Investing in real estate means buying, managing, and selling property consisting of land and/or buildings, which can all be defined as real property. A real estate investor is someone who purchases real property for the purpose of generating income by renting the property or eventually selling it at a profit.
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Home Ownership and Real Estate Investing
Home ownership is sometimes considered a real estate investment. Instead of essentially burning money by paying rent to a landlord, homeowners pay off a mortgage and thereby build equity. In real estate, the term equity refers to the current market value of a property, minus any outstanding debts the owner has against the property, such as a mortgage. Though owning and selling a home can be a profitable investment, homeowners are not considered real estate investors because they buy property primarily for their own shelter, not for income.
Pros and Cons of Real Estate Investing
There are many compelling reasons to get involved in real estate investing, but real estate investing isn’t for everyone. Before investing in real estate, consider the pros, cons, and your own particular situation.
Real Estate Investing Pros
- Monthly income: Rent payments from tenants can provide a dependable and growing stream of income.
- Price appreciation: Property values in the United States have risen, or at least kept pace with inflation, for decades. U.S. real estate prices have never declined nationwide over a period of three years or more.
- Tax benefits and incentives: The U.S. government offers benefits—such as income tax credits and deductions, rent vouchers, and more—to real estate investors.
- Low volatility: Though real estate prices can decline over extended periods of time, they don’t fluctuate on a daily basis like most other investments. The relatively low volatility of real estate prices makes real estate investing less stressful and more secure over time.
- Finite supply: Because the supply of land is limited, real property is a finite commodity, like gold or silver. As the global population continues to grow, real property will likely increase in value as supply struggles to keep pace with demand.
- Personal use: Real estate is among the few investments you can actually use. Though most real estate investors don’t live full-time in the properties they own, many do use their properties on occasion, such as during off seasons or other times when tenants are harder to find.
- Upgradable value: Real estate is the only investment that can be altered or improved to increase value. Additions to a property—such as a deck or a new garage, or upgrades to appliances, carpet, or other key components of the property—often boost the value of the entire property. The value of raw land can be increased by adding utility lines or by clearing forest areas or debris to create a suitable building site.
Real Estate Investing Cons
- Illiquidity: Many investments, such as stocks and bonds, can be liquidated, or sold and converted to cash, almost instantly. Real estate, however, often takes months or even years to sell and convert to cash.
- Long-term commitment: Real estate prices tend to appreciate steadily over long periods of time, usually at least 3–5 years. If you’re looking to invest and turn a quick profit, real estate investing is not the best option.
- Large initial investments: To invest in real estate, you almost always need a significant amount of money to put down up front. In most cases, you’ll need at least tens of thousands of dollars.
- Time commitment: Real estate requires maintenance (repairs and upgrades) and management (dealing with tenants), which can consume your time and energy.
- Tenant-related risks: Real estate investors are also landlords, which means that they typically have to choose and retain good tenants. A good tenant pays rent reliably and in full and does minimal damage to the property. A bad tenant does just the opposite. Though landlords sign leases with tenants to limit their risks, the legal costs involved in bringing a claim against a tenant often outweigh the losses related to the tenant’s broken lease or missed rent payments.
- Vacancy: There’s never a guarantee that someone will want to rent your property, which means that, as a real estate investor, you always have to be able to cover the costs of owning the property, such as utility bills and mortgage payments, even if you have no tenants. The best way to avoid the problem of persistent vacancy is to invest in real estate in areas with a steady supply of renters, such as large cities or college towns.