Types Of Real Estate Investments: Everything You Need To Know
Sidney Richardson9-minute read
May 19, 2021
There are many benefits to investing in real estate, if you play your cards right – which is why it’s considered one of the most popular assets. If you’re just getting started investing in real estate, however, it can be a little overwhelming learning about all the different types of investments available to you.
Understanding the different types of real estate investments and how they work is the first step. Before you get started deciding where to put your money, here’s what you need to know.
Understanding Different Types Of Real Estate Investments
When you think of real estate investing, buying an investment property and renting it out might be the first thing you think of – and while that is 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 investments are ventures that will cost you not only your money, but also likely your time and potentially physical labor. Flipping houses and managing residential rental properties are examples of active investing because they both require a lot of effort from you as the investor. Active investments tend to be a little more lucrative than passive ones, at the cost of being more expensive and typically riskier.
Passive investments are ways of investing in real estate that often don’t require you to personally own or manage a property. Investing in real estate investment trusts (REITs), real estate funds, and doing things like crowdfunding are considered passive. These methods allow you to invest in real estate without having to commit a lot of money up front or manage any properties.
Whether you have the time and money to spend on an investment property or not, there are a multitude of ways to get involved in real estate investing. Let’s explore a few of the options available to you.
1. Residential Real Estate
Residential real estate is probably the most widely known and understood real estate investment. That said, there are many different types of residential real estate investments that you may or may not know about, 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 you – but they have the potential to bring in sizable profits and continuous cash flow.
Types Of Residential Real Estate Investments
Since residential real estate investments can be a lot of different things, let’s explore a few of your options.
Long-term rental Pproperty: A long-term rental property is a piece of real estate that you buy with the intention of renting out to tenants. This property can be anything from a multifamily home with up to four units to a small, single-family house. As an investor, you make money on these types of properties by collecting rent from tenants and/or through appreciated property value if you decide to sell the property eventually. When managing a rental property, some investors choose to live on-site at the property, which is known as an owner-occupied multifamily property, though this is not required by any means.
Vacation rental: 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 then rent it out (usually short-term) to visitors who will stay in it for a short period of time. This can be one of the more work-intensive residential real estate investments because either you or someone who works from you will have to continually manage the upkeep of the property between guests.
Flipping and microflipping: Flipping a house is one of the most active investments you can take on. When you flip a home, you purchase a fixer-upper in desperate need of repairs, then make those fixes and sell it. This tends to be risky because you must invest a lot of your own money into the house and there’s a chance you might find additional problems and lose money rather than make a profit. If all goes well, however, you stand to make potentially thousands in profit upon sale.
Microflipping is the less extreme version of this; 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.
ADU: Accessory dwelling units, or ADUs, are extra living spaces on your property that you rent out to a tenant, commonly a family member. Basements and sheds converted into tiny homes are common examples of ADUs. Operating an ADU is typically less cost-intensive than managing another entire property, so this can be a good option for those interested in generating some passive income from their own current property.
- You have the potential to make a lot of money back on your investment if you know what you’re doing. Finding the perfect property in the perfect area could net you some sizable extra income each month.
- Real estate appreciates in value over time. If you buy a property, especially at a discount, make repairs and then sell it later on, odds are, you’ll make a decent return on your investment.
- There are tax benefits to investing in real estate, including tax deductions, depending on your income level.
- Investing in residential real estate can be very expensive. Especially if you’re doing something like flipping a house, remember that you have to pour your own funds into purchasing and renovating property, which can cost thousands upon thousands of dollars.
- 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 a lot of your time.
- Managing a property is not an investment with much liquidity, so you can’t just sell something quickly and use money from your investment right away like you might be able to with other investment options.
2. Commercial Real Estate
Commercial real estate refers to real estate investments that are typically nonresidential. Hotels, warehouses, offices and retail stores are all examples of commercial real estate investments. These types of investments are typically considered active as well and involve the investor owning and renting out a space to a business that will use it. Just like residential real estate, you can earn extra cash flow by collecting rent or selling the property as value appreciates.
- Commercial real estate is known to yield higher returns than residential. If you can afford to manage a commercial space, it can prove lucrative over time, depending on the area you’re in.
- 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.
- Upkeep may not be as risky as it tends to be with residential investments. Since you’ll likely be renting commercial spaces to businesses, there tend to be more professional relationships between tenant and owner.
- 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 crop up.
- Commercial investments tend to be more time consuming as well. Rather than dealing with just a few tenants, you’re likely going to have to juggle multiple leases and more potential issues.
- 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 may have more to fear in terms 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 appreciates in value over time as well. 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 at an appreciated value later.
- Raw land is easy to acquire, compared to many other investments. It’s much lower in cost than developed land or commercial or residential properties.
- It’s not very costly to maintain. Unlike managing a building, you won’t have to worry about constantly making repairs or updates.
- 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.
- 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.
- You may not make much money right away. If you’re buying and holding land, you may just have to wait for it to appreciate while potentially leasing it out for various purposes.
- Zoning can be complicated. The purpose the land that you invest in is zoned for may make or break your investment. Additionally, regardless of whether a property is residentially or commercially zoned, it can be difficult to get approval from the local township on anything you may plan to develop on the land.
Real estate trust investments, or REITs, are companies that operate as trusts and oversee a number of real estate investments. Unlike many of the previous options listed, REITs are considered passive investments. Rather than owning properties yourself, you can invest in a 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, so if you’re interested in commercial real estate but lack the capital to invest in a property yourself, a REIT can be a great option.
- You can make extra cash without ever having to see, manage or own a property personally. The workload of active real estate investments is entirely nonexistent when investing in something like a REIT.
- Depending on the REIT you invest in, you can expect to make steady, albeit small, bits of income.
- Many REITs are technically stocks, but since they’re real estate investments, they can help diversify your portfolio and have high liquidity.
- 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 will be of little help.
- REITs are taxed higher than qualified dividends, as well.
- You have little control over your investments with a 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 considered passive as well.
Some online platforms for real estate crowdfunding are open to general investors, but there are many that require users prove a certain level of income before investing.
- Crowdfunding is a great way to diversify your investment portfolio without having to invest a ridiculous amount.
- It offers access to unique opportunities that investors may not have had access to without the help of other investors online.
- There’s very little effort involved and the entire process can typically be done online, unlike other real estate investments that might require upkeep and other maintenance costs associated with managing a property or land.
- Crowdfunding investors are taxed on the dividends they receive.
- Some investing platforms may require that you meet a certain level of income in order to participate, which is counterintuitive to investors attracted to crowdfunding due to the low financial bar for entry.
- Crowdfunding platforms may charge users fees for using their service.
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