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There's more to real estate investing than just buying an investment property. In fact, conventional wisdom states there are four different types of real estate investors. As with any type of investing, each one has its own benefits and disadvantages. To that end, below is your guide to all four types of investing, as well as its pros and cons. Read them over so you can determine which type of real estate investing is right for you.
What is a real estate investor?
Put simply, a real estate investor is any investor who purposefully adds a real estate asset to their portfolio. Truthfully, real estate investors come in many different shapes and sizes. While many people think of someone who buys and holds a rental property as the classic example of a real estate investor, that is just one type. It's possible for real estate Investors to also put their money into a real estate investment trust (REIT), to follow a fix-and-flip investment strategy, or to be wholesalers.
Notably, it's also possible for real estate investors to be individual investors, institutional investors, or to fall somewhere in the middle. In this case, banks or other financial institutions would count as institutional investors, while individual people would count as individual investors. However, it's also possible for individuals to start a real estate investment company, which would fall somewhere in between those two ends of the real estate investing spectrum.
What are the different types of real estate investors?
Now that you know a little bit more about what a real estate investor is, the next step is to take a closer look at the different types of real estate investors. With that in mind, I've laid them out for you below. Read each of them over to get a better idea of what each distinct investment strategy entails.
Investing in a real estate investment trust (REIT) is the most passive form of real estate investing available. With this method, you'll invest similarly to the way you'd invest in the stock market. Here, you'll buy shares of a real estate investment company and receive dividends when the company pays out its profits. A publicly traded REIT will even have its shares listed and traded on major stock exchanges. However, a non-traded REIT may still be listed with the SEC, but it's not publicly traded or it may be a private company.
The major benefit of investing in REITs is that, like stocks, anyone can do it. You don't have to be an accredited investor or even have that much real estate experience. In this case, it's as easy as buying and selling shares. Notably, REITs also have to pay out 90% of their income as dividends.
That said, the downside of investing in REITs is that you have very little control over what they invest in or how they're managed. With that in mind, it's important to do your research before investing in any particular REIT. Also, dividends from REITs are taxed as ordinary income, as opposed to a lower rate.
Again, buy-and-hold investing is the classic example of real estate investing, where you buy up an investment property and rent it out for consistent monthly income. On the whole, this is a relatively active form of real estate investing. You do have to do the groundwork of marketing for a tenant, vetting all the potential applicants, and being on call to handle maintenance issues. It's also meant to be a long-term strategy since investors tend to buy an investment property and keep it in their portfolio for multiple years.
The big benefit of following a buy-and-hold investment strategy is that you have the opportunity to achieve relatively stable returns. In this case, landlords can usually count on the same amount of rental income coming in every month. Additionally, if you hire a property management company, you'll also have the opportunity to turn this into a more passive investment.
The major downside of this investment strategy is that it can be a lot of work for smaller returns than you might find with another method. As mentioned above, if you're an individual investor who hasn't hired a property management company, you have to be willing to take on landlord duties in order to receive any rental income, which can take a lot of time and effort.
Then, there is fix-and-flip investing. As you might be able to guess, this is the same type of investing that you often see on HGTV. In this scenario, the investor will do their best to find a real estate deal that's undervalued for the market. Then, they'll fix it up and market it for resale at a much higher price. Once the buyer is found, the investor gets to keep the difference between the initial investment and the final sale price as profit.
The main benefit of this type of real estate investing is that, if you find the right investment opportunity, it has the potential for high returns. Also, it's a short-term investment strategy, meaning you could see a return on your investment in just a few months.
That said, this is also a very active investment strategy. In this case, it's up to you or your real estate agent to find the right real estate deal. Then, you have to figure out how to fix up the property. Here, you can often achieve better returns if you can do the work yourself. However, if you aren't handy, you'll have to plan to pay for labor costs in your budget. Finally, there's also the risk that you could over-improve the property and lose money on the deal when it's time to sell.
On the other hand, real estate wholesalers will act as a middleman between a property owner and an end buyer. Here, the investment strategy is to find an underpriced real estate deal. Then, to quickly sell it for a higher price to an interested buyer without rehabbing it first. In this scenario, you get to keep the difference between the price you paid for the property and the price you sold it for as a profit.
In truth, this is a relatively passive investment strategy, and you have the potential to make a sizable profit. Typically, wholesalers will buy and sell a property the very same day in order to cut down on carrying costs. However, in order to make this work, you often need to have an established network of real estate contacts who can help you find interested buyers and distressed sellers.
How to decide which type of real estate investing is right for you
Once you know a little bit more about each type of real estate investor, it's important to decide which investment strategy may be the best fit for you. With that in mind, we've listed some of the criteria for you below. Keep reading to get a sense of which type of investing might be the best match for your lifestyle.
Active vs. passive investing
First, you have to decide whether you're interested in active or passive investing. As the name suggests, active investing is a lot more work. However, in exchange, you often have the potential to make larger profits. In this case, you're trading time and effort for the size of your returns. With a passive investment strategy, on the other hand, there is less to do but you may cut into some of your profits.
- Active: Fix-and-flip, buy-and-hold
- Passive: REITs, wholesaling
Long-term vs. short-term gains
Once you’ve decided between active and passive investing, the next question is whether you want to focus on short or long-term gains. While this is not always the case, often short-term gains take a lot more effort to realize then long-term ones.
- Short-term: Fix-and-flip, wholesaling
- Long-term: REITs, buy-and-hold
The Millionacres bottom line
Real estate investing can be a great way to diversify your portfolio. However, if you're just getting started in this arena, it can be confusing to differentiate between the different types of real estate investors. In light of that, use this as your guide to your options. Armed with this knowledge, you should have a better idea of what type of real estate investing is right for you.
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