Real estate is an area that tends to get a lot of focus when it comes to investing and with good reason. For many people, real estate offers a tangible investment product. In this post, we will look at the benefits of real estate, along with the ways you can add it to your investment portfolio.
What is Real Estate?
Our good friends at Investopedia define real estate as “property made up of land and the buildings on it, as well as the natural resources of the land including uncultivated flora and fauna, farmed crops and livestock, water and any additional mineral deposits”. While this is as comprehensive a definition as you could hope for, for this blog it is a little much.
At its most basic, real estate is comprised of land and property. As an investor, we are looking for the land and property to provide us with a return on our capital. This can be achieved in two ways; by the appreciation of the land and/or property and by the income gained by renting out the land and property. Real estate represents a separate asset class and is seen as a way to diversify your investment portfolio. You should not view your home as a real estate investment. Most countries class personal property differently to an investment property and you should not confuse the two.
Types of Real Estate
There are three basic types of real estate, each of which can provide a return on investment if you do your research. They are;
- Residential: People typically associate real estate with residential property. They are usually houses or apartments. Residential property is usually one of the most accessible ways to invest in real estate.
- Commercial: Commercial property is usually comprised of office buildings, shops and warehouses.
- Industrial: Industrial properties are usually factories, farms or business parks. Due to their size and nature, they are usually among the more expensive real estate investments.
Home Ownership Vs. Real Estate Investing
As mentioned in the definition paragraph, for this post we are going to separate homeownership from real estate investment. As you can imagine, both have a lot in common, but there are a few key differences.
- Expected Return: Investing as a whole is concerned with returns, or how much money your investment will make you. Homeownership is not primarily focused on returns. You should buy a house because it suits your families needs, not because it may make you money. Of course, it is positive if your home appreciates, but this is not the main area of focus.
- Financing: In a future post I plan to cover mortgages in detail but for now a short explanation will do. Mortgages are based on the underlying asset and banks view investment properties and principal residencies as different assets. As such, the mortgages will carry different terms and have different requirements. It is important to apply for the correct mortgage based on your needs.
- Upkeep: As a homeowner, the upkeep of the property is your responsibility. This means you are responsible for any repairs that are needed, but as you are the homeowner you can choose to ignore them. As a property investor, your primary source of income will be from renting out the property you own. Depending on your contract with the tenant, you may be responsible for the maintenance of the property. If this is the case, you cannot choose to ignore the upkeep or you run the risk of losing your income stream.
- Selling the Property: If you are a homeowner, you can sell your property whenever you choose. In Ireland, the sale of a principal private residence is tax-free (providing the home was not used for business etc.). You will not be taxed on the increase in the value of your home. When selling an investment property, you will have to pay tax (capital gains tax in Ireland) on the profits made. You will also have to consider the tenant. Different countries have different rules regarding tenant rights so make sure you are aware of these before trying to sell your rental property.
How to Invest in Real Estate
There are two primary ways to invest in real estate. Through the purchase of a property (for rental income or for reselling), or through a purchase of a fund, either a REIT (Real Estate Investment Trust) or an MBS (Mortgage Backed Security) fund. Both REIT and MBS funds trade like stocks and can be bought and sold on the open market. They are very similar to stocks, but instead of tracking a companies progress, they track the performance of a basket of properties. This section deserves a blog post of its own, which I will link to once complete.
- Property Purchase: Unless you are a cash buyer, property investment is usually funded by a bank. You will need to have a deposit (the percentage depends on the lender), but in Ireland, the deposit amount is typically 20% for a buy-to-let mortgage. Essentially this makes the purchase a leveraged one, you only need to pay a fraction of the purchase price.
- Fund Purchase: Buying into a fund is usually more accessible to the average investor. Rather than paying a percentage of the cost of a house or commercial property, you can buy a share in a fund that invests in these for you. With a fund, you don’t have any control over the properties the funds decides to invest in, but you should be able to fund a fund that focuses on whichever area of real estate you are interested in.
In future posts, I will outline the mechanics of investing in a property or a fund, but for now the above should provide an overview.
Why Should You Invest in Real Estate?
Like bonds, real estate is an asset class that offers steady income and diversification. Real estate tends to be correlated with the stock market even less than bonds, so the diversification benefits may even be greater. Real estate is also a popular source of income in retirement, with the added benefit (or a drawback depending on your view) of keeping you busy. There will be tenants to manage and a property to keep functional. Alternatively, if you invest in a real estate fund, you can take a hands-off approach and let the returns take care of themselves.
Like any asset class, real estate investing demands time and money. Be sure to do your research before investing in real estate.
The Stoic Trader