Real estate investment opportunities come in a variety of shapes and sizes, but one thing is common among many successful investors: they know how to ask the right questions. Veteran real estate investors approach an opportunity equipped with a list of insightful questions that, when satisfied, helps them evaluate whether an investment is worth their time and money. If you are unsure how to decide whether you should invest in real estate, learning how to ask the right questions is a wise place to start.

When considering a real estate investment, your first priority should be to clearly understand your own needs and expectations. Ideally, you should also determine what kind of real estate investment matches your needs and preferences along several dimensions. Do you want to independently own a residential house and become a landlord collecting reliable rent from tenants? Or do you think you are better suited to invest in real estate in a way that doesn’t involve actively managing property, like wholesaling, private equity funds, real estate mutual funds, or REITs?

If you choose an ill-suited investment method, you might find yourself in a painful situation, emotionally, psychologically, and, of course, financially. On the other hand, if you approach a real estate investment the right way, it can be deeply rewarding and extremely profitable. This brings us to our first important question:

How do you start investing in real estate? Does a real estate investment make sense for you?

The very first step in a real estate investment is education, and you might begin by reading an article just like this one. Real estate investing can be overwhelmingly complex, expensive, and, often, exclusionary, so the first thing a new investor needs to do is understand the limits of their knowledge about the subject. What limits should you consider? Your investment horizon, budget, liquidity needs, desire and ability to manage tenants, current market trends, and so on. In this article, we’ve broken down the various questions you should ask yourself into the following categories:

  • Your Financial Position & Preferences
  • Type of Investment & Sector
  • Market & Location
  • The Property

Do you know what you don’t know about real estate investing? Warren Buffett has popularized a concept called “the circle of competence.” Think about everything you know you know, and draw an imaginary border around it. Inside that circle is your comfort zone. As Buffett puts it, it doesn’t matter how big your circle of competence is — it’s much more important that you’re able to actually determine the limits and frontiers of the circle, regardless of whether its expansive or tiny, because outside of the circle is serious risk. That’s the dark zone where you have no way of ascertaining in advance that you’re walking into a bad situation. You can mitigate risk by not venturing outside of the circle, or by learning more, which, in effect, will expand your circle. The questions below will either help you confirm that your circle contains the knowledge you need to proceed, or they’ll introduce you to entire areas of brand new knowledge, which help you see the borders of your circle clearly.

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So, is it a good idea to invest in real estate?

Very likely yes! But even if the market looks ripe for new investment, a specific opportunity is good for you only if it makes sense for you and fits your risk tolerance. Here are some considerations:

Your Financial Position & Preferences

Fundamentally, understanding your financial position is pretty straightforward. It’s important to conduct a regular assessment of your personal balance sheet by evaluating your assets and liabilities. Assets typically include cash and investments, which produce cash flow, while liabilities, such as a home mortgage and credit cards, may require regular payments that reduce cash on hand. Maximizing and diversifying one’s assets and sources of income may help pay down liabilities consistently over time. However, without sufficient cash in the bank to make regular payments on outstanding liabilities, you could find yourself in trouble. As a result, it’s important to make a fair assessment of your cash flow needs.

How much active income do you expect to earn from your job, and how much current passive income can you expect to be produced by the assets you already own? What regular expenses do you have, and how much cash do you need in order to make timely payments? The answers to these questions will help you to determine not only how much you can afford to sink into an initial investment today, but also how long you can afford to keep your money invested, what kind of returns you need to make, and what percentage of your returns must be in the form of cash flow in order to remain current on any required regular payments (like your mortgage and monthly utility bills).

Do you have enough capital to invest in real estate?

This is probably the most obvious — and, in many ways, the most limiting — factor in determining whether you can or should invest in real estate. Traditional real estate investment involves owning a property directly, which almost always involves a combination of down payment and home loan financing — and a 20:80 split isn’t unusual. If a property costs $500,000, that means, up front, you’d need $100,000 available as liquid funds to purchase the property. Plus you’d need to be able to be approved for a loan that would cover the remaining $400,000.

Several factors play a role in determining whether you can secure a loan, such as credit score, outstanding debt, existing assets, and income. A credit score of 580 is typically the minimum needed to secure a mortgage, but the interest rate at that level likely wouldn’t be advantageous. You might decide that’s okay if you’re buying property to be your full-time home. But if you’re hoping to use it as an investment property to generate income, a higher interest rate can seriously impair your profitability.

Additionally, for many individual investors, a $100,000 lump sum down payment is a lofty barrier. Even if the property is likely to both appreciate and generate steady income, the initial leap into property ownership beyond your own home can be a huge commitment, forcing you to dedicate a significant amount of your liquid wealth to a single asset. Look at the projected outflows and inflows of capital and determine, “Is this deal feasible for me?” If so, can you cover the required outflows comfortably?

Alternative real estate investment models, such as online platforms, that offer more passive exposure are much more accomodating in meeting investors at lower investment minimums, and some don’t require you to be a wealthy, accredited investor — an absolute barrier for many people. Because of federal financial reforms, advances in technology, and innovations in investment structure, these flexible models don’t sacrifice excellent returns on the investor’s behalf.

Do you have the time to invest actively, or would you prefer to invest passively?

There are two kinds of real estate investments: active and passive. An active investment involves acquiring and managing a piece of property yourself, and generating returns on that real estate usually through a combination of collecting rent from tenants and asset value appreciation. In contrast, a passive investment lets you invest money with real estate professionals, who acquire and manage properties on your behalf.

There are merits and drawbacks in both strategies, as passive investing requires much less expertise, time, and work, but often comes with higher fees and limited control.

What financial gains can you expect?

While all investments involve risk, and there are typically no performance guarantees, it’s still important to take time to analyze the known factors in each real estate investment and make projections with the information available.

While the calculations behind an active real estate investment can be complex — including a combination of the down payment, loan interest, rental income from leased property, costs for repairs, upkeep and administration, potential appreciation, etc. — it’s not unusual for a well managed property to generate over a 10% average annual return (for reference the S&P 500 Index has a historical average of around 8.6%). But, of course, none of the projections can be guaranteed, and the exact math is always subject to change. Before entering a real estate investment, you should conduct a meticulous breakdown of the financial projections, and make sure they align with your economic goals.

What is your investment timeline?

In all investments, not just real estate, the expected time horizon of an investment is of utmost importance. Understanding your timeline doesn’t just help you weed out ill-fitting investment opportunities — it helps you formulate a plan for those you deem appropriate.

One of the biggest mistakes investors can make is reacting to changes in the market in a way that contradicts their intended investment timeline. If you decide you’re in an investment for the long-term, you should generally commit to that timeline, as deviating may result in adverse consequences.

For example, due to the closing costs incurred in purchasing a single family home, most investors who purchase a home with the intent to rent it for several years will be best suited sticking to this strategy regardless of short-term market movements. It’s unlikely that without significant value-add renovations that price appreciation would be large enough after just a couple months to profitably sell at a gain when you consider closing costs, taxes, fees and other expenses.

In contrast, for those looking to quickly flip a home for a profit following extensive rehabilitation, a prolonged holding period beyond expectation might cause diminished profitability due to added costs incurred during the extended holding period where no rent was collected.

How important is liquidity to you at this moment and in the future?

In short, when do you need your money back? This may depend on your stage in life, and anticipated upcoming purchases.

Liquidity, in simplest terms, is the ability to buy and sell an asset easily. This may sound like a good thing, but in many instances, it can actually be a drawback. For example, one of the latent advantages of real estate investing is its potential to yield higher returns, as a direct result of its lower liquidity. Many investors are unaware of how much of a premium they pay for holding highly liquid investments, such as publicly-traded REITs and stocks in their portfolio, for the often unused ability to withdraw funds at anytime. We expect real estate, however, to be illiquid, and the markets that sell real estate investments can often return more value to investors because, among other reasons, they haven’t been designed to integrate the extensive support that a liquid, public investment system requires.

By forgoing frequent liquidation opportunities, real estate investors often have the opportunity to earn extremely profitable returns by comparison. Online real estate investing has produced excellent historical returns for its investors. Its investment systems’ innovations allow for even further reductions in the fees and costs that traditionally go into supporting a daily liquid market.

The necessity of liquidity is a personal question any real estate investor should ask him or herself: Will I need the money I’m putting into this investment before it naturally liquidates? Or would I rather use this money to earn greater potential returns in the long-term?

Financially, how would you define a successful investment for yourself?

What kind of returns would you be happy with? Are those numbers realistic? Are they aggressive or conservative for your chosen investment strategy? If they are aggressive, are you willing to shoulder added risk? Do you need regular income, or can you wait until the end of the investment to have all of your returns paid out in a lump sum? The more specific your goals, the clearer your strategy will become. A real estate investment can be the subject of a multitude of factors, and the best map you can have for navigating your decisions is your own sense of a goal.

Do you have other assets in addition to your real estate investment? How might they enhance or detract from your decision to invest in certain types of real estate?

Consider what the rest of your investment portfolio looks like — what effect does adding different types of real estate have on your portfolio as a whole? The main goal here may simply be diversification, however, it may be preferable for some investors to use real estate to add income streams, or maximize their total returns via appreciation over time. For example, as investors age, they may look to replace active income from employment with more passive income from investments. For someone in this situation, REITs may provide an excellent opportunity to earn regular cash flow with minimal effort, as all REITs must distribute a minimum of 90% of their taxable income each year in order to qualify.

What is your risk tolerance?

Can you afford to lose all of your investment, or would that wipe you out financially? Ask yourself honestly about your risk tolerance, how much you can afford to lose, and how you’ll react if things take a turn for the worse.

Be sure to do the research to understand fully the risks involved, the best ways to mitigate those risks, the opportunities that help new real estate investors access the best deals on the market, and make your investments accordingly. If you’re making a passive investment with a third party manager, it’s important to understand their due diligence performed on the asset and the safeguards they have put in place in case of adverse consequences.

For example, Fundrise typically aims to secure rights in a real estate deal that will help to protect the company and our investors in the event of negative occurrences. If a real estate opportunity is not in a senior position within the capital stack with a first lien on the property, we generally look to secure various guarantees where possible (including personal, completion, and springing guarantees), as well as buy-sell rights whereby we can force a developer to sell the property in order to pay Fundrise (and Fundrise investors).

Why is real estate investing attractive to you?

There’s a good reason why real estate has been among the asset classes of choice for the world’s most successful investors for centuries. With a naturally limited supply, as long as people need roofs over their heads — for sleep, work, or entertainment — real estate will have persistent, inherent value.

But beyond real estate’s proven potential to excel in value, ask yourself why a real estate investment is appealing to you. Is it as simple as the superior returns, with historical performance outpacing the stock market for decades? Is it the opportunity to diversify your investments into a classic, low-correlated asset type? A path toward financial freedom? Are you looking forward to trying your hand at landlording as an active real estate investor hoping to invest not just money but time into work that you enjoy?

Or is it the opposite: as platforms like Fundrise have made real estate investing more accessible than ever before, are you looking for the potential to earn passive supplemental income?

There’s a range of legitimate reasons why you might be drawn to real estate investing, but each specific method involves its own set of nuanced strategies, relevant knowledge, realistic expectations, and general best practices.

Type of Investment & Sector

“Active vs. Passive” is the most obvious difference between many real estate investments. But beyond these broad categories, real estate comes in all shapes and sizes. The type of investment that you’re interested in might change based on the type of investment or real estate sectors available to you. In order to make a smart investment with optimal returns, you’ll need to be able to ask yourself questions about investment types and which is best suited to you.

Depending on your risk tolerance, liquidity needs, and required return, is debt or equity right for you?

Once your have a clear picture of your financial goals, you can begin to sketch a plan of the kinds of investments you’ll need to make to meet those goals. In real estate investing, one of the most basic considerations in an investment is whether you’d like to invest your money as debt or as equity. The option you choose will directly affect the riskiness of the investment, its liquidity, and the amount you stand to make as a return.

Generally speaking, debt has less risk than equity due to its senior position in the capital stack, which usually equates to lower potential returns. Additionally, it typically involves a fixed timeframe (i.e. mortgage term) with periodic cash flow. Equity, meanwhile, is riskier and typically lacks regular fixed payments. Given the structure and higher risk of equity investments, they usually feature higher potential returns than debt. In fact, upside is technically unlimited.

Put simply, investors who would like to maximize cash flow and minimize risk may be better suited to invest in debt, while those with a higher risk tolerance aiming for long-term appreciation are likely to prefer equity. Which is right for you?

Depending on current market factors, what asset type and strategy are right for you?

The real estate world is divided into commercial (office, retail, multifamily, industrial), and residential (single family homes). In addition to these broad categories, there are various different types of investment strategies beyond just a simple buy-and-hold, including value-add, wholesaling, and flips. During good times, every investment is likely to look good on paper. However, in down markets, things can get more complicated.

Within the residential property sector alone there are different types of strategies that perform differently in good times and bad. For example, in down markets, rental properties tend to outperform, while in upward-trending markets, demand for homes may spike, sending prices higher. For those with a long time-horizon, comfortable financial position, and limited liquidity needs, purchasing a home with the intention to rent it out may be a great defensive strategy to ride out a downturn. However, for those who need more liquidity, this strategy is unlikely to present a good option. Down markets are often the worst time to try selling a flipped home, as poor stock market performance and low investor confidence often lead potential homeowners to delay new purchases.

Be sure to pay attention to the overall market, determine whether one sector and strategy makes more sense than another, and, beyond that, consider local changes in the particular market you’re considering.

How does the amount you’re able to invest impact the type of real estate you should invest in?

Just as an active investor may need to be able to produce more money up-front than a passive investor, some market sectors will demand that investors have more available cash to invest than others. If you’d like to secure senior debt in the construction of a shopping mall in downtown San Francisco, you’ll need a considerable amount of additional capital than if you’re interested in buying a single-family condo in a Memphis suburb.

That said, real estate investment trusts and online investment platforms have opened the doors for more investors to access different asset classes than ever before, at lower dollar amounts. Before knowing what options are even on the menu, investors need to determine how much they’re able to invest in the first place, and understand what options are open to them as a result.

Does your access to financing limit or expand the real estate investment possibilities open to you?

Whether you are an active or passive investor, you may be interested in leveraging your investment through a bank loan or alternative funding source. If you’re an active investor it may not only be palatable but also necessary to borrow in order to finance a large, capital-intensive transaction.

Credit score, general financial position and prior borrowing history are major factors considered by lenders when determining if, and how much, capital they are willing to lend. Past bankruptcy filings, issues with the law, a high debt-to-income ratio, and poor credit history typically make obtaining a loan very difficult.

Market & Location

Because active investors undertake the responsibility of acquiring real estate themselves there is extra challenge in evaluating the market context inside of which that property exists. Do the specific market and location contribute positively to a smart investment? This can be a tricky question, but the success—or failure—of an investment over its lifetime can be determined by the location.

What are recent trends in the specific state, city, neighborhood and block?

A newly renovated duplex in a popular, transit-oriented Los Angeles neighborhood might be a great investment opportunity by all accounts, while an identical structure in Cleveland might be a guaranteed bust. Five years from now, the trend driving those home prices could reverse. The timing and tide of a location’s market is subject to many factors, but due diligence prior to investing would help you understand how other recent properties have sold nearby, the dynamics that drove those sales, whether they are associable to the property you’re considering or whether they’re unique.

Bottom-line: know your market. Do the elements combine to give you reason to believe that this real estate investment will appreciate from now until the end of the timeframe for the investment?

How well do you know the real estate market where you want to invest?

Not all cities are created equal in terms of real estate investing opportunity. Within a city, not all neighborhoods grow at the same rate or in the same way; and within a neighborhood, it’s crucial to understand the dynamics impacting each individual block. Sometimes fluctuations in value are obvious: maybe a house facing East features windows framing views over a sweeping, seaside vista, while across the street a same-sized home only overlooks a few melancholy dunes.

Other times, however, deciding factors can be much more subtle, but no less impactful on the viability of an investment itself. Perhaps you’re considering an investment in the middle of summer, unaware that the house sits on a street that’s the route favored by local college students to and from rowdy college bars every weekend of the school year? There’s no real substitute for knowing the living, breathing identity of the location where you’d like to invest. When investing actively, it’s crucial to have insight into shopping trends, quality of life, safety, noise, and local opinion about the specific property you’re examining.

Are there local financial risks that could affect a real estate investment?

If you plan to acquire property as a way to generate income, are there any financial qualities of the local market that could put that opportunity at risk? For example, maybe you’re thinking about investing in working class housing, but you’re unaware that the local employer, responsible for a recent influx of new residents, is scheduled to shut down. If a real estate property appears to make financial sense, are there any changes in the local market that could undermine some of those positive attributes?

Are there any natural disaster risks that could affect a real estate investment?

Similar to the question of financial risk and flux, be sure to consider all the ways nature herself could put a hitch in your investment. While the damage from many natural disasters can be covered by insurance, it’s always smart to have a full view of how something like a hurricane, earthquake, flood, or landslide might not agree with your plans for financial stability. Even if you can recover the expenses for damages, is the market secure enough to correct itself if the truly “big one” hits? Will a record-breaking storm change the course of your potential appreciation? Is this a risk worth taking?

Are there other significant real estate projects near the property that could affect its ability to attract tenants?

You’re mostly likely not the only one interested in getting into the real estate game in a given neighborhood. Consider the other property-related factors in immediate proximity to the property you’re considering. Is there a new Whole Foods going up? A new, well-funded museum? Or is the city slated to build a long-overdo, towering freeway overpass?

Maybe the city has recently approved plans to build large rental properties, just blocks away from the smaller building where you hoped to find tenants for your vacancy, who might be attracted to the newer, more feature-filled multi-family alternative.

Look into whether new restaurants or bars have been appearing in the area, how well public transportation functions in the immediate thoroughfares, whether the current tenants and neighborhood crowds like or dislike these changes, and whether any current demand for real estate is going to be oversupplied in the near future, due to other would-be moguls like you.

The Property

Beyond questions on the local market level, each and every piece of property will present a constellation of considerations with a detailed calculus of factors all its own. For active real estate investors, owning a piece of property can introduce a variety of new variables beyond money-in vs. money-out. While location is famously one of the most important characteristics of real estate, even if you have a plot of Eden, the value of the investment can be undermined by complications that might restrict your ability to profit, through building, leasing, or otherwise.

How much down payment and mortgage do you need to get started?

This is an obvious financial consideration, but no less important: what is the financial reality of the property? Even if you decide that you’re in a financial position where real estate investing makes a lot of sense, if you want to be an active investor and purchase a property yourself, the demand of a loan is a separate consideration in itself. Often these can be negotiated in the course of a specific deal, but the norm is for you as the buyer to present some combination of down payment and mortgage. So consider what that might involve: does a 30-year mortgage on a property that’s not your own residence work for you? Do you have satisfactory enough credit for a bank to agree to such a mortgage? Do you have enough funds to present the down payment comfortably? And finally, is the property really worth the asking price?

Between active and passive investors, this question clearly applies more to the former, who personally purchase the real estate behind their investment. An analogue for passive investors is a minimum starting investment. This might require investors to invest no less than a particular amount or purchase no less than a specific number of shares. While not a down payment or a mortgage, a minimum investment can present similar limitations, or call for long-term financial planning. This is especially true if the investment has specific liquidation windows — while usually not as long-term as a mortgage, an investment with low liquidity is similar in that it may lock-up some capital for a predetermined period of time. Be sure you’re comfortable with that situation — and keep in mind that lower liquidity often results in higher ultimate returns.

Are there any risks or devaluing qualities particular to this real estate investment?

This is where an intimate understanding of the property itself is essential. There are virtually innumerable ways a property’s value can shift, many of which are unpredictable. As an investor, one of your goals should be to try to forecast as much of the property’s future as you can.

For example, construction on property that neighbors certain kinds of real estate, such as public schools or parks, can find itself hampered by stringent regulations, often completely outside of your control. Similarly, if the house is historic, there may be limitations imposed on the type of work you can do to the home. Older homes in general may have serious structural problems, and hidden issues that are not immediately apparent.

Is there stucco siding that’ll need to be replaced in six months? Has the home had any history of flood damage, or mold? None of these details are outside of consideration, depending on the kind of real estate investment you’re evaluating.

How much additional money will you need to invest in the property to rent it, sell it, or use it on a service like Airbnb?

Active investors will usually need to invest more than a down payment and mortgage into a property to make it profitable. Each kind of active real estate investment involves a certain kind of monetary engagement to make it viable. These might involve HGTV-style home renovations and/or repairs to make the property as attractive and chic as possible in order to draw eyes from people browsing Zillow or Airbnb. These costs may not be nominal, and they might significantly alter the equation of what it will take for your real estate investment to turn a profit.

Meanwhile, the real estate behind passive investments generates income in the same ways (by being sold, rented, etc.), but passive investors don’t personally oversee the renovation processes that make the properties profitable, of course. Instead, the advisors who manage the investors’ properties must make these judgments and invest accordingly. Many passive investors will want to understand the capabilities of these teams, along with the developers and sponsors they work with. Even a passive investment depends on a property’s ability to attract income, and that attraction is often a function of cash invested in the property beyond the initial acquisition. Before investing with a passive investment platform, an investor might ask, “Do I have faith in this team handling its properties in a way that’s efficient and cost-effective, from beginning to end?”

How much time do you have available to manage your real estate investment?

The one piece of investment capital that you may be tempted to undervalue — but certainly should not — is your time. If you plan to be an active real estate investor, then you should prepare for your new investment property to impact your life in a range of ways beyond your bank account. Many landlords relish the job, with considerable satisfaction in generating an income through their own wholly owned property and hard work. However, being a landlord isn’t for everyone, and sometimes it’s hard to tell if you’ll be cut out for it until you’re already fully committed.

Unlike passive real estate investing, which presents the opportunity to earn sizeable returns through real estate without the hands-on requirements, active investing may levy additional, intangible costs — or pay back intangible, surprise dividends — depending on your disposition and whether handling property ownership feels like a treat or a chore.

Will you need to hire a property manager?

Before committing to a real estate investment, active investors need to consider whether they’ll want to hire a property manager as a way to help them handle the many responsibilities that go along with servicing tenants and the demands of a property itself. Be aware that many properties will be more successful, and tenants happy, if a manager is on-site. Be sure to count all the costs in hiring a property manager and include it in your investment calculations, budgeting both time and money to find the right person or company.

What’s Next if You Want to Invest?

Of the questions covered here, you’ll notice that most involve either expectation-setting or planning for potentially unpredictable, damaging developments. On one hand, you need to understand exactly what your investment goals and plans look like. On the other, it’s important to do your best to project how an investment is likely to play out, and soberly recognize where those plans could go off track. The questions regarding your financial and personal situation are applicable to and important for everyone, but if you feel intimidated or unable to fully commit to the due diligence required while answering these questions you might find passive real estate investing the more attractive option.

That’s where platforms like Fundrise present a revolutionary value for anybody who wants to invest in real estate. Fundrise’s investment platform makes getting started with a diversified, professionally selected portfolio of real estate properties faster, more affordable, and easier than it’s ever been. Want to learn more? You can read about Fundrise’s investment plans and opportunities here.