Investing In Real Estate

The limited return on investment in the stock market has many individuals looking at alternatives such as investing in real estate.  There are 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 individuals might not consider a home as an investment.  But for many of us, we'll spend more money on a home than any other single investment.

Buying a home is a fairly common event.  In fact, it is such a commonplace occurrence that it's considered a pretty safe transaction.  However, if you take a closer look at this investment, 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 to 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, with 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 that has been covered in more detail elsewhere on this website, but the method involves taking physical possession of the investment property, just like a second home.

There are many websites offering information on how to get started in the real estate market through the acquisition of investment properties.  If you think this form of investment is akin to a hobby, then think again.  Owning investment property can be a full time job.

Finding Real Estate Investment Properties

Being a landlord is a 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.

It's clear that there are many different ways to invest in real estate on your own.  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 conduct, which brings up an important point.

If you think you can own 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 a lot of homework, speaking to county clerks, and attending sheriff sales.  Most of these activities need to take place 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 explaining.

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.  The topic of REITS is discussed in more detail 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, which brings up a final point.

According to Morningstar, real estate mutual funds have enjoyed above average returns in the past.  It's an individual decision as to whether or not this success will occur in the future.  However, most analysts agree that real estate investments can play an important role in any long term investment portfolio.

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