Types Of Real Estate Investments: Everything You Need To Know

Investing in real estate comes with several benefits, from opening an extra stream of income to diversifying your investment portfolio. If you’re just getting started, it’s important to understand the different types of real estate investments that may be available to you.

Whether you’re a new or seasoned real estate investor, there are certain property investments that may be better suited to your lifestyle and financial goals. Weighing the pros and cons of each type of real estate investment can help you decide what opportunities work best for you.

Real Estate Investing: An Overview

When you think of real estate investing, buying an investment property and renting it out might be the first thing you think of. While that’s often a viable option, it’s just a drop in the ocean in terms of all the real estate investment choices at your disposal.

Most real estate investments fall under two general categories: active or passive.

Active Real Estate Investing

Active real estate investing involves directly managing properties or being actively involved in real estate development projects. This type of investing often requires more hands-on involvement from the property investor in daily operations and decision-making.

Flipping houses and managing residential rental properties are examples of active investing because they require a lot of effort from you as the investor. Active investments tend to be a little more lucrative than passive ones, but they require more cash flow and are typically riskier.

Passive Real Estate Investing

Passive real estate investments are opportunities that don’t require you to personally own or manage a property. Investing in real estate investment trusts (REITs), real estate funds and real estate crowdfunding are considered passive. These methods allow you to invest in real estate without having to commit a lot of money upfront or manage any properties.

Understanding Different Types Of Real Estate Investments

Whether you have the time and money to spend on an investment property, there are many ways to get involved in real estate investing. Let’s explore a few real estate investment examples to decide which option may be best for you.

1. Residential Real Estate

Residential real estate is probably the most widely known and understood type of real estate investment. That said, there are many different types of residential real estate investments, from micro-flipping to accessory dwelling units (ADUs).

Residential real estate investments are usually active, meaning they will likely require significant monetary and labor contributions from the investor – but they have the potential to bring in sizable profits and continuous cash flow.

Since residential real estate investments can be a lot of different things, let’s explore a few of your options.

Long-Term Rental Property

A long-term rental property is real estate that you buy with the intention of renting out to tenants. Long-term rentals can include single-family homes, duplexes or multifamily properties. As an investor, you make money through rental income and/or through appreciated property value if you eventually decide to sell the property.

When managing a rental property, some investors choose to live on-site, which is known as an owner-occupied multifamily property.

Vacation Rental Property

Owning a vacation rental is similar to owning a long-term rental property. You buy a property, typically in an area popular with tourists, and rent it out to visitors who stay for short periods of time.

This can be one of the more work-intensive residential real estate investments because you, a partner or an employee will have to manage the upkeep of the property between guests.

House Flipping

Flipping a house is one of the most active real estate investments. When you flip a home, you purchase a fixer-upper, renovate the property and sell it.

Flipping houses can be one of the riskier ways to invest in real estate. Not only are you investing a lot of your own money, but you’ll need to have the cash flow for any unexpected problems that pop up. If all goes well, however, you could stand to make thousands in profit from the home sale.

Micro-Flipping

Micro-flipping is the less extreme version of house flipping. You buy homes that are sold for less than their potential market value and then quickly resell them, usually without major repairs. This is less profitable than traditional flipping but is also less risky and cost intensive.

Accessory Dwelling Units (ADUs)

Accessory dwelling units (ADUs) are extra living spaces on your property that you rent out to a tenant. Basements and sheds converted into tiny homes are common examples of ADUs. Operating an ADU is typically less cost-intensive than managing a separate property and can be a good option for generating some extra income from your current property.

Pros Of Residential Real Estate Investing

There are a lot of benefits to investing in residential real estate, including:

• High earning potential: You have the potential to make a lot of money on your investment if you know what you’re doing. Finding the perfect property in the right area could net you some sizable extra income each month.
• Property appreciation: Real estate appreciates in value over time. If you buy a property, especially at a discount, make repairs and then sell it later, odds are, you’ll make a decent return on your investment.
• Tax benefits: There are tax benefits to investing in real estate, including tax deductions, depending on your income level.

Cons Of Residential Real Estate Investing

Though residential real estate can be a great investment there are definitely some cons to weigh before committing, including:

• High costs: Investing in residential real estate can be expensive, especially for activities like house flipping that require substantial cash flow and upfront renovation costs.
• Time-consuming management: Managing real estate yourself can be time consuming. Having to do property upkeep or perform various landlord duties, such as collecting rent and overseeing repairs, can eat up your time.
• Lack of liquidity: Managing a property is not an investment with much liquidity. You can’t sell real estate quickly if you need to use money from your investment right away, like with other investment options.

2. Commercial Real Estate

Commercial real estate refers to real estate investments that are typically non-residential. Hotels, warehouses, office buildings and retail stores are all examples of commercial real estate investments.

With commercial real estate investing, you’ll own and rent out a space to a business. Just like residential real estate, you can earn extra cash flow by collecting rent or selling the property as the value appreciates.

Pros Of Commercial Real Estate Investing

• Higher returns: Commercial real estate is known to yield higher returns than residential real estate. If you can afford to manage a commercial space, it can prove lucrative over time, depending on your area.
• Value tied to revenue: The value of commercial real estate is determined in part by how much revenue it generates. That being said, if your property is housing successful businesses, it may appreciate in value much faster than a residential property.
• Lower upkeep risk: Upkeep may not be as risky as residential investments. Since you’ll likely be renting commercial spaces to businesses, there tend to be more professional relationships between tenant and owner.

Cons Of Commercial Real Estate Investing

• Public and tenant concerns: With commercial investments, you have to worry about the public as well as your tenants. You might need professional assistance to keep your property up to standards and to help you manage any issues that might pop up.
• Time demands: Commercial investments tend to be more time-consuming than residential properties. Rather than dealing with just a few tenants, you’re likely going to have to juggle multiple leases with different business owners.
• Increased risk: Since your investment property is public, there’s more risk involved all around. While residential building owners also have to worry about property damage, commercial building investors have an increased risk of someone being injured on the premises or damaging the property.

3. Raw Land

Raw land refers to a property with absolutely nothing on it – buildings, paths, crops or otherwise. Undeveloped land tends to be cheaper to invest in than developed land, and like other examples of real property, it can appreciate in value over time. You can also use a land loan to purchase raw land, especially if you plan on developing it.

Many raw land investors lease their properties to farmers for agricultural purposes or seek out properties with potential for future development to sell later at an appreciated value.

Pros Of Raw Land Investing

• Easier acquisition: Raw land is often easier to acquire compared to other types of real estate investments. Buying raw land can be cheaper than buying developed land, commercial properties, or residential properties.
• Low maintenance costs: Raw land isn’t as costly to maintain as other property investments. Unlike managing a building, you won’t have to worry about constantly making repairs or updates.
• Versatility: You have multiple options at your disposal with raw land. You could buy and hold, lease or even build something on the land you acquire.

Cons Of Raw Land Investing

• Limited tax benefits: Vacant land grants you few tax advantages. With raw land, you won’t be able to reap the benefits you might be eligible for with an investment in a building with a mortgage.
• Delayed returns: You may not make much money right away. If you’re buying and holding land, you may have to wait for it to appreciate while potentially leasing it out for various purposes.
• Zoning complexities: Zoning can be complicated. The zoning for the land you invested in can make or break your investment. Regardless of whether a property is zoned for residential or commercial use, it can be difficult to get approval from the local township for your plans to develop on the land.

4. Real Estate Trust Investments (REITs)

Real estate trust investments (REITs) are companies that operate as trusts and oversee a number of real estate investments. Unlike many of the previous options, REITs are considered passive investments. Rather than owning properties yourself, you can invest in an REIT and generate income from the properties managed by the company.

Some REITs are listed on the New York Stock Exchange (NYSE) and are publicly traded. These companies typically specialize in commercial properties, such as malls, offices and hospitals. If you’re interested in commercial real estate but lack the capital to invest in a property yourself, an REIT can be a great option.

Pros Of REITs

• Passive income with reduced workload: You can make extra cash without ever having to see, manage or own the property personally. The workload of active real estate investments is not your responsibility when investing in a REIT.
• Steady stream of income: Depending on the REIT you invest in, you can expect to make steady, albeit smaller, bits of income.
• Diversification and liquidity: Many REITs are technically stocks, but since they’re real estate investments, they can help diversify your portfolio while maintaining flexibility and liquidity.

Cons Of REITs

• Long-term focus: REITs are best utilized as long-term investments that yield you growing amounts of cash over time, so if you want to make a lot of money quickly, REITs might not be the best option for you.
• Higher taxation: REITs are taxed at a higher interest rate than qualified dividends, which can reduce the overall returns on your investment.
• Lack of control: You have little control over your investments with an REIT, since you don’t own or manage any of the properties or loans yourself.

5. Real Estate Crowdfunding

Real estate crowdfunding is a new method in which investors band together, typically online, to pool their funds and invest in opportunities they would be unable to finance on their own. This method of investing, like REITs, involves much less money upfront and is also considered passive income.

Some online real estate crowdfunding platforms are open to general investors, but there are many that require users to prove a certain level of income before investing.

Pros Of Real Estate Crowdfunding

• Portfolio diversification: Crowdfunding is a great way to diversify your investment portfolio without having to invest a large amount of money.
• Access to unique opportunities: It offers access to unique opportunities that investors may not have had access to without the help of other online investors.
• Ease of use: There’s often minimal effort involved in crowdfunding, and the entire process can typically be completed online.

Cons Of Real Estate Crowdfunding

• Taxation on dividends: Crowdfunding investors are taxed on the dividends they receive, which can reduce overall returns.
• Income requirements: Some investing platforms may have income requirements for participation, which is counterintuitive to investors attracted to crowdfunding due to the low financial bar for entry.
• Platform fees: Crowdfunding platforms may charge users fees for using their service.

Which Type Of Real Estate Investment Is Right For You?

Real estate investments offer significant gains but can also carry a fair amount of risk. Active real estate investments like residential real estate, commercial real estate or house flipping require financial stability and cash flow to potentially turn a profit.

Active property investments can also demand a considerable amount of your time and knowledge of the real estate market, which can make them challenging as a side hustle.

For beginners, or those looking to diversify their investment portfolios, passive income investments are simpler to purchase and are more low maintenance. If your time, cash flow or market knowledge are limited, investments like public REITs, private REITs or crowdfunding might be a better option.

Whatever you choose, keep in mind that there’s always the potential to lose money. Make sure your risk tolerance is in line with the type of real estate investment you choose.

The Bottom Line

Every type of real estate investment strategy comes with its share of risks and benefits. Real estate can often be the most profitable but are also some of the most high-risk investments for your money, depending on how you choose to be involved.

Already have your eye on an investment or rental property? Contact Rocket Mortgage^® today and begin the mortgage application process.