With careful research and planning, investing in real estate can be a solid source of income, as well as a good way to diversify your assets. Whether you’re buying a rental property or putting up your spare room on Airbnb, real estate offers many options for you to earn extra income. However, there is a lot to learn before investing in real estate, including tenant laws in your area, tax implications, loans, mortgages, interest rates, and much more.
What Does it Mean to Invest in Real Estate?
Real estate investments are purchased properties that you generally do not reside on. To obtain a decent return on your investment, you’ll likely have either of the following goals when purchasing real estate:
- Renovating and selling the home for a higher price (also known as “flipping”)
- Renting out the property so that tenants can contribute to the mortgage payments
- Keeping the property and letting it appreciate in value over time.
The most common goal with real estate investment is to obtain enough rental income to offset the costs of mortgage, interest, taxes, utilities, and repairs.
Check out the hidden costs of buying a house.
Advantages of Investing in Real Estate
There are many reasons why purchasing real estate has become a popular choice for consumers looking to get into investing or diversify their investment portfolios. investment.
Like any business, investing in real estate comes with many costs that you will be able to deduct from your income, and thus receive a higher tax return. You can deduct the following real estate expenses off of your income:
- Property Tax
- Mortgage and Interest
- Repairs and maintenance
- Property Depreciation
Having Tenants Pay Your Debt and Build Your Equity
With monthly income from tenants’ rental payments, you essentially have a property that’s paying off its own mortgage. This also allows you to build your equity without having to set aside thousands of dollars every month to pay a mortgage.
Real estate investments offer buyers leverage. If you’ve secured reliable, monthly rental income for your investment property, the money going toward your mortgage can be leveraged without you having paid much of the total value of the property. Many real estate investors use this leverage to borrow against a property or take out a second mortgage, in order to secure a down payment for a second investment property. Then, you can have multiple properties with mortgages paying themselves off. This builds your equity despite the fact that you only paid a small portion of the total value of the property.
Check out how to get landlord mortgage.
Have you ever heard the phrase advising you to “diversify your assets?” This is an important piece of financial advice as it protects you in the event that one of your investments is unsuccessful. If your investments are different, or diversified, you have a better chance of financially surviving a recession, or stock crash because you didn’t put all of your investments into one area. So, adding real estate for example, to a portfolio of stocks, savings, bonds, or businesses can protect you financially via diversification.
Disadvantages of Investing in Real Estate
Like every type of investment, there are downsides and risks involved along with the benefits. Here are a few disadvantages of investing in real estate:
Larger Down Payment
Lenders might want to see a larger down payment for a real estate investment. This is especially true for commercial real estate, for which lenders often require a whopping 40% down payment. If you have a partner or friend that you trust, it’s worth considering investing in property together, as it makes it easier to come up with the down payment.
New to investing? Try using robo-advisors.
Capital Gains Tax
When you purchase a property with the intention of living in it, you can sell the property (even if it appreciates in value) and keep all of the profit. For example, if you purchase a home that you make your primary residence for $500,000 and resell it a few years later for $600,000, you earn a clean $100,000 in profit and do not need to declare it as income on your taxes.
Specifically, you won’t need to pay capital gains tax. Capital gains refer to the profit you make in selling an investment property. 50% of any capital gains are taxable and need to be added to your income come tax season. Depending on your income, adding capital gains can significantly increase the amount of taxes you pay.
Since housing is a top priority when citizens vote, governments are more likely to interfere with the laws and regulations surrounding investment real estate property. For example, the government can increase the tax on capital gains, increase interest, or introduce other tools to regulate the market, all of which can affect your income from your real estate property.
Increased Interest Rates
Interest rates tend to be higher for mortgages on investment properties, thus creating higher costs for landlords every month. Make sure you shop around and compare rates from different lenders to secure a reasonable interest rate.
Vacancy Rates – Rent Falling
Another risk of investing in real estate is vacancy. In between tenants, or during the period you are seeking out a tenant, you will have to carry the cost of your mortgage without the assistance of rental income. This will happen every so often, as tenants come and go. It’s good to prepare for some rent-free months so that you’re not financially strained when you have to pay the mortgage out of pocket.
Ways to Invest in Real Estate
Real estate is a diverse type of investment, and there are many avenues to take when investing:
The most common way to invest in real estate is to buy a property that you intend to rent out. You can either rent out the entire property or live in a portion of it and rent out the rest. The trick is to find a property with monthly expenses that can be covered by the monthly rent that you’ll charge. With rental properties, you need to be mindful of the time you’ll need to deal with your tenants, manage repairs and maintenance, or even to hire a property manager.
Check out why you should invest in landlord insurance.
Investing in real estate that requires renovation can often result in a lower purchase price. Some investors like to purchase properties that require a lot of work in order to renovate the property and resell it at a higher value. You’ll want to ensure the profit you make from reselling the property is much greater than the costs you incur from renovating the property. One important consideration of flipping properties is that you won’t have rental income helping you pay off the mortgage. So, you’ll be faced with both renovation costs and mortgage costs.
Another approach to flipping a property is to avoid renovations altogether. In soaring housing markets like Toronto’s, for example, housing prices keep going up. Some investors might buy a piece of real estate and hold onto it for a while before reselling at a higher value in future, matching the rising market prices.
Rent out Your Space – Airbnb
If you don’t feel ready to jump into buying an investment property, you could invest in a smaller way by renting out part of your primary residence. Roommate agreements are more flexible. You don’t have to commit to living with a roommate for the same amount of time as you would with a landlord-tenant agreement. Furthermore, short-term rental platforms like Airbnb are a smaller time commitment, and they also offer protection in the event of damages.
Invest in REITs
REITs, or Real Estate Investment Trusts, are companies that own commercial real estate. Some examples of commercial real estate include hotels, office buildings, and large apartments. Paying high dividends, REITS are a common retirement investment. Furthermore, you have the option of having your dividends automatically reinvested. Publicly traded REITs are recommended for new investors and are available for purchase through creating an account with a brokerage firm.
Real estate investments require a lot of time, planning, and capital upfront. However, with so many investment options, real estate is a great way to secure a second source of income and to build equity.