How to invest in real estate for beginners  

What is real estate investing?

Real estate investing is a popular way to generate income today as demonstrated by a host of house-flipping TV shows. Real estate is often attractive because it’s a physical thing, unlike other investments like stocks and mutual funds. However, it can seem complicated, and the barrier of entry can be high.

So, what actually goes in to making an investment in real estate, and are there different ways to get started? Several factors go into a real estate investment, and yes, there are several ways to get started. Real estate investing involves using land or buildings to earn a return on the money you put into it. Whether you’re buying your first home, looking into rental income, or exploring hands-off investment options, there are many ways to include real estate in your investment strategy.

Because everyone’s current situation and future goals are different, the information in this article, or any article for that matter, should not be taken as individual investing advice. Instead, use this information as a guide as you discuss your investment options with a financial professional, preferably a fiduciary. If you don’t have one, we can connect you with an experienced financial professional in your area.

How much do you need to invest in real estate?

Purchasing real estate can be pricey, but when it comes to investing, there are ways to get started that may cost less than you think. The overall cost depends on the type of investment. Location, size, and type (commercial vs. residential) are just some of the factors that influence cost. Buying property typically requires a down payment that can range from 3% to 20% of the purchase price plus closing costs, maintenance, and insurance. But other types of real estate investments like real estate investment trusts (REITs), crowdfunding platforms, or even renting out a part of your home can lower the cost of entry significantly (more on that later in the article).

Related: How to buy a home, even if you have student loan debt

How to evaluate real estate investment opportunities

Real estate investing can be complex and involves risk. Looking at these criteria can help you determine if a particular investment opportunity is worth your consideration:

• Location: Is the property located in a growing area where there’s a demand for rentals or resale? Are there any factors that make the area inconvenient or less desirable?
• Condition: Does the property require repairs or renovations, and if so, will you be able recoup those costs?
• Cash flow and return on investment: Will the eventual sale of the property bring in enough to cover the mortgage and maintenance costs, and make a profit? Will renting the property cover the mortgage and operating expenses, and provide positive cash flow?
• Market trends: What’s happening with interest rates, housing prices, and rental demand?

When evaluating real estate investments, it’s advisable to seek the help of experts like real estate agents, property inspectors, or professionals, depending on the type of investment opportunity.

How to calculate the ROI on a real estate investment

Determining the return on investment (ROI) of a real estate opportunity is key to deciding whether to invest. ROI is a metric used to estimate the profitability of an investment. It provides a standardized method for comparing investment opportunities.

Simply put, ROI is how much profit you stand to make relative to the cost of your investment.

ROI = (Net Profit ÷ Total Investment) × 100

For example, if you purchase a property for $200,000, spend an additional $50,000 on closing costs and renovations, and then sell it for $300,000, your net profit would be $50,000 ($300,000 - $250,000) and your ROI would be 20%, which is ($50,000 ÷ $250,000) × 100. This is, of course, very simplified. As soon as you begin adding time, mortgage payments, interest and principal, and other factors, this math becomes much more complicated.

For rental properties, the ROI is calculated using the net annual rental income, which is the annual rental income minus costs such as insurance and property taxes. The calculations become more complex if the property is financed since downpayment and mortgage interest are also taken into account. While it’s not an ROI calculation, a general rule of thumb when considering a rental property is that you should charge no less than 2% of the property’s purchase price as rent to ensure profitability.

These methods of evaluating real estate investments are general guidelines and not guarantees of success. Like all investments, there is risk. Working with a real estate agent and a financial advisor can be helpful when weighing your investment options.

Examples of real estate investment opportunities

With so many ways to invest in real estate, how do you decide which is the right fit for you? It really comes down to your goals and desired level of involvement. Do you prefer a regular stream of income or long-term appreciation? How much time, capital, and effort are you willing to commit? Are you comfortable managing properties, or are you seeking a more passive role?

Here are common types of opportunities that require varying levels of involvement and monetary investment:

Home ownership

Home ownership is the most obvious consideration when it comes to real estate investing for beginners. In fact, many investors get started by purchasing their first home.

Pros: Instead of making rent payments that you’ll never recover, paying down a mortgage allows you to build equity in your home. Because home values tend to appreciate, ownership is often considered a solid approach to increasing your net worth while also contributing to your quality of life.

There’s even potential to turn it into a rental property at some point. You can borrow against the equity if necessary, and certain tax benefits like deducting mortgage interest and property taxes may be available as part of a tax-efficient investing strategy. It’s important to check with a tax professional to know what can be deducted.

Cons: The upfront costs of home ownership can be high, and maintenance costs are ongoing. Appreciation of home values is not guaranteed, and downturns in the economy and/or changes in neighborhood conditions can cause home values to drop. Even when property values appreciate, you only realize the gains when you sell your home.

Being a landlord

Rentals may include single-family homes, duplexes, apartments or condominiums. Short-term rentals like Airbnb or Vrbo may also be an option.

Pros: Renting out a residential or commercial space can provide a steady stream of income. With the right circumstances, you may be able to use the rental payments to pay off the mortgage and cover maintenance costs.

Tax advantages like deducting mortgage interest payments, and depreciation may also apply. Commercial rentals often have longer lease terms and higher rent than residential properties, and the tenants may cover expenses like maintenance and taxes.

Cons: The upfront cost of the property can be high and there’s always the possibility of rising taxes and insurance premiums. As a landlord, you’re responsible for the upkeep of the property. Either you need to have the skill and time to make repairs or hire someone to take care of the property for you.

When renting, there’s always the risk of prolonged vacancy, property damage, or difficult relationships with tenants. It’s also important to know the local laws governing long- and short-term rentals in the area. Although the rent from commercial properties may be higher, the purchase price is usually higher than that of residential properties and more sensitive to the economic shifts within business sectors.

House Hacking

Instead of purchasing a separate rental property, you can opt to rent out space in your own home. Depending on your preferences and circumstances, you may rent to friends, family, or strangers.

Pros: This option creates an opportunity to partially or completely cover mortgage payments, taxes, insurance, and other costs, making home ownership more attainable.

Cons: Renting out a room or portion of your house means sharing your space, which most likely reduces your privacy. If there are issues with tenants, you’ll be directly affected.

House Flipping

House flipping involves purchasing a property, making improvements, and selling it for a price that’s higher than the original purchase price plus the cost of the improvements.

Pros: With flipping, there’s a potential for high returns in a relatively short time frame. This option is well suited to those with renovation skills as costs can be kept low with do-it-yourself projects. Flipping can also be turned into a repeatable business model.

Cons: The risks of flipping can be high. It’s easy for costs to escalate, and as a business model, is vulnerable to shifts in the market and requires time, effort, and real estate knowledge. If sold quickly, capital gains taxes may apply, and you may need to hire professional help for construction, building inspections, and property purchases and sales.

When it comes to flipping a property, a general rule of thumb is that you should purchase the property for no more than 70% of what you can sell it for after making renovations. So, if the house can be expected to sell for $300,000 after $50,000 in renovation costs, the maximum you should purchase the house for is $160,000, which is ($300,000 × .7) - $50,000.

How to invest in real estate without buying property

While property ownership may be the first thing that comes to mind when thinking of real estate investing, there are ways to invest without purchasing a property:

Real estate investment trusts

Real estate investment trusts, or REITs as they’re often called, are companies that own or finance income-producing properties. You can invest in them the way you would invest in stocks or mutual funds.

Pros: The barrier to entry is relatively low—no downpayments or mortgages required, and it’s a hands-free investment with no property management duties. REITs provide passive income through dividends and offer diversification across multiple properties and property types.

Cons: Like stocks and mutual funds, REITs are subject to market volatility. You have limited control over the assets, and the dividends are taxable as ordinary income.

Real estate crowdfunding platforms

Platforms like Fundrise or RealtyMogul allow you to invest in real estate projects with a relatively small amount of money. Crowdfunding allows investors to invest in specific properties offered by developers by buying shares of ownership, or by operating as a lender for regular interest payments.

Pros: The minimum investment is lower than other options because you are pooling funds with other investors. Some companies offer entry at $5,000 or less. Through crowdfunding platforms, you can gain access to large-scale real estate deals with the potential of making passive income.

Cons: Crowdfunding shares can be difficult to sell, resulting in longer holding periods, and are considered risky because of the potential for project delays or failures. Fees can cut into your earnings, and your investment is somewhat dependent on the performance of the platform itself. This type of investment is not recommended for beginners.

Real estate investment exit strategies

Real estate is not a liquid investment, and eventually you’ll want to cash out or transition your holdings to another type of investment. Common exit strategies include:

• Selling the property when values are high
• Refinancing to pull out equity
• 1031 exchange where an investment property is sold and the proceeds are invested into similar property (capital gains taxes are deferred, however, it’s important to note that several conditions may apply)
• Passing it on to heirs or converting it into a trust

Real estate can be a powerful tool for building wealth, but it’s not a one-size-fits-all venture. Start by determining your goals and exploring your options. Talk to a financial advisor or licensed professional to help you choose the right investment opportunity for you.

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