Investing in real estate can be a great way to diversify your investment portfolio, whether you’re just starting out as an investor or maximizing your assets during retirement. Unlike other common investments, real estate does not typically correlate to the stock market, which means that the performance of real estate as an investment does not always rise and fall along with the stock market. So, having some real estate in your portfolio can reduce your overall risk by reducing correlation.
Is Being a Landlord Right for You?
However, buying rental property and becoming a landlord isn’t for everyone. First, it takes knowledge and experience of the real estate market to choose a property that has the potential to generate a good return on your investment. If you buy an asset that’s in good condition, you’ll pay top dollar, and you may not end up making much money. On the other hand, with a fixer-upper you can spend a lot of your time, energy, and money getting it up to speed.
Once your property is ready to rent, you’ll need to find reliable, responsible tenants. That requires more time and money, since you’ll need to take photos, run advertisements, show the property, and run credit and background checks on prospective tenants.
Even after you have rented the units, there are maintenance and repair costs to consider. Keep in mind that as the landlord, you will be the person who gets the phone call about a plumbing problem on Thanksgiving weekend.
Of course, you can always hire a property manager to handle most of the day-to-day hassles of being a landlord, but it will cost you. A typical property management company charges 6 percent or more of the revenue each month, plus expenses, to take care of maintenance, repairs, and administrative tasks like collecting the rent. Finding a new tenant or evicting a bad tenant usually results in an extra fee, and some property managers also charge additional fees for other miscellaneous situations.
Passively Investing in Real Estate
If being a landlord doesn’t sound appealing, it is still possible to diversify your portfolio by passively investing in real estate. As a passive investor, you provide the funds, and a deal manager or sponsor handles the rest, from finding and purchasing the right property to managing tenants and maintenance.
There are several benefits to passively investing in real estate, especially if you don’t have any experience as a landlord. An experienced deal sponsor has the expertise and connections needed to hunt for the best opportunities and perform all the necessary due diligence before buying a property, such as reviewing the financials, title, and environmental conditions for the property. Sponsors may look at dozens of properties before choosing the one they think has the best potential.
After negotiating the purchase and taking ownership of the property, the sponsor implements their long-term business plan for the property. This could include making interior or exterior renovations, hiring a property management company, and marketing the property effectively to attract good tenants. All of these improvements are designed to increase cash flow for the property and eventually make it more attractive to potential buyers. After the business plan has been executed, the sponsor will sell the property and hopefully generate a good return for the investors.
Methods to Passively Invest in Real Estate
There are several ways to passively invest in real estate, and each has its pros and cons.
- Public REITs, or real estate investment trusts, are companies that own, operate, or finance income-generating real estate, using money from passive investors who are not involved in any of the decisions about which properties to buy or sell. As an investor, you can buy and sell shares in a REIT on the stock market, which makes public REITs a more liquid option than many other ways to passively invest in real estate. However, because the value of shares fluctuates with the greater equities market, public REITs may not be as effective a way to diversify your portfolio, if that is your goal.
- Private REITs are similar to public REITs, but a private REIT is not traded on any of the stock exchanges or registered with the U.S. Securities and Exchange Commission (SEC). As a result, stock market fluctuations do not typically impact the share value of a private REIT. However, private REITs often have very high income and asset requirements for investors, which prevent many investors from qualifying to participate. Additionally, private REITs are typically illiquid, especially compared to public REITs.
- Real estate crowdfunding is different than REITs in that as an investor, you choose to invest in a specific property, rather than buying a share in a group of properties chosen by the REIT management. There is also a high degree of transparency about the properties available, as crowdfunding investors typically have access to many of the same due diligence materials as the deal sponsors. Crowdfunding often does not require a large outlay of capital, which makes it accessible to investors with more moderate income and assets. Crowdfunding is usually less liquid than public REITs. Depending on the deal they choose, investors may need to hold their investments for 18 months or more before they get back their investment.
When you’re buying into a deal through a crowdfunding platform, it’s critical to work with experienced operating partners who have strong relationships in the real estate industry and sponsors that have a long track record of success.
ArborCrowd was the first crowdfunding company launched by a real estate institution, and its leadership brings more than 30 years of real estate experience to the table. You can learn more about their expertise in this message from ArborCrowd’s co-founders, Adam and Ivan Kaufman.