Real estate has been one of the best ways of getting rich. But a lot of people have also learnt that it is far from a risk free way of making money. Buying the wrong property or paying too much can get you into big trouble. Here is an introduction to real estate investing.
First we should make clear that with real estate investing we are talking about investing in a property that is rented to a tenant. Your own home is not a real estate investment. It is nothing wrong with owning the place you live in but you should not look at it as an investment.
Real estate investing is divided into residential real estate and commercial real estate. Residential property means single units or duplexes. In the US, the banks classify four units or less as residential real estate, larger properties are commercial real estate. Note that this means that apartment buildings are commercial real estate, if they consist of more than four units.
Most people invest in residential real estate, commercial real estate is often seen as something for the big players. Commercial property investing is difficult and mistakes can be very expensive but it is far from impossible to get started in commercial property investing. And the profits can be very handsome. But residential property is much easier to value than commercial property so it is a good idea to start with residential property before moving on to bigger things.
Why should you invest in property? After all, the stock markets generally generate higher returns, over longer periods of time, than real estate. There are a couple of good reasons to have a relatively large part of your wealth invested in real estate. If you have all your money invested in one single asset class, you are very vulnerable. So diversifying your investments is very prudent. It will not maximize your return in the short term but it will reduce the risk of heavy losses. This means that even if property is a very good investment, having all your wealth in real estate is not advisable.
Even if shares seem to return, on average, a little bit more than 10% per year and property normally significantly less than 10% per year, property is often a superior investment. This is because you generally get a far better return on your money when you invest in property than in shares. This is because of leverage. When you buy shares, you generally use your own money. But when you buy property, you typically pay 10% to 20% out of your own pocket and borrow the rest.
Thanks to OPM, Other People’s Money, property can make you rich. But leverage is a mixed blessing. As long as prices keep on going up, the more leverage, the richer you get. But if the prices go down, too much leverage can kill you financially.
There are some disadvantages with property investments. Sometimes, you need a fair bit of money to get started. If you can’t find a tenant, you have to pay the lender out of your own pocket. Every now and then, something will need to be mended or replaced in the property. Compared with shares, a property investment can be an uncomfortable thing. But there are solutions for most problems, the potential rewards make it well worth the extra hassle.
Buying the first investment property is often a scary experience. It is after all a big transaction and you are generally borrowing a lot of money. But as long as you avoid making big mistakes, it is one of the best ways of building wealth. Here you can learn more about residential real estate investing.
Commercial real estate investing is actually not only for big players. It can be very rewarding and is well worth having a closer look at. Here you can learn more about how to get started in commercial real estate investing.