May 20, 2019
Real estate investment remains to be one of the most stable and popular methods of investing. Land doesn’t go out of fashion, and it certainly doesn’t change value due the tweets of its owner. There are however several ways to go about investing in property, and many things to take into consideration when deciding the route to take.
Understanding the different investment opportunities
When most of us think about real estate investment, we picture a property developer who buys and directly owns many properties, and monetises through either rent or renovating and selling-on for a profit.
This is a very active way to invest. But not all real estate investments require your operating decisions. There are passive ways to invest, such as Equity REIT and owning shares in a real estate company.
An equity REIT is a popular choice for those with limited time or knowledge. For example, those with a full-time job and no prior construction knowledge.
Additionally, retail investors (beginners) buying a second home to rent out has meant that many property markets are saturated. Because of the low barriers to entry (e.g. low interest rates and low deposit required), opportunities to buy under-priced housing is becoming more competitive.
Ways to overcome this has been through more sophisticated real estate investment that is more out-of-reach to retail investors. For example, there are REITs that will pool money from investors and make more complex investments, such as buying multiple properties, renovating and monetising through AirBnB.
These investments are also usually managed by experienced professionals, offer great diversification across markets and you do not have direct ownership of the properties (you own a share of the company instead).
Owning a property itself (or partially) between a group of investors is usually known as a real estate crowdfunding.
Crowdfunding is the more modern and accessible version of syndicates, and are becoming increasingly popular, offering many great advantages.
There are many real estate crowdfunding platforms that connect you with other investors, with the added bonus of not having to administer the properties that you invest in.
However, not all real estate investments have to be through purchasing equity. There are many debt-based investments, such as buying bonds issued by real estate companies or even private debt.
Funding and time
How much time and money do I need?
When purchasing equity privately, perhaps a second home you want to rent out, usually the minimum deposit for a buy-to-let mortgage is slightly more than regular mortgages. In the UK for example, this tends to be around 25% of the value of the house. This varies from country to country, but generally you should expect around 20% to 40%. In a developed country, this usually means saving a minimum between $30,000 and $80,000.
Investing in a REIT though, requires next to nothing. You could invest what you saved on last month’s paycheck, and it could happen in a matter of minutes online. This is clearly the faster option, with direct-ownership investments usually taking several months.
What investments are liquid?
Converting your direct-ownership investment into cash again will mean waiting for a buyer for the property, or for someone to buy your equity share in real estate crowdfunding project. Evidently, this is a very long-term investment and is not a liquid investment like REITs, which only take moments to sell.
How to save for this?
The necessary basics to save for a buy-to-let mortgage:
- Create a budget
- Practice frugality
- Calculate and try to improve your savings rate
- Increase your income in the meantime through other investments.
Location and yield
When weighing up your investment choices, location is definitely a major factor (particularly with direct-ownership).
Firstly, you should get to grips with all the relevant property legislation in the area before considering an investment. Major changes in legislation can have a dramatic effect on your rights as a landlord surrounding evictions, rent payments and tenant vetting process.
Some regions may offer slightly more rent, but higher capital gains tax which could limit your profits upon selling the property. Even worse is the situation where you could be double-taxed: in the country you reside and in the country of your investment.
A basic economic evaluation should also be necessary. You only have to drive around the many Greek and Spanish towns which have an apocalyptic look of abandoned and half-made constructions due to unsuccessful property investments. A struggling local economy can also mean failure to find tenants, and cash flow problems even once you find them.
If you are restricted in finding a good viable location, then REITs are great global option that can be accessible remotely. They also can diversify across different regional markets, making them less prone to the negative effects of volatility or a local economic recession.
Some locations have better yields than others, too. Yield is the return you are expected to receive from the property relative to its price.
Some regions naturally have high rent but low equity price, but a rental yield of around 7% or 8% is considered good.
This is similar to what you may expect from your REIT return. You may find that REITs can return slightly more, sometimes between 10% and 15%. Whilst the returns are similar, direct-ownership means selling the property at the end of the investment.
This is the ultimate benefit from direct-ownership, in fact, that it can be leveraged. If house prices are likely to rise, your return upon selling can be extremely vast. This is because if you own only 25% in equity (and 75% is debt) then a 25% increase in the house price = 100% return on your investment.
Which type of investment is right for me
If you have less of an appetite for risk, and fear interest rates may rise, then perhaps an REIT investment is preferred. After all, the risk will be diversified and spread and the capital required can be as low as you want it to be. If you have researched a property well and have the capital to back it up, then direct-ownership can usually offer a greater leverage return.
It may ultimately come down to your time available and prior experience. A REIT or crowdfunding may be a great option to start with, and as you become more knowledgeable about real estate, and decide to dedicate more time to it, then direct-ownership may then naturally follow.