Real estate can be a good investment. In fact, it’s minted more than its fair share of millionaires and billionaires, but that doesn’t mean that every real estate investment is worth pursuing.
As with much in life, the devil’s in the details, and if you’re buying rental properties yourself, your success will depend on the price, loan terms, local demand, repair costs, and the time needed to manage the property.
But that’s not the only avenue that individual investors have to add exposure to real estate. There are other avenues that are far easier and less expensive than owning a building.
3 Real Estate Investments to Consider
1. Publicly Traded REITs
A real estate investment trust, or REIT, owns, operates or finances income-producing real estate. Publicly traded REITs allow investors to add real estate exposure to a portfolio without purchasing or managing an individual property.
Depending on the REIT, its holdings may include apartments, warehouses, offices, shopping centers, hotels, healthcare facilities, data centers or mortgages.
Investors can buy shares of publicly traded REITs through a brokerage account. This makes it possible to invest in real estate without becoming a landlord.
REITs can offer steady income and broad exposure to many properties. However, their value can rise or fall with interest rates, the economy, and demand for certain types of buildings.
2. An Owner-Occupied Multifamily Home
Buying a two- to four-unit property, living in one unit and renting the others is sometimes called “house hacking.” Rental income from the additional units can help offset the mortgage and other ownership expenses.
This can potentially lower costs while providing firsthand experience with property management.
It can be a smart way to lower housing expenses and begin investing. Still, owners must deal with repairs, vacancies, and tenant concerns. They must also be comfortable living close to their renters.
3. A Long-Term Rental Property
A conventional long-term rental can produce income and potential appreciation, but only when it is purchased at a price that supports realistic cash flow.
Before buying, investors should estimate all recurring and irregular expenses, including:
- Mortgage principal and interest
- Property taxes and insurance
- Repairs and routine maintenance
- Property-management fees
- Vacancy and unpaid rent
- Utilities paid by the owner
- Association fees
- Major capital expenses, such as a roof or HVAC replacement
Investors should also study local employment, population trends, rental supply, neighborhood conditions and tenant demand. And don’t rely on eventual price appreciation to justify incurring a monthly loss.
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3 Real Estate Investments to Avoid
1. Timeshares
A timeshare can be a viable way to get regular access to a particular vacation destination, but it should generally be treated as a lifestyle purchase rather than a conventional real estate investment.
Owners may face annual maintenance charges, assessments, booking restrictions and exchange fees. Those expenses can increase over time, even when the owner uses the property less frequently than expected.
Selling can also be difficult. A timeshare’s resale value may be substantially lower than its original purchase price, and owners looking for an exit are frequently targeted by companies demanding upfront fees or making questionable promises about ready buyers.
Investment opportunity aside, if you’re considering a timeshare, you may be better served by comparing the total cost of a timeshare with the cost and flexibility of renting hotels or vacation properties as needed.
2. A Vacation Home That Depends on Rental Income
A vacation home can be enjoyable, but it may be risky when the owner needs rental income to afford it.
In addition to the mortgage, buyers must account for taxes, insurance, maintenance, furnishings, utilities, association fees and travel costs. Properties in vacation destinations may require frequent cleaning, guest support and professional management. Income can fluctuate sharply between peak and off-peak seasons.
Buyers should be able to afford the home even when it is empty. If the deal only works when the property is rented almost all the time, the risk may be too high.
3. A Highly Leveraged Short-Term Rental
Short-term rentals are often marketed using attractive nightly rates, but gross booking revenue is not the same as profit.
These properties can carry unusually high operating costs, including:
- Furnishings and frequent replacements
- Cleaning and booking-platform fees
- Utilities and internet service
- Guest communication and property management
- Higher insurance costs
- Permits, licensing and local taxes
- Repairs caused by frequent turnover
- Seasonal vacancies and fluctuating demand
Local governments and homeowners associations may also restrict or prohibit short-term rentals. A property that depends on nightly bookings can lose much of its expected value as an investment if regulations change or the association adopts new rules.
Leverage adds to the risk. An investor with a large mortgage must continue making payments even when bookings decline, competition increases or an unexpected repair takes the property out of service.
As you can see, what’s “best” for one investor may be a non-starter for another; someone who’s comfortable living next to their tenants and who does a lot of DIY work might find “house hacking” far more appealing than an investor who’s primarily concerned with portfolio diversification (and who might find REITs more attractive).
That said, real estate investing is a viable strategy for building longer-term wealth. Just make sure your return expectations are grounded and that you do your due diligence.
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*This post has been updated from a previously published version.
