There’s more than one way to crack an egg… and to invest in real estate. Is one of them right for you?
Investing in real estate always seems to be a hot topic in the financial world. Who hasn’t dreamed of buying a fixer-upper, fixing it up, and selling it for a huge profit? However, that’s just one approach to real estate investing, and none of them are as simple as they sound. With that said, investing in real estate can potentially be a valuable part of your broader retirement income strategy. In this blog, I’ll cover the riskiest real estate strategies; less risky options and their challenges; options that make the most sense for investors in or nearing retirement; and today’s real estate market.
Generally speaking, real estate investing is considered a high-risk, high-reward strategy. That’s why it’s most popular among wealthy investors who can afford to take big risks. You see those types of investors on any number of reality shows focused on real-estate trading, more commonly known as ‘flipping’. Here, you invest in a property, typically a house, make improvements, then quickly resell it at a higher price. The word ‘quickly’ highlights one of three major risks involved in flipping: One, the longer you own the house, the less money you make because you’ll be on the hook for its taxes, mortgage, and upkeep. Two, flipping requires making a very accurate estimate of the renovation costs, which isn’t easy. Finally, number three: you need interest rates and the housing market overall to keep moving in your favor.
A more income-oriented and popular approach is to invest in rental properties. Two of the most common approaches are to buy a residential or commercial property and rent out the rooms or offices. You can also do what’s called house-hacking, where you buy a big house, live in one section of it, and rent out the other sections to tenants. Just remember, when you purchase rental property directly, whether commercial or residential, you are, by definition, investing in equity. As with flipping, you need to count on economic trends going in your favor to make the investment pay off, among many other risks. However, there are other options.
One is to invest in a vacation rental, which is different than a long-term rental property in several ways, some good and some bad. On the good side, you may be able to use the home when it isn’t occupied, and it can be much easier to finance a vacation rental. On the bad side, marketing & managing a vacation rental is more involved and way more expensive.
Another option I should mention is crowdfunding. Here, an experienced real estate developer identifies an investment opportunity. Typically, it’s one commercial real estate asset and a value-adding modification. There’s usually a target date when the developer plans to sell or refinance the property. But instead of funding the entire project with their own money and bank financing, they raise some of the capital from investors like you in exchange for an equity interest in the project. This can be a less expensive way to invest in equity real estate, but because of the value-added component, it carries the same risks associated with flipping.
Now, let’s talk about some strategies that can work especially well for investors in or nearing retirement that are seeking minimum risk and reliable income. As you may have guessed, the main strategy I’m talking about are real estate investment trusts, or REITs. A REIT is a company that owns, and in most cases operates, income-producing real estate. REITs operate a bit like mutual funds, although there are plenty of differences. The most important one is that while mutual funds are strictly a growth-based investment strategy, REITs can be an effective income strategy if you have the right risk tolerance. REITs are highly-varied, complex, and carry more risk than the most conservative income strategies for several reasons.
On the plus side, REITs take some of the risk out of real estate investing by helping you diversify and invest smaller amounts of money. Typically, you can’t do either with direct real estate investing, which involves committing a very large sum to a single piece of property. REITs also tend to pay high dividends, which is what makes them a good option for certain investors in or nearing retirement. Also, the right REITs peppered throughout an actively-managed income portfolio can actually help reduce your overall risk in certain market conditions. Even better, if you don’t need the REIT income, you can reinvest your dividends to grow your portfolio organically, which carries less risk than investing directly for growth. All the positive aspects of REITs highlight perhaps the most important thing to remember about them: determining whether REITs are right for you, and maximizing their value to your broader income strategy, are both best done with the help and guidance of an Income Specialist.
With all this in mind, is now a good to invest in real estate? Well, the ultra-low interest rate environment we’ve been in since the pandemic has generally been great for real estate, as you probably know. If rates remain low and the economy keeps moving in the right direction, as many expect it will, real estate could have another strong year in 2022, and possibly beyond.
Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm. Arbor Financial Services of Florida, Inc. and Sound Income Strategies, LLC are not associated entities. Arbor Financial Services of Florida, Inc. is a franchisee of the Retirement Income Store. The Retirement Income Store and Sound Income Strategies LLC are associated entities.