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Do you play Monopoly? How about Cash Flow 101? Both board games cater to our desire to be real estate tycoons.
When I was little, I used to play Monopoly for hours on end with my best friend. I just knew that when I grew up I would own all kinds of real estate. After all, Dad owned rental homes the entire time I was growing up – and even tried to do a fix up and flip residential property.
But, alas, life has gotten in the way. We have owned 2 homes, 40 acres and a condo, but I haven’t become a real estate whiz. I don’t yet have rental real estate or other real estate investments that yield a steady, reliable income. Plus, I have a spouse that is very risk averse and real estate can be full of risks.
I want part of my portfolio in real estate, but how can I structure it to meet my lifestyle and keep my marriage intact?
Is it time to invest in real estate?
Some sources are beginning to encourage investors to take the plunge into residential rental real estate, with low rates and a lot of lower house prices as the bait. Others fear that we are not out of the woods yet with real estate prices and that as the inventory of foreclosures that have been bottled up hit the market, prices will sink still lower.
In addition, stock market researchers and traditional investment analysts are proclaiming that there is now a new order in the investment world. Criers say ‘Buy and hold is dead. Advisers are recommending new types of diversification in your portfolio.
Merrill Lynch just put out a new study, The Great Global Shift: New World, New Rules in which Lisa Shalett: Chief Investment Officer for Merrill Lynch Global Wealth Management says:
“The new rules of global investing revolve around truly embracing kind of a global perspective and having that global perspective be as inclusive as you can tolerate as an investor and being willing to consider it. Second, being flexible, looking beyond the traditional asset classes of equities, cash and bonds, and being willing to consider opportunities that may be out there. And finally, being dynamic, being willing to accept that volatility may exist and that volatility doesn’t have to be your enemy.”
“In addition, you need to be flexible. It may not simply be cash, equity, fixed income anymore. We may need to think about cash, equities, fixed income, commodity, currencies, real estate and other alternatives.”
All in all, I think I agree with that statement. My traditional portfolio of cash, equity and fixed income didn’t weather the storm too well in 2008 and 2009 and most of the investments seem to be moving in tandem now as well (up and down – over and over!).
So, is now the time to invest in real estate and if so, how can you do that?
If you are like me, you don’t necessarily have the time or the inclination to actually hold and manage residential rentals AND take on the added risk of legal action against you in doing so.
I’m currently struggling with wanting to invest in real estate and not knowing how I want to do it. Here is what I found on the types of investments that can be done to keep part of your portfolio in real estate sectors.
Types of Real Estate Investments
Residential real estate
You could buy a foreclosure or a bank owned property at a discount and rent it out. You know (or can easily find them at places such as The Real Estate Investing Club) the pros and cons of this so I won’t go over them again here.
I’m over 60 and as I mentioned above, have a very risk averse spouse. If it was just me, I might go for this option (and I might eventually anyway), but in current circumstances I would need a management company to handle everything, more insurance and access to quite a bit of unallocated cash to feel comfortable doing so.
You could also buy other property types, such as an apartment building, a duplex, a mobile home or a condo to rent out as well. Some folks like the low income rentals (section 8 housing) and others like to own properties that attract more affluent tenants. You could buy a house in a college town and rent it out to college students. You could also rent out part of your home or you could buy a house and then rent it out to own – so that the tenant ends up with it after a certain period.
All involve you becoming a landlord and that means YOU are responsible and could be sued if something happens to a tenant or if you violate one of the fair housing regulations at any point in the process.
Another option with residential real estate would be to buy a fixer up and then try to sell it at a profit. That seems like risky business in this market – with houses staying on the market for so long these days. My Dad actually had a bad experience with this in a good market, even though he tried to follow all of the typical advice (buy a lower priced house in a neighborhood with better houses, do the work yourself and etc).
My final thoughts on residential properties are about vacation properties. Many individuals buy vacation properties as second homes and then rent them out in nightly or monthly rental programs when they aren’t using the property themselves.
We own a vacation rental. Don’t buy these with the expectation of making a steady rental income. The income can offset the costs of the property but probably won’t make you much more than that. In our case, we have a condo, with monthly dues.
We have monthly utilities, extra insurance costs and the county considers it a commercial property, since we rent it out – with a much higher tax rate. Nightly rental management fees are much higher than regular rental management fees (we currently pay 38% of the rental income) and nightly renters can be pretty rough on the property.
Commercial real estate
My ex-brother in law deals in commercial real estate (which by the way you can sell with just a normal real estate license according to him). He buys and sells things like huge data centers, office buildings and retail complexes.
You could own a strip mall, lease out the stores and make money that way. Commercial property is usually leased for longer periods than residential property. The commercial real estate market, at least according to some sources, has already staged somewhat of a comeback from the real estate crash in 2008.
This option feels totally out of my path. I’ve had no exposure to it and haven’t seen too much information on it. Plus, the structures are typically more expensive – out of my desired investment levels.
A variation of commercial real estate that might be within my reach are self storage units. In a way, they are similar to residential real estate – in that you rent them out to individual people. They have the added advantage of not typically needing repairs in the middle of the night. However, cities are beginning to regulate what can and can’t be included and what the facility must look like. In addition, competition is growing.
Land to develop
Speculative buying of raw land in anticipation of price increases as development moves into the area is another possible real estate investment. If you are willing to work with local and state and federal governments to get approvals to rezone the land so that a developer can build on it, as well as install public utilities (such as water, sewer, curbs, and etc) you would make more from the land than if you just sat on the raw land waiting for someone to come along and buy it.
In my area 30 years ago, an ‘international’ airport was built in an area with lots of undeveloped land and an interstate was built to serve it. Land speculators bought up much of the land along the highway and around the airport. They are just beginning to be able to realize some profit. Another issue you might encounter is taxation. As the area around your raw land develops, your land taxes may rise – before you can sell the land for a profit.
Farm land
Recently I’ve learned that some are investing in America’s Midwest farmlands. You can read what I wrote about that in my post American Farmland – an Alternative Investment.
Real Estate Investment Groups
If you don’t want to go it alone, you could invest as part of a group. The investment group buys or builds properties, sells them to investors and then manages the sold properties. They are said to be a way to have direct ownership in a property without having to manage it. Investors pool part of their rentals to insure that the investment group gets paid for their services.
The only way I would consider doing this is if I was able to thoroughly research the group and really trust it – or if I formed the group myself – with other people that I know.
Real Estate Investment Trusts
In contrast to a real estate investment group – in a REIT what you own is a security, not the property behind the security. You can buy and sell shares in a REIT on the exchanges.
Most REITs concern themselves with commercial real estate as opposed to residential property. Different types of REITs may invest directly in property (equity REIT) or they can invest in the mortgages on the properties (mortgage REIT) or they can invest in a mixture of the two (hybrid REIT). Distributions from equity REITS are treated as taxable income (instead of as a dividend).
I am considering REITs, but they do feel more like a stock to me than a real estate investment.
Real Estate Mortgages
You could provide private funding for someone else’s mortgage, earning your income from the interest that they pay. Seller’s sometimes offer to provide the funding or sometimes a third party investor wants to fund a mortgage just for investment purposes. The mortgage can then be sold to another party, just as a bank initiated one can be sold.
This is probably not for me. I’m more interested in more direct ownership of real estate.
Tax liens
In the US, when a homeowner gets behind in the payment of their real estate taxes to their county, at some point the county offers either a tax lien for sale on that property or the actual property for sale – so that the county gets paid their perceived due. I attended our county’s tax lien sale this past year and wrote several posts about that experience – starting with Tax Lien Certificates – Sure Thing or Risky Business?.
Each county and state has their own laws and procedures relating to these sales. In a tax lien certificate sale, typically an investor is buying the lien certificate. When the homeowner pays off the tax lien, the investor gets their money back, plus interest on the tax lien amount (sometimes significant interst rates such as 10%).
Property derivatives
Like other derivatives, property derivatives are for sophisticated investors – typically ‘qualified’ investors (institutional or private investors with access to large sums of money). They (according to Investopedia) utilize swaps, forwards and property index notes.
I won’t be using derivatives – as I don’t really know anything about them!
Help me out here, do you know of other ways to allocate a portion of your portfolio to the real estate market? Lets talk about it in the comments!