Ways to invest in Real Estate

There is a common misconception that real estate investing requires property ownership. It’s understandable to presume that the only way to invest in real estate is through direct property ownership. But in truth, there are many real estate investment opportunities that don’t involve property ownership, offering lucrative, steady cash flows and far less maintenance from an investor.

With these options, investors can reap the rewards of rent from the property’s tenants, benefit from the real estate’s appreciation, and take comfort in their portfolio’s diversification into an alternative, but tested asset class — all without the ongoing responsibilities of building maintenance, landlording, and other obligations of property owners.

In this article, we discuss five different ways you can invest in real estate that don’t involve direct property ownership. These methods of real estate investment open up many different options for individual investors, who aren’t ready or willing to commit to a large down payment or secure a large loan for a single property. Investors who choose to invest outside of direct property ownership enjoy the options of investing across multiple locations, property sizes, and classes of real estate.

These methods of investing can serve as a precursor to future property-owning investments, or you may find returns from these investments compelling and avoid the hands-on approach of property-owning investments altogether.

Wholesaling

Wholesaling is the only active form of real estate investing that does not require property ownership. Instead, it requires intent of property ownership. Wholesaling is a form of property-flipping where an investor signs a contract to buy a property that they believe is underpriced and then quickly sells it to another investor at a higher price for a profit. Most often, wholesalers search for homes in need of renovations and sell them to house-flippers who want to renovate the home. However, they may also seek out homes that they believe will sell quickly to regular homebuyers in a particular housing market.

In a wholesale investment, a wholesaler signs a contract to buy a home and produces an earnest-money down payment. They then try to sell the home as quickly as possible to a house-flipper or homebuyer at a premium. In essence, a wholesaler earns a finder’s fee for brokering the sale of a home between the seller and buyer. Unlike a traditional broker, a wholesaler uses their position as a buyer with a contract to purchase the home to broker the deal.

Wholesaling is a very risky investment that requires a great deal of financial, legal, and real estate expertise as well as negotiation skills and a connection to a network of prospective buyers. A wholesaler is directly responsible for securing the purchase price and arranging the timing of the sale. A wholesale deal may be relatively liquid if the wholesaler is able to find a buyer quickly, but it can also be quite illiquid if they’re unable to find a motivated buyer immediately.

Unlike a passive investor, a wholesaler bears a great deal of responsibility in ensuring the success of an investment. If a wholesaler has difficulty finding a buyer quickly, they risk diminishing their return, earning no return, or worse, losing money on the investment.

Private Equity Funds

A private equity fund in an investment model in which investors pool their money together into a fund intended to make investments on behalf of the group. This private arrangement is usually legally operated in the form of a limited liability partnership with a fixed manager or management group in charge of the operation of the fund. The manager or management group controls the daily management of the fund leaving the investors available to work full-time jobs or pursue other options.

Investing in real estate through a private equity fund is a passive form of investment in which investors provide only capital and leave the duties of investment management to their fund manager(s). However, it’s still important for fund investors to carry the financial and real estate knowledge needed to understand the implicit risks and returns of private equity investments, because investment minimums and costs are typically substantial.

Access to private equity funds is generally limited to accredited investors and institutions with large amounts of capital. Investment minimums vary, but are typically at least $100,000. They also usually carry a “two and twenty” fee structure, where the fund charges its members a 2% annual management fee as well as a 20% fee applied to any profits earned by the fund. Private equity funds are also very illiquid and are therefore only viable for investors who can afford to tie up large amounts of money for extended periods of time.

Real Estate Mutual Funds

Similar to the concept of a private equity fund, a mutual fund is an investment model where an investment company pools together its clients’ money for the purpose of investing on their behalf. Mutual fund investors own a share of the mutual fund while the mutual fund itself owns the investments that it makes. Mutual fund investors earn returns from a mutual fund in the form of a dividend and share appreciation, depending on the performance of its investments. Real estate mutual funds typically invest in REITs, real estate stocks or direct purchases of real estate. These options can include residential real estate (e.g. single-family homes, townhomes), commercial real estate (e.g. office buildings, storage units, large apartment buildings), and industrial real estate (e.g. warehouses and factories).

There are many mutual funds available to individual investors. Each offers its own level of real estate diversification, investment minimum, and fee structure. Mutual funds generally offer low barriers to entry and high liquidity, giving ordinary investors access to a professionally-managed fund. As a passive investment, they require only capital and no management from investors.

Unlike a private equity fund — which holds illiquid private investments — mutual funds typically invest in publicly-traded assets. While liquidity is often viewed as a benefit, public markets’ high efficiency and transparency also comes with the drawback of offering fewer opportunities to make outsized returns. It’s no surprise then that mutual funds have gained a performance reputation of “guaranteed mediocrity”.

It’s also important to keep in mind that because mutual fund assets are publicly-traded, the net asset value of its shares can be highly correlated to the fluctuations of the public market rather than tied solely to the inherent value of its underlying assets. As a result, it is one of the most volatile real estate investment options.

When choosing a real estate mutual fund, it is important to understand the composition of the fund’s investment portfolio. Mutual funds are able to invest across industries and asset classes, but U.S. law also requires them to allocate at least 80% of their assets to the investment type implied by their names. However, a mutual fund’s name can be vague and deceptive, and it is incumbent upon the investor to have the financial acumen necessary to understand the mutual fund’s allocation and choose wisely. Moreover, mutual funds can come laden with high-veiled fees and expenses, making them a less cost-effective option.

Opportunity Funds

An Opportunity Fund is a relatively new investment vehicle available through the Opportunity Zone program, which was created in 2017 under the Tax Cuts and Jobs Act. The program was established with the purpose of stimulating private investment in economically distressed areas in exchange for capital gains tax incentives for investors. Under this investment model, investors invest in the development of the Qualified Opportunity Zones through Opportunity Funds. Opportunity Funds are required to invest at least 90% of their capital into Opportunity Funds, and qualified investments within Opportunity Zones are also limited. Only three types of investments qualify for Opportunity Fund investments – one of which is real estate.

In exchange for investing in Opportunity Zones through Opportunity Funds, investors can get access to substantial capital gains tax incentives, which can rival or surpass tax advantages offered under active investments, such as the 1031 Exchange. To capture all of the capital gains incentives offered under Opportunity Funds, investors must invest before 2022 and hold their investment for at least ten years. Specifically, Opportunity Fund investors can receive the following capital gains tax incentives:

• Capital gains tax deferment: As long as an investor invests in an Opportunity Fund within 180 days of realizing a capital gain, they can defer any capital gains tax payments for those earnings until December 31, 2026 or when they sell or exchange their Opportunity Fund – whichever happens first. This provision allows investors to hold onto their cash for longer, which enables them to earn greater returns than they would have been able to if they had paid their capital gains taxes when a gain was realized.
• Capital gains tax reduction: Investors who hold an Opportunity Fund investment for at least five years prior to December 31, 2026 can expect a 10% reduction on their capital gains tax bill for the deferred principal invested. If the investment is held for at least seven years prior to December 31, 2026, investors can expect to reduce their capital gains tax bill for the deferred principal invested by 15% total.
• Capital gains tax elimination: If an investment is held for at least ten years, investors can expect to pay no capital gains on any appreciation earned from the investment thanks to the permanent exclusion from capital gains taxation offered under the Opportunity Zone program. There is also no limit on how long an Opportunity investment can be held, which means that an investor can realize capital gains without a capital gains tax liability ten years, twenty years or even later.

Because tax incentives for Opportunity Funds are maximized at the ten-year mark, it is naturally a long-term investment. That aspect limits availability to those who can afford not to touch their investment for at least a decade. Investment minimums and liquidity may also vary by provider, which can limit investor access even further.

REITs

A real estate investment trust (REIT) is a company that makes debt and/or equity investments in commercial real estate. REITs were introduced in 1960 for the purpose of giving individual investors access to invest in real estate as an asset, without the need of direct property ownership. Like a mutual fund, REIT investors own shares of the REIT, and the REIT owns the investments that it makes. Investors earn returns in the form of a dividend depending on the performance of the REIT’s debt and equity investments. REITs are passive investments that require only capital from their investors.

By law, a REIT is required to invest at least 75% of its assets in real estate and earn at least 75% of its gross income from real estate investments. It must also distribute at least 90% of its taxable income to shareholders. If a REIT meets these qualifications, earnings are not taxed at a company level. Instead, REIT investors only pay income tax for dividend earnings.

Today, REITs can be broken down into three categories based on investor access: private REITs, publicly-traded REITs and public non-traded REITs.

Private REITs are not publicly traded on a stock exchange and are unregistered with the SEC. Although their legal structure is different from private equity funds, they share many similarities. Access to private REITs is generally limited to high net worth accredited investors. Investment minimums are at the discretion of the REIT managers, but they are usually substantial. They can also carry high fees — as much as 15%. And like private equity funds, private REIT investments are typically illiquid, limiting their access to wealthy investors by necessity.

Publicly-traded REITs are traded on the stock exchange and registered with the SEC. They are the REIT category that most individual investors are familiar with. Like mutual funds, publicly-traded REITs offer high liquidity — but unlike mutual funds, they carry no minimum investment requirement. This method of real estate investing offers the lowest barrier to entry of all real estate investment options, but, as a publicly-traded investment, publicly-traded REITs are also subject to the greatest volatility due to their correlation with the public markets.

A public non-traded REIT can be viewed as a blend of a private REIT and a publicly-traded REIT. Non-traded REITs are not traded on a stock exchange, but they are registered with the SEC. Access to a non-traded REIT is at the discretion of the REIT’s manager(s). Non-traded REITs can offer wide access to investors with low or no minimum investment, or access might be restricted to wealthy investors with high investment minimums.

In general, non-traded REITs are illiquid investments, and have a reputation for carrying high fees, although this is not always the case.

Online Investment Platforms

Online real estate investment platforms pool investments from many investors and invest on their behalf in opportunities that would otherwise be difficult or overly expensive to find or access. Real estate investment platforms range widely in investment offerings, property types, investment minimums, and investor access offered. Online real estate investment platforms either focus on a single property type or a combination of residential and commercial real estate. They also provide investors access to invest in single properties or in a diversified portfolio of real estate.

Generally, investments made through a real estate investment platform offer little to no liquidation for the duration of the investment’s horizon. Investors should try to match their own horizons as much as possible. Many real estate investment platforms carry restrictions, including high investment minimums and accreditation requirements.

In contrast, Fundrise pools investments to leverage all investors’ collective buying power to invest in real estate opportunities that would otherwise be inaccessible to the majority. Fundrise offers both accredited and unaccredited investors the ability to invest in a diversified portfolio of private either residential real estate across the US. Fundrise offers access to invest for a $500 investment minimum and also offers investors greater liquidity than other real estate platform investment options with monthly redemptions.

Which Option is Right for You?

If your interests don’t lie in buying a rental property and becoming a landlord or a professional real estate investor, there are many other ways to add real estate to your portfolio. When chosen and managed wisely, the real estate investment options we’ve outlined here can offer potentially significant returns and valuable asset class diversification — without the hassle of tenant troubles, evictions, foreclosures, mortgages, and more. However you choose to invest, it is important to assess the time commitments of each option, gauge the money and attention you have available to devote to an investment, and determine which option best fits your personal preferences and financial goals.

Source: Fundrise