In an era marked by single-digit returns, investing in real estate has become a popular alternative for investors searching for both diversification and yield. The Yale Endowment is famous for its strategy, which has outperformed traditional stock and bond allocations for decades by allocating up to 20% of its investment portfolio to real estate.
For individual investors in particular, owning an investment property has become popular recently due in part to the number of fix-and-flip TV shows making it seem like an easy way to “get rich quick”. And it’s not all hype – owning an investment property can be lucrative with the potential to make money from steady residual income, tax benefits, and long-term appreciation.
However, buying an investment property isn’t quite as simple as the TV shows make it out to be. It is a time intensive process that can be deceptively difficult and expensive.
Purchasing an investment property isn’t a decision to take lightly and it certainly isn’t the right choice for every investor. Below we’ve outlined a few key considerations to help you determine if buying an investment property is right for you.
Consider These Factors Before Buying An Investment Property
Choose an investment that compliments your financial goals.
Understanding your financial goals will help you determine the type of investment strategy you should pursue and whether property ownership should be a part of your portfolio. For example, those with a reasonable tolerance for risk who are looking to grow their portfolio over the long-term may determine that investing in a property that has the potential to appreciate over time makes sense. Conversely, those who are looking to minimize risk, might decide that a more passive investment in a REIT is a better fit.
How much time are you willing to put in?
Many first time investors dramatically underestimate the amount of time required to effectively manage a property. According to professional real estate investor and author Leonard Baron, a property requiring minimal repairs and management is “the exception, not the norm.” As an owner you will be responsible for the maintenance of the property – which can mean fixing broken toilets, landscaping, and coordinating rent collection. Alternatively, you could hire someone else to manage the property which will save you time but end up decreasing your overall return. When purchasing an investment property it’s critical to consider the amount of active management that you want to be responsible for.
Make sure the investment fits within your budget.
What you can afford is also inherently a question of risk, because it will be impacted by how much debt you want to put on the property. More debt means you can buy a larger property with the same amount of equity. However, more debt means more risk and servicing (making payments on) that debt becomes an obligation regardless of how the property itself is performing. This cost along with property taxes and insurance should all factor into what you can afford. Generally, investment properties have been viewed as an investment only available to the wealthy because of the large amount of up-front money that is required to be able to purchase and maintain a property.
Alternatives to Buying Property
Publicly Traded REITs
REITs give the average individual the opportunity to benefit from income-producing commercial real estate with the same passive ease as owning stock. While investors also receive the benefit of liquidity, a potential downside of REITs can be their correlation to broader market volatility.
Online Investment Platforms
New online platforms have emerged that use technology to make real estate investment more efficient, resulting in lower fees, higher returns, and increased transparency. Fundrise, a pioneer in the space, has leveraged new regulations and technology to offer the first ever eREITTM investment – a low-fee, diversified commercial real estate investment available directly online to anyone in the United States.¹
Regardless of which avenue you decide to pursue, an essential part of the investment process is objectively evaluating each opportunity. Take your time to figure out which approach makes the most sense for your investment goals, and remember that diversification into different asset classes is one of the most effective ways to build a profitable portfolio!