Investing in real estate is ideal for accumulating continuous passive income, providing inflation protection and diversify your portfolio.
But real estate also offers better recession protection than most assets.
But there are many ways to invest in real estate. If you are considering buying rental properties or investing in real estate crowdfunding, how do you choose between the two?
Let’s look at the options and some things to consider for each.
The case of rental properties
Direct purchase of properties has many advantages. When exploring buy-to-let investing, keep the following benefits in mind.
High return potential
Experienced real estate investors consistently earn high returns on their investments. Higher returns than stocks, bonds and other investments.
I recently got a 47% return on a house flip, and it only tied up my money for six months. That’s almost a 100% annualized return. If I had kept the rental property, I would have earned an annual return of around 15% on net cash flow – then I would have earned an even bigger salary years from now when I sold it.
Certainly, it takes skill to get high returns on real estate. And this skill takes time, effort and often money to develop. But once you know how to invest in real estate effectively, you can easily earn returns that exceed what the average investor can get from traditional investments.
And when you finance your real estate transactions, you can earn even higher returns.
You can buy investment properties with other people’s money, with a minimum of your own money.
Lenders often cover 75-85% of the purchase price of investment properties. Good luck finding another asset that someone else will provide you with that much money to buy.
Leveraging other people’s money can improve your returns on bargains. If a property paid an annual return of 8% if you bought it with cash, it could reach a cash return of 12% (the return on your down payment) if you get a low interest rate on a mortgage.
Leverage also strengthens your protection against inflation. Your monthly mortgage payment stays the same for the next 30 years, but rents increase over timeand the difference between the two will grow disproportionately faster than the rate of increase in gross rents.
Just beware that leverage can also cut the other way. On a bad deal, you could go from a poor return to losing money on negative cash flow.
You can write off every conceivable expense you incur on your rental property. This includes costs such as mortgage interest, property management fees, repairs, maintenance, insurance, property taxes, and even travel and your home office.
You can also deduct depreciation on the building, even if it actually goes up in value.
Even better, you don’t have to itemize your personal deductions to write off those deductions. Your rental income and expenses are listed on a completely separate tax return (Annex E), so you can also take the standard deduction personally.
When it comes time to sell, you can also defer or reduce capital gains tax through techniques such as 1031 exchanges or simply pass on their assets to their children as part of their estate.
You keep control of your investments with rental properties. Compare that to buying stock in a company, over which you have no control.
For example, you can do renovations to improve the value of your property and increase your rents. You can accurately run the numbers on what a the renovation project will cost and how it will affect the value and rent of your property. Which means you know the ROI before you spend a dime.
You can also mitigate risk through aggressive tenant screening, buying in stable neighborhoods, purchasing rent default insurance.
Again, all this also has a downside: get it wrong, and you can also lose money. But experienced real estate investors know how to control their investments to minimize risk and maximize returns.
The case of real estate crowdfunding
Despite all their advantages, rentals come with their own set of challenges and drawbacks. For the average investor, real estate crowdfunding investments can offer a balance of the benefits of real estate without the headaches, work, and skills required.
Rental properties are not 100% passive investments. It takes work to find bargainsperform due diligence, align funding, post vacant units, tenants screencollecting rent, making repairs, etc.
Crowdfunding real estate investments come with none of these hassles. All you need to do is create an account and transfer some money, then turn around and go back to bed. Returns arrive in your checking account – end of story.
No skills required
Real estate investing requires a complex skill set that you cannot acquire overnight. Even after extensive reading and online courses, most new real estate investors lose money on at least one of their first two trades.
I lost six figures on my first wave of real estate investments. I could have quit and never touched real estate again. Instead, I thought of it as the cost of tuition to get an informal degree in real estate investing.
But real estate investments in crowdfunding does not require any skills to invest. It helps to do your homework on a given crowdfunding platform before investing of course, but once you’ve decided to invest, all you need to do is create an account and transfer funds. Anyone can invest in real estate crowdfunding, with no real estate experience required.
Easier to diversify
Even with a mortgage, it still costs tens of thousands of dollars to buy a rental property, between the down payment and the closing costs. Sometimes hundreds of thousands.
But real estate crowdfunding investments let you buy into funds owning dozens of properties, for as little as $10. Or you can spread your money among hundreds of home-backed loans. Either way, you can spread your money across many properties in areas across the country, for simple and safe diversification.
You also get exposure to different types of real estate, including residential rentals, but also commercial properties, large apartment complexes, and sometimes even niche investments, such as self-storage facilities. This kind of fractional real estate investment prevents you from having too much money tied up in one property.
Whether you invest directly in rental properties or indirectly through real estate crowdfunding investments, you can always earn on both the income return and the appreciation of the property. Consider that in 2021 the the average price of houses in the United States increased by 16.9% — higher than the average annual home appreciationbut it shows how powerful appreciation can be.
Add to that continued high returns, and real estate is the ideal counterweight to stocks in your portfolio.
If you want to invest in real estate as a hobby or side hustle, consider investing in rental properties. If you just want to diversify your portfolio, invest in real estate crowdfunding. Try Fund raising, Streitwise and Ground floor as easy ways to get started, all open to non-accredited investors.
G. Brian Davis is a real estate geek and co-founder of Spark Rental.