Summary: There are so many different options for investing in real estate that for a new investor, it can be pretty confusing. There are Real Estate Investment Trusts (REITs), real estate syndications, flipping and much more! So the natural question is, how do you choose? Why would you choose one option over another? In this two part series, we’ll cover the different criteria you can use to choose the investment strategy that’s best for you, and then we’ll apply these criteria to the spectrum of real estate investing options. Let’s dive into Part 1!
Are you looking to invest in real estate?
If you’re just venturing into the real estate space, it’s probably pretty confusing. There are so many different options for investing in real estate and even more companies out there vying for your attention.
For example, there’s been a lot of buzz around real estate syndications. How about short-term rentals? You might have heard about the post-COVID short-term rental boom. You also probably know something about investing in rental properties based on the fact that we have all rented something at some point in our lives.
Chances are, you’ve heard about the positives and negatives of each type of real estate investing.
So if you’re new to all of this, how do you choose?
In Part 1 of this two article series, we’re going to cover criteria to help you choose a real estate strategy that is best for you. In Part 2, we’ll go over the spectrum of real estate investing options and how the criteria plays out for each option.
Which investing strategy is right for you?
Let’s start out by defining some criteria you should consider when choosing an investing strategy.
Criteria #1: Return on investment
Just as there is a wide range of real estate investing strategies, there’s also a wide range of return.
Some forms of investing yield returns that are no better than what you can get from investing in the stock market, in the 5-8% range.
On the other end of the spectrum, you can achieve 200+% returns.
You might wonder, why would anyone choose 5-8% return when you can get over 200%?
This is where the other criteria come into play. The higher return real estate investing strategies require considerably more involvement. It typically requires you to acquire a considerable amount of knowledge and experience.
The lower return strategies generally require very little effort. More on this below.
Criteria #2: Risk
Investing and risk go hand and hand.
No investment is guaranteed. There’s always some element of risk.
Oftentimes, there is a direct relationship between risk and reward (return). The higher the reward, the greater the risk.
However, with real estate, the correlation may not be as strong. Some of the highest return investment vehicles can be the lowest risk investments.
A big component of risk is mitigated with greater levels of information about a deal. With real estate, there is such a thing as “insider information,” which would be illegal in the securities world. In other words, you can get access to the best deals through relationships. For example, we acquired a $3 million property that was worth $4 million when we bought it. This was an exclusive off-market deal that only we had access to through our relationship with the agent who brought it to us.
Risk can also be mitigated with high levels of knowledge, skill and experience. If you know what you’re doing and you become really good at it, you gain a competitive advantage over others. This enables you to acquire property after property that yield high returns.
Criteria #3: Level of involvement
As mentioned above, some forms of real estate investing require more of your involvement than the others.
Some call this the “hassle factor” of investing.
The most involved is owning and managing your own rental properties. Some call this “active” investing. However, we’re purposefully avoiding the term “active” because owning your own rental properties can be very passive if you choose to operate them that way.
On the other end of the spectrum, investing in a Real Estate Investment Trust (REIT) requires very little involvement. You simply move money into an investment account and someone does the rest. This is often referred to as “passive” investing.
Criteria #4: Tax benefits
Some forms of real estate investing give you access to tremendous tax benefits. Others give you little to no tax benefits.
The best tax benefits are associated with more active forms of investing, for example owning rental properties. When you own your own rental properties, you can create ways to shelter your salary.
For long-term rentals, you can use real estate professional status to shelter your income. With short-term rentals, you can use the short-term rental tax loophole.
The more passive forms of investing don’t benefit you at all from a tax perspective. For example, when you invest in REITs, the majority of the dividends you receive are taxed as ordinary income.
Criteria #5: Control
When it comes to money, some people want more control over how their money is invested.
Others are comfortable having someone else manage their money. In fact, some even have the mindset, “leave investing to the professionals.”
Real estate investing gives you a range of options in terms of control.
On one end of the spectrum, all of the investment decisions are made by someone else. Your financial destiny for a particular investment is fully in their hands. REITS and real estate syndications are examples of investments where you have little or no control.
On the other end of the spectrum are rental properties. You have full control over major decisions like, when to sell, when to pull money out of a property (e.g., cash-out refinance or HELOC), when to make property improvements to force appreciation. As mentioned above, you can choose to make the investment more passive by hiring property managers.
Criteria #6: Liquidity
One of the most important aspects of investing is how easy it is to access your money.
Some passive forms of investing are essentially illiquid. Once you put your money in, you generally can’t get it out. And depending on the investment, it might be five or more years before you can get your money out.
Other investments are more liquid. For example, certain REITs are fairly liquid. In some cases, it might take a few weeks to withdraw your money after you submit the request.
Then there are investments like rental properties that fall somewhere in between illiquid and liquid. With rental properties, you can choose to sell the property if you need the money. Selling a property isn’t as easy as going to the ATM, but you generally can sell a property within a couple of months if you really need the money. You may also have the option of borrowing against the equity you have in the property using a cash-out refi or HELOC.
Choosing an investment strategy based on criteria
Now that we’ve outlined the criteria, here are some ways to use the criteria to choose the best investment strategy for you.
Example #1: Let’s say that all that matters to you is the return you make from your investment. So imagine using that lens and ignoring all of the other criteria. It simplifies things considerably. All you have to do is compare the return you can get from each investing strategy. So what type of person would prioritize return on investment over all other criteria? If your goal is to secure your freedom (both time and money), as quickly as possible (we call this Fast FIRE), it makes sense to prioritize the return on investment. Something like “hassle factor” doesn’t even register as something you want to avoid.
Example #2: Someone else might prioritize level of involvement. They have a busy career and just can’t take the time to learn the skills to acquire properties themselves. They are willing to forgo return on investment and control. They’re counting on the people who are investing their money for them to do a good job.
Example #3: We know others who prioritize the tax benefits. They are sick of paying high taxes and want to do something to reduce their tax burden. So they don’t mind the higher levels of involvement required to receive these tax benefits.
Download Your First $100k Year – Real Estate Blueprint Guide
The different real estate investing strategies
In part 2, we’re going to cover the spectrum of real estate investing strategies. As we go through each strategy, we’ll show you how each strategy ranks in terms of the criteria.
What you’ll find is that there isn’t a perfect real estate investing strategy out there. One might rank high on return on investment and tax benefits but comes with higher levels of involvement and risk. Others are less risky but have low return on investment and zero tax benefits.
Stay tuned for Part 2 to see how it all pans out!
