Types Of Real Estate Investments: Everything You Need To Know
Sidney Richardson9-minute read
July 13, 2023
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 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 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.
Whether you have the time and money to spend on an investment property or not, there are many 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 type of 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 property: A long-term rental property is 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 home. As an investor, you make money through rental income and/or through appreciated property value if you eventually decide to sell the When managing a rental property, some investors choose to live on-site, 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 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.
- Flipping houses: Flipping a house is one of the most active investment When you flip a home, you purchase a fixer-upper, make repairs and upgrades and sell it. Flipping houses is risky. 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 a 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.
- 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 a separate property and can be a good option for generating some extra income from your current property.
There are a lot of benefits to investing in residential real estate, including:
- 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.
- 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.
- There are tax benefits to investing in real estate, including tax deductions, depending on your income level.
Though residential real estate can be a great investment there are definitely some cons to weigh before committing, including:
- Investing in residential real estate can be very expensive. Especially if you’re doing something like flipping a house, remember that you’ll need a lot of cash flow and may need to renovate the 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 your time.
- Managing a property is not an investment with much 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, offices and retail stores are all examples of commercial real estate investments.
These types of investments are typically considered active as well and mean 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.
- 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.
- 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 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 pop up.
- Commercial investments tend to be more time Rather than dealing with just a few tenants, you’re likely going to have to juggle multiple leases and 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 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 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 later at an appreciated value.
- 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 have to wait for it to appreciate while potentially leasing it out for various purposes.
- 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, or 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 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 the property personally. The workload of active real estate investments is not your responsibility when investing in a REIT.
- Depending on the REIT you invest in, you can expect to make steady, albeit smaller, bits of income.
- Many REITs are technically stocks, but since they’re real estate investments, they can help diversify your portfolio while maintaining flexibility and 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.
- 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 also considered passive income.
Some online crowdfunding platforms for real estate are open to general investors, but there are many that require users to prove a certain level of income before investing.
- Crowdfunding is a great way to diversify your investment portfolio without having to invest a large amount of money.
- It offers access to unique opportunities that investors may not have had access to without the help of other online investors.
- There’s very little effort involved, and the entire process can typically be done online.
- Crowdfunding investors are taxed on the dividends they receive.
- Some investing platforms may require that you meet a certain level of income 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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Which Type Of Real Estate Investment Is Right For You?
Real estate investments offer big gains but can also carry a fair amount of risk. Unlike some other kinds of investments, active real estate investments like residential, commercial real estate or house flipping need a fair amount of financial stability and cash flow to potentially turn a profit.
They can also take up a fair amount of time, so if you're considering these types of real estate investments as a side hustle, balancing your time could be difficult. Another factor to consider is how well you know the real estate market where you are investing. Make sure to do your due diligence and really know the neighborhood before making an investment.
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 or private REITs or investing through crowdfunding platforms might be a better option.
Whatever you choose, keep in mind that, as with any investment, there is always the potential to lose money. So make sure that your risk tolerance is in line with the type of real estate investment you choose.
The Bottom Line
No matter what kind of real estate investment you choose, each type has risks and benefits. Real estate can be one of the most profitable, but also 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? Get started today with Rocket MortgageⓇ and begin the mortgage application process.
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