The stock market's low return on investment has many individuals evaluating alternatives such as real estate. There are at least three ways investors can get into this 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 a Home
Anyone lucky enough to have a mortgage or own a home is already investing in real estate. Some might not consider a home an investment; but for many individuals, their home may be the largest investment they will ever make in their lives.
Buying a home is a fairly common event. In fact, it is such a commonplace occurrence that it's considered a very safe transaction. However, taking a closer look at this agreement, the purchase of a home using a mortgage is actually taking a highly leveraged position in real estate.
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 the homeowner experiences.
Let's take a look at a quick example to see how that happens.
Return on Investment 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 home rose by almost 11 percent in 2004, up from 7 percent in 2002 and 2003. That means the home purchased in 2002 was 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 real estate? With a flat stock market over those same three years, that 333% return on investment has many people looking for 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 getting started in the real estate market through the acquisition of properties. Anyone thinking this form of investment is akin to a hobby needs to think again. Owning investment property can be a full time job.
Given the fact being a landlord is a big commitment, the below list describes some of the ways it's possible to purchase real estate properties for investment purposes:
No doubt it's difficult to own real estate properties on a part time basis. It involves a lot of homework, speaking to county clerks, and attending sheriff sales. Most of these activities need to take place during normal work hours on weekdays, not weekends.
Real Estate Mutual Funds and Investment Trusts
The third, and final, way to get started in the real estate market is through 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.
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 provide oversight into the purchase of investment properties. A REIT offers the investor advantages that include:
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: Real Estate Investment.
Real Estate Mutual Funds
Another way the average investor can participate in the real estate market, and rely on professional management services, is through the purchase of specialized mutual funds. These funds typically invest in real estate investment trusts as well as real estate companies. The latter category would include large builders or owners / operators of properties such as Hovnanian Enterprises and Toll Brothers.
Like all forms of mutual funds, they 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 entitled Real Estate Mutual Funds provides some additional guidance in addition to a list of the top performing funds. This brings us to our 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 should play an important role in any long term investment portfolio.
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