Once you’ve decided that you’re ready to invest in rental real estate and taken the quiz to see if your personal finances and real estate knowledge are solid, you need to decide what kind of investor you’ll be.
Know Your Investor Personality
When it comes to managing your real estate investments, would you prefer to be heavily involved in the day to day or a passive investor that puts their trust in someone else to manage things?
If you want to be a “hands-off” real estate investor, then you’ll have little to no involvement in the selection and management of investment properties themselves, and instead will be putting your money and trust in a team of real estate professionals to make those decisions for you.
Alternatively, if you have the time, knowledge and interest in the real estate world, you may choose to be a “hands-on” investor. That means you’ll be actively researching, selecting, and managing individual investment properties, although you may choose to hire a property manager to handle the day-to-day work associated with any of your investment properties.
Active Real Estate Investing Options for Hands-On Investors
Single Family Home: A single-family home is a standalone house meant for one family.
Pros
- Families can be long term tenants
- Most potential for appreciation
- Easiest to sell
Cons
- Maintenance is more expensive
- Lots of capital is required to develop a diversified portfolio
Condominium/Townhouse/Co-op Unit: Single unit condos and townhouses have similar investment characteristics as single-family homes. Co-op units are similar, but may have additional community regulations for owners and tenants.
Pros
- Generally less expensive
- More urban opportunities
- Condo association pays maintenance
Cons
- Condo or co-op association fees and assessments
- Co-op board must approve tenants (but not condo boards
Fix and Flip: A fix and flip involves buying a house that needs updating, making renovations and then selling quickly (hopefully for a profit).
Pros
- Potential for a quick profit
- Flipping looks so fun on HGTV
- Get paid for sweat equity
Cons
- Unanticipated renovation costs
- It could take longer to renovate or sell
- Carrying costs if the home doesn’t sell
Multi-Family (2-4 units): Multi-Family Housing contains independent dwellings from more than one family. This could be a duplex (2 units), a threeplex (3 units), a fourplex (4 units) or an apartment building (5 more units).
Pros
- Multiple monthly rents
- You can be an owner-occupant and investor
- Owner-occupied 2-4-unit buildings can be financed with lower down payment loans
Cons
- Increased landlord responsibilities
- Maintenance more expensive
- Apartment buildings (5+ units) are financed by an apartment loan
Manufactured/Mobile/Tiny Homes: A manufactured home is ready once it leaves the factory. A mobile home is a standard sized trailer which is placed in one location.
Pros
- Inexpensive
- Lower maintenance
- Easier to purchase multiple units
Cons
- Lower rent
- Hard to finance
- Higher tenant risk
Commercial buildings: Commercial buildings house businesses such as offices, retail stores, restaurants, etc.
Pros
- Comes in many sizes and purposes (office complex, shopping center, medical building, industrial, warehouse, etc.)
- Multiple monthly rents and flexible lease terms (e.g., tenants pay maintenance)
- Objective standards for valuation
- Tenants have strong incentives to maintain the property
Cons
- Increased landlord responsibilities
- Requires professional help to maintain property
- Specialized commercial loans which may require a personal guarantee (recourse)
- Large down payment
Passive Real Estate Investing Options for Hands-off Investors
Real Estate Investment Trusts (Publicly traded REITs)
Pros
- Funds must pay out at least 90 percent of income in dividends
- Publicly traded – easy to buy and sell during market hours
- Own real estate without the headaches of managing it
Cons
- Need to invest in many REITs to have a diversified REIT
- Stock market risk
- Requires faith in management to pick the right properties
- Rising interest rates affect profitability
Mutual funds and exchange traded funds (ETFs)
Pros
- Actively managed or passive index funds available
- Diversification across real estate sectors
- Publicly traded – easy to buy and sell during market hours
- Own real estate without the headaches of managing it
Cons
- Mutual fund trading can pass unexpected capital gains to shareholders
- Stock market risk
- Requires faith in portfolio manager if buying actively managed
- Management fees
Crowdfunding Sites: Crowdfunding sites match real estate investors looking for funding for their real estate project with investors looking to invest.
Pros
- Invest in real estate loans
- Crowdfunding site does the underwriting
- Easier to build a loan portfolio
Cons
- Poor investor protections/higher potential for fraud
- Hidden fees
- Loan risk and bankruptcy risk
Private Placements – REITS and Real Estate Limited partnerships: Higher net worth (“accredited”) real estate investors have access to private real estate funds through private placement.
Pros
- Potentially higher dividends or net income
- Diversified portfolio of properties or loans
- Funds which specialize (e.g., hospital properties, manufacturing, apartments, etc.)
Cons
- Only available to higher net worth investors
- High fees
- Illiquid
Know Your Exit Strategy Before You Invest
When investing in real estate, you must begin with the end in mind — before you even make an offer or purchase a fund, you need a plan for if and when you will dispose of your investment. Decide ahead of time under what circumstances you will sell — after a certain number of years? Once the property has appreciated a certain amount? When you need the capital for something else? It’s important to establish this up front so that you aren’t at risk for emotional selling. No matter what type of investor you are, or what type of property you would like to buy, if a short-term loss of value is something that would cause you to “cut your losses” and liquidate, you may not yet be ready to invest in real estate.