Topics:real estate investing
Guest Post by G. Brian Davis
Not long ago, mainstream investment advisors considered real estate an “alternative” asset class. Only the wealthy diversified their portfolios to include real estate investments.
Today middle-class investors consider it a core investment in their portfolios. But with so many ways to invest in real estate, how should you go about it?
While rental properties and real estate crowdfunding platforms are far from the only ways to invest in real estate, they do make up two of the most common. Make sure you understand the pros and cons of each before committing your own money to either strategy.
I love rental properties as a source of passive income, but they come with their fair share of drawbacks too. Here’s what you need to know before investing.
Rental properties generate ongoing income, with no need to sell off assets. In fact, the cash flow from rental properties only improves over time, as rents rise but your mortgage payments remain fixed.
And one day, your tenants pay off your mortgage for you entirely. Then your cash flow really takes off.
Speaking of cash flow, you can calculate the cash flow for any rental property before buying it. That lets you accurately predict your returns before committing money, which you can’t do with investments like stocks.
You can also leverage other people’s money to cover most of the cost to buy rental properties. That could mean financing 80 percent of the property cost with a rental property loan, and just coming up with the 20 percent down payment. Or you can use tricks like the BRRRR strategy to finance 100 percent of the property, by buying a fixer-upper with a hard money loan and then refinancing it after you complete the repairs, to pull your original down payment back out of the property.
Modern technology also makes it easier than ever to manage rentals. Take advantage of rental property management software to handle tenant screening reports, advertising vacancies, and collecting rent.
Finally, rental properties come with tax advantages. You can deduct all relevant expenses, plus some paper expenses like depreciation. Best of all, these deductions don’t require you to itemize your personal deductions, as they take place on a different tax return schedule. You can also take advantage of ways to defer capital gains taxes, such as 1031 exchanges.
For all those upsides, rental properties come with plenty of risks and challenges.
To begin with, it takes both labor and skill to find good deals. While you can start with a typical real estate search through an agent, expect to pay market pricing for properties listed on the MLS. The best deals require you to find motivated sellers before other investors reach them. These include owners in foreclosure, or in tax sale, or going through a divorce. Or simply “tired landlords” who have been burned one too many times by deadbeat tenants trashing their properties or defaulting on rents.
Learning how to market to these people — and actually executing that marketing — requires enormous effort on your part. Many new investors take real estate investing classes or online courses, or study under an experienced investor. Skimp on that education at your own peril.
Once purchased, rental properties require labor and skill to manage. Screening tenants itself takes work, as do vacant unit repairs and cleanout, chasing down tenants for rents, ongoing maintenance and the occasional kitchen or bathroom remodel.
Rentals also add bookkeeping wrinkles to your tax preparation, adding labor or cost to it.
Real estate crowdfunding investments come with their own ups and downs. Here’s how they compare with directly owned rental properties.
It takes no skill, labor, or time to invest in crowdfunded real estate. You can spend two minutes creating an account, transferring money from your bank account, and you’re invested.
Nor do you have to manage your investment after making it. You don’t have to hassle or budget for repairs and maintenance, or filling vacant units. The crowdfunding platform takes care of that for you, for truly passive extra income streams.
You don’t have to learn any new skills either, such as identifying and marketing to motivated sellers, or overseeing renovations like investors flipping houses or doing BRRRR deals do.
Some crowdfunding platforms let you invest with as little as $10. Compare that to investing $300,000 in a rental property — even if you took out a rental property loan for 80 percent of that, you’d still have to cough up $60,000, not including closing costs.
Even within each platform, you can often get broad diversification exposure. Fundrise spreads your money among pooled funds that own dozens of properties and hundreds of loans secured by real property, for example.
Despite those upsides, real estate crowdfunding has its own drawbacks.
Because there’s so little barrier to entry, anyone can invest. That cuts both ways, and means you won’t find oversize returns among crowdfunding platforms. Expect to earn average returns as an Average Joe investor.
Rental properties have a higher barrier to entry, with the higher costs, labor, and skill required. But experienced investors can earn high cash-on-cash returns by leveraging a rental property loan combined with scoring a good deal on purchase price.
Unlike rental properties, you have no control over your returns on crowdfunding investments. You can’t tighten tenant screening practices or raise rents after improving the property. You’re stuck with whatever management decisions the crowdfunding company makes.
Many real estate crowdfunding platforms only allow accredited investors to participate as well, excluding most of the public due to regulatory reasons.
If you just want to add real estate to your investment portfolio, start with real estate crowdfunding platforms.
They let you invest passively with a small amount, to help you start diversifying. You don’t need any special skill to do so, and it doesn’t cost you any time. Start with Fundrise as a reputable option that lets non-accredited investors participate. You can get started with just $10, to help you start small and build confidence as you go.
Only consider expanding into rental properties if you plan on approaching it as a side business. Because that’s effectively what it takes: you have to learn a whole new skill set, and it will take ongoing labor to find deals and manage properties once purchased.
If you like the idea of investing in real estate as a hobby business on the side, then go for it. You can potentially earn high returns and take advantage of tax benefits. But don’t expect it to be easy, passive, or cheap to get started.
G. Brian Davis is a real estate investor and founder at SparkRental.com, which helps middle-class people replace their day job with rental income. The company offers a wealth of free courses and tools, along with online landlord software that’s (mostly) free for landlords. He spends 10 months out of the year traveling overseas with his family and has an insatiable appetite for reading, hiking, and perfectly paired wine and food.
June 27th, 2022
May 27th, 2022
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