high dividends.

Cons

• Some real estate crowdfunding sites are only open to accredited investors, meaning those with an income of $200,000 or higher or a net worth of $1 million or higher.
• Crowdfunding often comes with high management or advisory fees, meaning less money is passed along to investors.
• Some platforms require that you keep your money invested for a certain amount of time.
• Similar to traditional real estate investing, if the property you invest in doesn’t make money, neither do you.

5. Flip Houses

Another way to invest in real estate is to purchase a property with the sole intention of flipping it quickly for a profit. The process is pretty straightforward. Start by finding a home that needs a considerable amount of work. You purchase the home, make all of the necessary updates and then put it back on the market to sell.

The upside to flipping houses can be huge, but it comes with a lot of risks. There may be major issues with the home that you don’t know about until you start your renovations. And those issues can eat into your profits.

Additionally, flipping houses requires speed. Every day the house is under construction is one more day you’re paying the mortgage and losing out on potential profits. The goal is to purchase the house, renovate it and sell it again in as few days as possible. If you’re not well-versed in construction, flips will require hiring great contractors you can trust to get the job done well and quickly.

That being said, flipping houses can be very profitable. The work you do on the house increases the property value. And the more you can increase the value, the more money goes into your pocket as profit. Many flippers use a 70% rule, where you should keep your total costs below 70% of the home’s after-repair value.

Pros

• Flipping a house can result in a quick profit if you can renovate and sell the house quickly.
• Flipping homes is an excellent way to network with others in the real estate industry, including real estate agents, contractors, lenders, and more.
• Flipping homes requires less long-term risk than buying a rental property since you’ll sell it rather quickly.

Cons

• Flipping houses requires a high upfront cost since you’ll have to pay for the house itself, as well as the necessary repairs and renovations.
• Renovations may uncover more serious maintenance issues with the home, which could eat into your profits.
• Flipping houses requires either lots of manual labor or lots of money to hire a contractor to do the job for you.

6. Invest In Your Own Home

Many people may want to take advantage of the real estate market without buying a rental property, buying REITs or participating in real estate crowdfunding. The good news is you can invest in your own property and see a long-term financial return.

As we discussed, home values rise over time. So the house you buy to live in should theoretically be worth more when you sell it than when you buy it. Of course, you won’t see the recurring income you would with a rental property or the dividends you would with REITs. But you can enjoy long-term appreciation.

Keep in mind that most people have a mortgage on their homes. To see a real return on your investment on your own home, you would ideally pay off your mortgage early or have a mortgage rate that’s lower than the average real estate appreciation rate.

Pros

• Opting to invest in your own home instead of other forms of real estate investments requires fewer costs.
• Owning your own home and investing in improvements over the years can leave a valuable asset for your heirs.

Cons

• Investing in your own home doesn’t result in rental income or dividends the way that other forms of real estate investing do.
• Your entire investment return may be eaten up by interest, property taxes, maintenance and other expenses.
• You won’t be able to enjoy the return on your investment until you sell your home, which could be much later in life (or never).

7. Consider Real Estate Funds

A lot of people think of REITs and real estate funds as being the same thing. They are actually different investment vehicles, though they work together.

Earlier we said that REITs are businesses that invest in income-generating real estate like shopping malls or office buildings. In contrast, real estate funds are mutual funds that frequently invest in REITs. Real estate funds are managed by portfolio managers, so they are a much more hands-off form of investing.

Similar to REITs, real estate funds are heavily correlated to the real estate market as a whole. When commercial and residential prices increase, fund prices are going to be increasing as well. Like REITs, real estate funds can be bought and sold through a broker or through a mutual fund company.

Pros

• Requires a lower upfront cost than many other forms of real estate investing.
• Provides more diversification than REITs since you’re investing in many through the fund instead of just one.
• Real estate funds are far more liquid than actual real estate since you can generally sell your shares at any time.

Cons

• Real estate funds may charge high transaction and management fees, which means less money goes to the investors.
• Like REITs, real estate funds can be correlated to both the stock market and the real estate market, meaning if those markets decline, you could make less money.
• Mutual funds — including real estate funds — are generally tax-inefficient than other real estate investments, including individual REITs.

Tax Benefits For Real Estate Investors

As we briefly mentioned earlier, real estate investing has some tax benefits. The IRS allows you to deduct many of the expenses associated with your investment, including:

• Mortgage interest
• Property taxes
• Maintenance and repairs
• Property management fees
• Advertising
• Other business expenses

The most significant tax benefit you’ll receive as an investor is depreciation. Typically, you’re allowed to depreciate the residential property over 27.5 years and commercial property over 39 years. Depreciation gives investors the ability to deduct a certain amount each year, reducing your tax liability.

There are two ways this can be done. The first way would be to take an equal deduction each year. Or you could use an accelerated method which allows you to deduct a greater amount in the beginning and then a decreased amount over time.

Real estate investing often also allows you to take advantage of long-term capital gains tax rates when you sell a property.

When you sell an investment you’ve owned for less than 1 year, you’ll be taxed on your gain at your ordinary income tax rate. But when you hold the asset for more than 1 year, you’ll get a more favorable long-term tax rate of either 0%, 15% or 20%, depending on your income.

When you sell a primary residence, you’re given an exclusion on paying capital gains taxes on the profits. Currently, you can exclude the first $250,000 when filing single or $500,000 when filing married. Unfortunately, real estate investment properties are not taxed the same way. Instead, when you sell a rental property, you’ll be taxed on any amount over the original purchase price plus the costs to bring it to its current rentable state.

What Risks Should Real Estate Investors Be Aware Of?

Real estate investing comes with plenty of advantages, but it also comes with plenty of risks you should be aware of.

• Unpredictable real estate market: The value of real estate generally rises over time, but that’s not always the case. There are seasons when real estate values decline. And those seasons could result in reduced rental income or dividends, as well as a lower sale price if you want to (or need to) sell the property.
• Bad locations: Location is key when it comes to real estate investing. While a good location can net you lots of rental income and asset appreciation, a bad neighborhood can do exactly the opposite.
• High vacancies: Vacancies are always a risk for real estate investments. There are likely to be times when you don’t have a tenant for a property. And during that time, you’re still on the hook for the mortgage payment.
• Problem tenants: When you own a rental property, you could end up with tenants who cause problems such as failing to pay their rent or damaging the property. These tenants can end up costing you a lot of money, and some states can make it difficult to evict even the worst tenants.
• Hidden structural issues: When you buy a home, you don’t always know what’s under the surface. And a surprise structural issue can be a major cost. That’s why it’s critical to have an inspection done on any property you’re considering buying.
• Negative cash flows: Real estate investing can be highly profitable, but it can also result in a negative cash flow at times. It’s important to properly calculate costs like maintenance. Otherwise you could charge too little rent and have an investment that isn’t profitable.
• Lack of liquidity: Real estate is a generally illiquid asset, meaning it’s difficult to turn into cash. Unlike stocks and other assets, you can’t sell a house at a moment’s notice. However, you may be able to access your home equity through something like a home equity loan, which can make the investment more liquid.

Strategies For Investing In Real Estate Successfully

Are you considering investing in real estate? Here are some strategies that can help make you more successful.

Master The Market

You’ve probably heard the saying, “Location, location, location.” If you’re purchasing a rental property or a flip, the location should be a major factor in where you purchase.

Buyers want to live in desirable locations that have a lot of upsides. They want to see amenities like grocery stores, restaurants and shopping malls nearby. They like being able to walk to parks or public transportation. When you’re buying a property, make sure you’re considering what your ideal buyer or tenant would want.

Before buying a property, be sure to research the best places to invest in real estate to help you determine what’s a good deal.

Work With A Real Estate Agent

When you bought your primary residence, you probably worked with a real estate agent. The same should be true for an investment property.

There are a lot of benefits to having a knowledgeable professional on your side throughout the process. It doesn’t matter if you’re looking to purchase your first investment property or your 10th, agents know exactly what you need to look for when purchasing a home.

You probably know how many bedrooms or bathrooms you want or whether you prefer carpet or hardwood floors. But an agent understands deeper issues like potential problems with an HVAC system or an aging roof.

Start Small

Getting started as a real estate investor is exciting, but it’s important to take things slow instead of jumping in too fast. This is especially true if you’re planning to purchase a rental property.

A lot of younger investors are choosing to start with a duplex. They rent out one side and live on the other. This has become known as house hacking. When done right, the rent you collect can cover a majority of the mortgage payment each month. This can help you save money and grow your real estate business.

Check Potential Tenants

As we’ve mentioned, problem tenants are one of the biggest risks facing real estate investors. When you own a rental property, it’s critical that you screen each prospective tenant before renting them the property. This screen should include a credit check and a call to their references and past landlords.

Financially Prepare

Investing in real estate often requires high upfront costs, especially if you’re buying your own rental property. For that reason, it’s important to prepare financially ahead of time.

Part of this preparation is saving enough money to buy the property, as well as handle any emergencies or unexpected costs that may come your way. Doing so can help you avoid having to dip into your emergency fund or retirement accounts or go into debt.

Diversify Your Portfolio

One of the biggest keys to your success as an investor is diversification. By investing in different sectors of the economy, you’re protecting yourself from weakness. Real estate is an excellent hedge against the overall stock market because housing prices typically lag behind the overall market.

Some experts recommend investing no more than 10% of your portfolio in real estate, while others say you can go as high as 30%. The ideal number should depend on things like your risk tolerance and desire for liquidity.

FAQs For Investing In Real Estate

Are you considering investing in real estate? We’re answering some of the most frequently asked questions on the topic.

Do I need to get a real estate license as an investor?

You don’t need to get a real estate license to be an investor. However, you should work with a licensed real estate agent to buy a property.

What do I need to know as a first-time home buyer?

There’s a lot to know as a first-time buyer in the real estate market. It’s critical that you understand the finances of rental properties, including how to calculate your expenses, set a budget when buying a property and determine if a property will be profitable.

Can I invest in real estate with no money?

You can’t invest in real estate with no money at all. But strategies like REITs, real estate mutual funds and real estate crowdfunding make it easy to get started with a relatively low start-up cost.

How do I finance the first real estate deal I find?

You can finance your first real estate deal through a lender, just as you would a traditional mortgage. Keep in mind that unless you’re planning to live in the home, your lender may have stricter requirements for qualifying for the loan.

The Bottom Line: Invest In Real Estate However You Can To Best Grow Your Portfolio

It’s no secret that real estate is a great way to build wealth. It can lead to a continuous stream of passive income.

However, certain types of real estate investments are not going to be for everyone. If the thought of fielding calls at 2 a.m. when the water heater breaks or having a difficult conversation with a tenant who’s late on rent doesn’t excite you, then becoming a landlord probably isn’t a great fit.

That being said, if real estate investing is right for you, we can help. When you’re ready to buy your first investment property, start the approval process with Rocket Mortgage^®.