Types of real estate investments: Everything you need to know

Investing in real estate comes with risks and rewards. Maybe you’ve heard of real estate success stories and want to try it out for yourself. If others can do it, why can’t you? But knowing where to begin can feel daunting.

To get you started, it’s essential to learn about the many different types of real estate investments — both their pros and their cons. Read on to gain the knowledge and confidence you’ll need to invest wisely.

How to start investing in real estate

The first decision you’ll want to make is how involved you want to be in your real estate investments. There are two basic approaches:

• Active real estate investing. These investments require you to directly manage properties or participate in property development.
• Passive real estate investing. These investments are more hands-off, where you don’t personally own or manage the property.

The main types of real estate investments

Next, you’ll want to choose a type of real estate investment. Each requires a different commitment of time and money.

1. Residential real estate

If the number of TV shows devoted to turning residential real estate into an income stream are any indication, this is one of the most popular ways for people to invest in property.

Residential real estate is most likely an active investment. Most investors put time and money into improving the property in addition to buying it. It can be a lot of work, but residential real estate can deliver a reliable cash flow every month or an impressive payout when you sell.

There are a few ways you can invest in residential real estate.

Long-term rental property

A long-term rental property is one you buy to rent out to long-term tenants. This is most often a single-family home, duplex, or multiunit property. Your investment pays off two ways: First, you collect rental income. Second, you can earn a profit when you sell the property, assuming it’s appreciated in value.

Vacation rental property

A vacation rental property is similar to a long-term rental in that you purchase a home in a popular area for tourists or temporary visitors and rent it out for income. The difference is that a vacation property is rented for shorter times, such a day, week or season like summer. You can charge more per night, but always need to attract new guests. Online platforms such as Airbnb and Vrbo have made this option more popular.

In addition, vacation rental properties involve extra labor in the way of upkeep. The property should be inspected, cleaned, and repaired between each stay by either you, a partner, or an employee.

House flipping

If you want an even more active investment, consider house flipping: You buy a fixer-upper, renovate it quickly to increase the value, and sell it for a profit.

House flipping is riskier and requires investors to have access to cash. The risk comes from purchasing a rundown home that may require more love than you initially anticipated. To flip it into a marketable property, you’ll then need to invest more into renovations before seeing any return on your investment.

While risky, house flipping can lead to a substantial paycheck when you sell, which you can then use to invest in your next property.

Micro-flipping

Micro-flipping is the lower-risk version of house flipping. In micro-flipping, you buy homes below their potential market value and quickly resell them. The goal here is to spend less time and money on repairs. While the profits may not be as big, the reduced risk may better suit your investing style.

Accessory dwelling units, or ADUs

You can turn unused rooms on your own property into rental spaces known as accessory dwelling units. By upgrading your basement, shed, or other space into a livable unit, you can bring in rent-paying tenants. You also can build a guest house as an ADU if you have enough free space on property you already own. An ADU is a way to invest in real estate that doesn’t require you to buy a separate property.

Pros of residential real estate investing

Some of the benefits of investing in residential real estate include:

• High earning potential. Selling a renovated home and collecting rent from tenants can be profitable.
• Property appreciation. Real estate properties generally appreciate. If you buy at a discount and make smart repairs, you may be able to sell at the right time to maximize your payout.
• Tax benefits. There can be federal and state tax benefits for investing in real estate. You might be able to reduce your tax burden.
• Diversification. It’s inevitable that the economy will affect your investments. Rather than putting all your investment eggs in one basket, you can diversify your finances and protect yourself by adding real estate to your portfolio.
• Control. The fluctuations of the stock market are largely out of your hands. However, fixing up an old home or building an ADU is the direct result of your effort. Plus, real estate has been shown to be more stable than many other types of investments.

Cons of residential real estate investing

There always are risks to investing in real estate, including:

• High costs. Real estate investments aren’t cheap. You’re looking at purchasing expensive properties and paying for upkeep.
• Time-consuming management. Maintaining a property can be a full-time job. Make sure you have the time to manage and maintain your investment.
• Lack of liquidity. It takes time to get your cash out of real estate. You don’t want to put all your resources in real estate and need cash quickly.

2. Commercial real estate

If residential properties don’t interest you, consider commercial real estate investments, including:

• Hotels
• Warehouses
• Office buildings
• Retail stores

When you buy a commercial property, you collect rent from business tenants, build equity and turn it into cash when you sell.

Pros of commercial real estate investing

Some of the benefits of investing in commercial real estate include:

• Higher returns. You can earn higher profits in commercial real estate compared with residential. Dealing with the complexity of commercial spaces and businesses can seriously pay off.
• Value tied to revenue. When the business operating within your commercial property does well, so do you. A business's success can further appreciate the value of your real estate, potentially at a rate faster than a residential property appreciates.
• Lower upkeep risk: Business tenants likely will be easier to manage than residential ones. Shops and offices are only open during business hours and there may be less wear and tear on your utilities.

Cons of commercial real estate investing

Risks to investing in real estate include:

• Tenant and public concerns. Commercial real estate projects get more scrutiny from both tenants and the public. Zoning laws, labor laws, and state laws all may affect your commercial ambitions, and you might need professional assistance to stay up to code.
• Time demands. Plan to spend more time working on your commercial property than you would a residential property. Each business under lease means extra time commitments to manage their needs.
• Increased risk. Public real estate involves more risk. For example, you might be on the hook for injuries and property damage.
• Low liquidity. It can be difficult to quickly sell commercial real estate. Selling your property with multiple occupying businesses will likely take longer than selling a single-family home. Make the most of your rental income to sustain you in the meantime.
• Market fluctuations. All markets experience ups and downs, and the commercial real estate market is no different. While not as volatile as the stock market, you still must react to shifts in the economy.

3. Undeveloped land

If wide open spaces are more your style, you might consider investing in undeveloped land without buildings, roads, crops, or utilities. It’s usually cheaper to buy, and a land loan can assist you in developing it.

While it might not have value from attached structures like with real property, raw land can still appreciate over time. The more you can help the land find its potential, the higher its value reaches. For example, you might find developers wanting to build on the land due to its geographic location. If you’re looking for rent, you might lease the property for farming.

Pros of undeveloped land investing

Advantages of investing in undeveloped land include:

• Easier acquisition. You’ll have less competition for raw land. It’s often a cheaper path to investing compared to commercial and residential properties.
• Low maintenance cost. No structures means nothing to repair. Your monthly maintenance costs will pale in comparison to other real estate ventures.
• Versatility. Raw land is all about potential. Hold it, lease it, or build on it – the choice is yours.
• Long-term gains. Due to its lower cost, you can hold onto a cheap plot of raw land until it appreciates in value. Not a bad idea for a long-term investment.

Cons of undeveloped land investing

Disadvantages to investing in undeveloped land include:

• Limited tax benefits. Tax benefits are minimal for vacant land. Don’t expect the government to help you out much when holding an empty property.
• Delayed returns. It could take a while before seeing gains. With a longer path to value appreciation and fewer opportunities to collect rent, raw land is certainly no gold rush.
• Zoning complexities. Check the zoning restrictions for your property to see what you can build — and what you can’t.
• Unexpected complications. Just because you have no attached structures doesn’t mean you can ignore your plot. Without fencing, vacant land may be an invitation for illegal dumping. In addition, your municipality may require you keep plant growth orderly.

4. Real estate investment trusts, or REITs

Real estate investment trusts are companies that own and oversee multiple income-producing properties. Some REITs are trade on the New York Stock Exchange. You buy and sell them like any other stock. They tend to deal in commercial properties, such as malls, offices, and hospitals.

This is a great option if you’re looking for a passive investment. Because you don’t own the real estate yourself, you’re off the hook for any labor or extra money needed to run the properties.

Pros of REITs

• Passive income with reduced workload. Like buying any other type of stock, REITs require no active work on your part. Your only involvement is choosing when to buy and when to sell.
• Steady stream of income. You’ll find some REITs pay dividends. It will only be a percentage of your total investment, but it’ll give you cash on hand without having to sell your shares.
• Diversification. Investing in multiple markets strengthens your overall portfolio. Adding REITs to your other stock purchases helps protect you when one market dips and opens you up to more opportunities for when the real estate market climbs.

Cons of REITs

• Long-term focus. Like other stock investments, REITs work best when you’re able to hold them for a while. It’ll take time before you see a return on your investment.
• Higher taxation. REITs face higher taxes than qualified dividends. These taxes add up over time, reducing the overall return on your investment.
• Lack of control. The REIT is under the company’s control, not yours. You’ll have to trust their ability to make good decisions as you watch from the sidelines.

5. Real estate crowdfunding

Finally, you might consider real estate crowdfunding, an investment strategy in which investors pool their funds, typically done through online platforms. This allows investors to share up-front costs while reaping the benefits of passive income.

Different crowdfunding platforms offer varying barriers to entry. While some are open to any investors willing to participate, others require proof of income.

Pros of real estate crowdfunding

• Portfolio diversification. Crowdfunding offers a relatively cheap way to diversify your investment portfolio.
• Access to unique opportunities. By pooling money with others, you’ll be able to invest in properties that would be difficult to afford on your own.
• Ease of use. Like REITs, crowdfunding is a passive investment. You can often complete the entire process online.

Cons of real estate crowdfunding

• Taxation on dividends. Dividends received are taxed, something to take into consideration when estimating your long-term gains.
• Income requirements. Expect some crowdfunding platforms to have income requirements. If you can’t meet the threshold, you can look for platforms that are open to all investors.
• Platform fees. Crowdfunding platforms may charge service fees, making investing more expensive than initially anticipated.

The bottom line: There are several real estate investments to choose from

If you’re searching for your real estate investing success story, you can now see the many paths that can take you there. Each investment type carries its share of risks and rewards. To make the right decision, take an honest look at what you can afford, where your interests lie, and how long you can hold out before seeing returns. Others have found high returns on their real estate investments. You can, too.

Do you already have an eye on your next real estate investment? Contact Rocket Mortgage^® today and begin the mortgage application process.