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 With the miserly returns the stock market has offered us over the past five years, many individuals are looking for attractive alternatives such as investing in real estate. We can think of at least three ways investors can get into the real estate market - purchasing a home or apartment as a primary residence, owning investment properties, and buying into a real estate mutual fund or investment trust.
Investing in Your Home
If you're lucky enough to have a mortgage or own your home, then you're already investing in real estate. Some of you might think this sounds silly, but you'll probably spend more money on your home than any other single investment.
Buying a home is a pretty common event. In fact, it is such a commonplace occurrence that many individuals feel it's a pretty safe transaction. However, if you look at this investment a little closer, you will see that the individual purchasing the home is actually taking a highly leveraged position.
Many first time home owners might be paying as little as 5 - 10% of the purchase price upfront in the form of a down payment. This means they are borrowing nine to nineteen times more money than they are willing, or able, to put down. This leverage serves to magnify any appreciation in value that the homeowner experiences. Let's take a look at a quick example to see how that happens.
Home Buying Real Estate Example
Let's assume a home in 2002 is purchased for $300,000 and the buyer puts down $30,000. According to information released by the Office of Federal Housing Enterprise Oversight, the house price index (HPI) for the average house rose by almost 11 percent in 2004, up from 7 percent in 2002 and 2003. That means that this home purchased in 2002 was probably worth in the area of $400,000 by 2006.
That's an increase of $100,000 over four years on an initial investment of just $30,000. Is there any wonder that people are interested in investing in real estate? With a flat stock market over those same three years, that 333% return on investment has many people looking for more real estate investment opportunities beyond just owning a home.
Owning Investment Properties
A second way investors can participate in a booming real estate market is by owning investment properties. This is a topic we will cover in more detail in the future, but this method involves taking physical possession of the investment property, just like a second home.
There are lots of websites offering information on how to get started in the real estate market through the acquisition of investment properties. But if you think this form of investment is akin to a hobby, then think again.
Finding Real Estate Investment Properties
Being a landlord is time consuming business. You need to thoroughly evaluate the property before purchase and you have to maintain it for as long as you own it. Warnings aside, here is a short list of some of the other ways you can purchase real estate properties for investment purposes:
- Bankruptcy Properties - Acquiring the property from sellers that have gone into bankruptcy.
- Tax Lien Investing - Acquiring a property from an owner that has not paid their property taxes.
- Foreclosure - Purchasing real estate as part of a foreclosure proceeding.
- Unknown Owners - Acquiring the property from local tax authorities when the heir to the home cannot be located.
The bottom line is that there are many different ways to invest in real estate on your own. But be careful if you see those "get rich with no money down" advertisements or books explaining to you how you can sell a home before you even own it. These are obviously difficult and time consuming transactions to pull off. And that brings up another point.
If you think you can pull of owning real estate properties on a part time basis, then you need to be prepared to be very busy during those part time days. This is not an easy way to invest in real estate. It involves lots of homework, speaking to county clerks and attending sheriff sales, which happen during normal working hours on weekdays - not weekends.
Real Estate Mutual Funds and Investment Trusts
The third and final way you can invest in the real estate market is through real estate mutual funds or real estate investment trusts (REITS). These are two somewhat different ways that an investor can participate in the market without having the ongoing responsibilities that are required of landlords. The differences between real estate mutual funds and REITS is subtle, but worth covering here.
Investing in Real Estate Investment Trusts
A real estate investment trust or REIT is a trust that is set up for the sole purpose of investing in real estate. These trusts are typically run by a board of directors that provides oversight into the purchase of investment properties.
A REIT offers the investor advantages that include:
- Professional property management services necessary to run and maintain the properties.
- Oversight of purchases to ensure investment dollars are used wisely.
- Diversification of purchases beyond single and multifamily dwellings.
REITS can invest in multifamily dwellings, commercial office space, hotels and shopping malls. Earnings on these investments come from the sales of the properties themselves, efficiencies gained through changes to operations and rehabilitation of properties to improve their marketability. We also discuss REITS in our article on Real Estate Investment.
Investing in Real Estate Mutual Funds
Real estate mutual funds are another way the average investor can participate in the real estate market and rely on professional management services. These mutual funds typically invest in real estate investment trusts and real estate companies. The latter category would include large builders or owners / operators of real estate properties such as Hovnanian Enterprises and Toll Brothers.
Like all forms of mutual funds, real estate funds offer the investor the advantage of diversification and liquidity. Typically, investors can buy into a mutual fund with as little as $2,500. Our article on Real Estate Mutual Funds provides some additional guidance and includes a quick look at some of the top performing funds in 2007 - which brings up our final point.
According to Morningstar, real estate mutual funds have enjoyed above average returns over the past five years. It's an individual decision as to whether or not this success is nearing the end of its cycle. However, most analysts agree that real estate investments can play an important role in any long term investment portfolio.
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