What is real estate investing?
Real estate is often touted as a tried-and-true method of generating income and securing your long-term finances. Over 23 percent of Americans consider it the best way to build wealth. But real estate investment requires careful planning – and also calls for large up-front cash outlay.
What are the benefits, risks, and potential drawbacks of real estate investment? How does it stack up to other alternatives? In this post, we get into the finer points of real estate as an alternative investment so you’ll have all the info you need to make an informed decision.
- How does real estate investing work?
- Types of real estate investments
- Benefits and challenges of investing in real estate
- Trends in real estate investing
- How does real estate investing compare to franchising?
How does real estate investing work?
Real estate has long been a favored method of diversifying investment portfolios. It offers both short-term cash flow and long-term stability due to its strong asset value. It provides a steady income stream while building equity for the future through asset appreciation. With careful research and planning, any investor can take advantage of these opportunities and benefit from investing in real estate.
Types of real estate investments
For many, real estate investment is synonymous with residential rentals. While this is a popular method of creating cash flow with real estate, it’s only one of several ways to make real estate part of your portfolio. There are many direct and indirect methods to invest in real estate.
Residential & commercial leasing (short- & long-term leases)
Many investors choose direct investment in residential or commercial properties. Some buy and maintain the properties, source tenants, maintain the property according to the lease, and collect rent payments. Other investors create a semi-passive investment by engaging a management company to handle the day-to-day operations for a portion of gross rent, usually around 15 percent.
Residential & commercial flipping
“Flippers” make money through short-term investments in distressed properties. They purchase a property that is in foreclosure or needs updates, fund the necessary updates and systems repairs, and sell it at a profit. A long-term version of this method is called “Buy, Rehab, Rent, Refinance, Repeat” or BRRRR. In this approach, the rental income pays off the property, and the proceeds from refinancing the property then fund the next project.
As land investors are fond of saying, “They’re not making more of it” … and how true that is. During downturns in the market, investors buy a piece of land to hold until a future time when the value has increased. Buying land is a long-term strategy that allows investors to secure their funds in a real asset that appreciates over time. The investor can either sell the land or develop it into residential or commercial properties to sell.
Real estate investment trusts (REITs)
REITs are a popular passive method of investing in real estate. These investment vehicles allow investors to pool their funds in commercial and residential buildings, apartments, hotels, warehouses, shopping malls, or other desirable commercial properties. The REIT management team purchases the properties on behalf of the investors, collects rent payments from tenants, and manages the buildings. The collected rent payments are then distributed to shareholders as dividends.
REITs are popular because they require no management or upkeep from individual investors, while still providing a modest return. Although REIT investors enjoy a lower initial investment than leasing or flipping, one downside of REITs is that investors don’t benefit from asset appreciation. They’re also susceptible to market volatility.
Real estate crowdfunding typically uses an online platform to collectively finance real estate projects or purchases. Investors can browse listings, choose projects that meet their criteria, and become shareholders. The company managing the listing acts as a general partner and oversees the development or renovation process for all investors. As with a REIT, the fund pays dividends from rental income.
Benefits and challenges of investing in real estate
Real estate investment offers many advantages for cash-rich investors looking to broaden their portfolios and generate cash flow. Despite its popularity, however, investors should do their homework and understand the market before diving into a direct investment opportunity.
Benefits of real estate investment
Real estate investment is a long-term proposition, but the returns are comparable to public markets: around 10 percent based on the 100-year average of the S&P 500.
Reasonable risk profile
Real assets like real estate offer some relief from market volatility, sheltering a portion of your investment and cash flow from inflation and recessions. This is more true in direct investment models such as leasing and flipping.
Potential tax benefits
Owning rental properties provides certain tax write-offs for depreciation and mortgage interest deductions. Also, local and federal assistance programs may provide funds or incentives to invest in residential properties.
Adding real estate investment to your portfolio helps reduce overall investment risks.
Consistent cash flow
Real estate provides predictable investment and income numbers, making it easy to plan your investment and estimate returns.
Challenges for real estate investors
High up-front investment
Residential and commercial real estate purchases often require a down payment of 20 to 30 percent or more. Depending on market conditions, your credit profile, and the type of property you select, the initial investment costs may exceed several hundred thousand dollars.
Vacancy & non-payment
Although the current housing supply makes vacancy seem unlikely, real estate investors must always consider the financial impact of property temporarily sitting empty. Estimating a 5 percent vacancy rate into your cost calculations helps plan for periods where your property doesn’t generate income to pay the rent. Keeping contingency funds in reserve is important when planning your investment.
Depending on local laws, renters have rights and protections associated with non-payment. A non-paying resident may be able to occupy the property for a certain period of time despite non-payment, which could impact your income. To ensure success for your investment, check a renter’s credit history and establish contingency plans.
Potential investors must realize that owning and maintaining a property is not pure profit. Many expenses factor into the cash flow of your property, such as:
- General upkeep and routine building maintenance
- Landscaping, snow removal, and waste disposal
- Intentional or “force of nature” damages to the property
- Property taxes and other assessments
- Code-related or mandatory safety updates
When evaluating a potential investment, build a conservative budget with reasonable estimates for necessary repairs and maintenance.
Trends in real estate investing
Three things to know about the state of real estate
- Currently, the residential real estate market is a sellers’ market. The supply of residential homes remains at record lows, with high market values and competition. While rent values are also high, finding and financing residential and commercial rental properties is a huge challenge.
- Current economic conditions have drastically increased mortgage interest rates and the cost of commodities and repairs. These factors create downward pressure on returns for both direct and indirect real estate investment.
- In comparison, commercial properties have been relatively slow, with rental rates rising slowly over the past few years. Smaller property classes outperform larger (B- and C-class) office buildings. The move to remote work and the contraction in the need for commercial space complicate these investments.
The rise of retail in real estate investing
The fractional real estate investment model has become increasingly popular for those who want to diversify their holdings without a huge initial investment. It offers many of the benefits of real estate without some of the drawbacks. Technology and crowdfunding have made it easier than ever to invest in real estate locally and globally. Still, investors should use the same due diligence they’d apply to other investment decisions when considering investing in fractional or crowdfunded real estate opportunities.
How does real estate investing compare to franchise investing?
While real estate offers many advantages to other forms of investing, many wealthy investors prefer the advantages of franchises for building wealth and securing their investments.
Advantages of investing in franchises
Superior recession resistance
Successful franchises operate in recession-resistant industries like food service, professional services, healthcare, education, and personal care. These industries serve vital needs for customers regardless of the larger economy.
While real estate offers some shelter from turns in the public markets, franchise investment has even more staying power through economic change. In many cases, revenues for franchise businesses rise with the cost of inflation, which provides a secure hedge against future uncertainty.
Franchise owners who successfully build one franchise location often branch into a network approach, buying multiple locations or investing in a complementary franchise network to minimize seasonality and fully diversify and scale. Residential and commercial rentals may have limits to their scalability.
Invest in the power of franchising with FranShares
If you’re an alternative investor who’d like to diversify by adding franchises to your portfolio, consider passive fractional franchise investing with FranShares. Our approach offers high earning potential and diversification in a completely passive investment model. We give both retail and accredited investors access to all the benefits of franchising with low initial capital outlay and zero fees.
To learn more about FranShares and this unique opportunity, sign up for our platform on our home page.