Real Estate Investments explained

Real Estate Investments explained – that will be the topic of today’s article.

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Introduction

Real Estate:

Real estate refers to land and any additional permanent improvements that are attached to that land. These attachments can be natural or artificial such as water, trees, minerals, buildings, homes, fences, walls, etc.

Real estate is a form of real property and should not be confused with the term itself. Real property is a rather less used term and because of that very few people understand the concept.

Real property is used while referring to the big picture, where we are talking about real estate along with the rights/privileges of its use and any of its improvements.

Real Estate Investments explained

A real estate property is different from a personal property, on which, temporary things like vehicles, furniture, and farm equipment, etc., might exist.

However, when we say land, we are just talking about the surface of the earth and nothing else. However, when we talk about real estate we also refer to the buildings or any other structures present on that.

Types of Real Estate Properties:

  1. Residential Real Estate:

Residential real estate refers to houses that are meant for living. This includes both newly constructed houses and resale properties.

The most preferred residential real estate property is a single-family home.

However, there are other types of residential real estate properties such as condominiums, townhouses, duplex houses, villas, high-value homes, multi-generational homes, vacation homes, and so on.

In simple words, any type of property used for residential purposes is known as a residential real estate property.

2. Commercial Real Estate:

Properties that are used for businesses like apartment complexes, hospitals, hotels, offices, restaurants, shopping malls, stores, movie theaters, etc., are ‘Commercial Real Estate’ properties.

Even though apartments are used for residential purposes, they are considered commercial property because the main objective of apartments is to generate income.

3. Industrial Real Estate:

Properties that are used in the processes related to manufacturing, production, distribution, storage, and research & development.

Some of the best examples of industrial real estate properties include factories, industries, warehouses, etc.

Some properties come under both industrial and commercial properties, yet the main difference would be based on factors like location, construction, and sales.

4. Land

Properties like undeveloped land, vacant land, agricultural land, ranches, etc., come under this category of real estate properties.

Having described the terms related to real estate properties, now let us have a general look at some other important terms, which are related to mortgages.

Mortgage:

Mortgages are the loans that allow an individual to buy a house, or any other real estate property.

There is no requirement for any external collateral because the property intended to be purchased with the help of that loan acts as collateral. For example, if you acquire a mortgage to buy a house, then that house itself acts as collateral for that mortgage.

The cost of a mortgage entirely depends on the purpose of the loan, the term of the loan, and the interest charged by the lender.

Depending on some factors such as the type of mortgage product or the credit score of an individual, the mortgage rates may vary.

There are different types of mortgages such as fixed-rate mortgages and adjustable-rate mortgages.

The most common types of mortgages are a 30-year mortgage and a 15-year fixed-rate mortgage.

However, certain mortgages may have a term period as low as five years. On the other hand, some other mortgages can be of a term period of around 40 years or more.

Opting to make payments for more years will generally reduce the amount needed to be paid monthly, anyhow, there would be a substantial amount of increase in the total amount of interest that the borrower needs to pay until the mortgage is paid off.

Fixed-Rate Mortgage – A fixed-rate mortgage requires the borrower to make monthly payments, while the interest rate remains the same for the entire term of the mortgage.

There won’t be any changes in the monthly payments toward the mortgage as well. A fixed-rate mortgage is what most people would call a ‘traditional mortgage’ or ‘common mortgage’.

Adjustable-Rate Mortgage – Coming to an adjustable-rate mortgage (ARM), the interest rate remains the same for a specific period (initial term).

After that, the interest rate would change periodically depending on the prevailing market interest rates.

In the beginning, the interest rate is generally lower than the market interest rate. This makes the mortgage look more affordable, but it is only applicable for the short term.

As the days pass by, the interest rate becomes less affordable, when there is an increase in the market interest rate.

Adjustable-rate mortgages come with limits/caps, which determine how much the interest rate can increase every time there is a fluctuation in the market interest rate and in the entirety of that mortgage.

Interest-Only Mortgage – These fall under the category of one of the less common types of mortgages.

Interest-only mortgages and Payment-option ARMs come with highly sophisticated repayment schedules and are compatible with complex borrowers.

It has been reported that many house owners had to undergo financial stress because of these types of mortgages, especially during the housing bubble scenario.

Reverse Mortgage – Reverse Mortgages are specifically designed for homeowners who have an age of 62 years or more and intend to convert a fraction of the equity in their properties into cash.

By doing so, these individuals can borrow against the value of their home while obtaining the resulting amount in the form of a single payment, fixed monthly payment, or line of credit.

The afore-said loan due is collected when the borrower dies decides to move away permanently or sells their home.

Major types of Real Estate Investment:

Real Estate Investments explained

There are several types of real estate investments, yet, we will discuss briefly the major types of real estate investments that are common all over the world.

  1. Rental property:

Buy a property and renting it can be considered a great opportunity for individuals who are familiar with renovations and have the patience to manage tenants.

Nevertheless, this strategy does require a hefty sum of money to finance up-front costs related to maintenance and to cover for months when there is no tenant.

Important aspects:

  • Offer income regularly and the possibility of capital appreciation
  • Maximizes profits via leverage
  • Most expenses are involved with hefty taxes
  • Damage can be done to the property by tenants and it might become hard to manage them.
  • Reduced income during vacant periods.

Based on the data obtained by the U.S. Census Bureau, the selling price of new homes has been experiencing a consistent increase in their value from the period between 1940 to 2006, until the housing bubble of 2008.

Even after that, the selling prices continued their ascent, which even surpassed the pre-crisis estimates.

We have yet to determine the long-term effects of the coronavirus pandemic, especially on the real estate sector.

2. Real Estate Investment Groups (REIGs):

Real estate investment groups (REIGs) are specifically tailored for the people who want to be owners of rental real estate while not having to bother about management and maintenance.

Investing in REIGs requires financial stability along with access to financing.

REIGs are similar to small-scale mutual funds, except they invest in rental properties.

In this way, a single investor can own one or more units of self-managed properties, yet the company operating the investment group takes care of all the units.

The company takes care of things like managing maintenance, advertisements for vacant portions, and approving tenants.

In return for handling these management tasks, the company requires a percentage of the monthly rent obtained from the tenants.

Usually, a real estate investment group leases out in the investor’s name. A significant portion of money pooled from the rent is used to guard against vacancies (if any).

This means you’ll receive at least some income even when the unit owned by you is empty. Until the vacant portions for the pooled units increase, the money should be enough to cover the expenses.

Important aspects:

  • The passive form of owning rental properties
  • Income and capital appreciation
  • Subject to vacancy risks
  • Fees are similar to those of mutual funds
  • Possibility of inefficient managers

3. Flipping:

House flipping is suitable for individuals having a considerable amount of experience in the aspects of real estate valuation, marketing, and renovation/repairs.

House flipping requires a person to have capital and the ability to handle repairs as needed.

This is generally considered a risky form of real estate investing. Like short-term trading is different from buy-and-hold investing, real estate flippers are distinct from people who opt for a buy-and-rent strategy.

Real estate flippers try to sell the undervalued properties for a profitable price, within less than six months.

People considered as mainstream property flippers usually don’t invest in improving properties.

Hence, they lookout for an investment that already has the intrinsic value necessary to obtain a profit without any renovations, or they’ll eliminate that property from their choices.

Property flippers who are not able to sell a property quickly enough might find themselves facing problems.

This is because they generally don’t keep enough free cash in hand to pay the mortgage on a property for a longer period. This can result in continuous losses.

Apart from the mainstream flippers, another kind of flippers is those who obtain profits by purchasing affordable properties and add value to them by renovating them.

This is usually a longer-term investment, where investors can only afford one or two properties at a time.

Important aspects:

  • Capital is locked for a shorter period.
  • Can offer quick profits
  • Requires in-depth knowledge of real estate markets
  • Possibility of unexpected price fluctuations

4. Real Estate Investment Trusts (REITs)

A real estate investment trust (REIT) is compatible with investors who want to have real estate exposure in their portfolio whole not having to own the actual asset.

A REIT is created when an entity or a trust makes use of investors’ money to buy and operate properties that offer income. REITs are generally purchased and sold on major exchanges, which is similar to stocks.

A company must pay 90% of its returns in the form of dividends in order to remain as a REIT.

In this way, REITs won’t have to pay corporate income tax, when a traditional company would be taxed on its returns and would have to decide about distributing the profits as dividends.

Similar to regular dividend-paying stocks, REITs can be a robust investment for investors who intend to have a regular income.

When compared to the other types of real estate investments, REITs allow an investor to have exposure to nonresidential investments, such as shopping malls, office buildings, etc.

These types of properties are usually not available for individual investors to invest directly.

More important, REITs come with a high amount of liquidity as they are exchange-traded. In simple words, you won’t be requiring a realtor or a title transfer so that you can cash out your invested capital.

To make it more clear, REITs are nothing but a simplified version of a real estate investment group (REIG).

After deciding to invest in REITs, investors must determine whether they want to invest in equity REITs that own the actual assets or mortgage REITs that offer to finance for real estate properties while getting involved with mortgage-backed securities (MBS).

Both of the above-mentioned REITs provide exposure to real estate, yet the nature of the exposure is different.

An equity REIT is more common, and it represents ownership in real estate properties. On the other hand, mortgage REITs concentrate on the income obtained from mortgage financing of real estate.

Important aspects:

  • REITs are similar to dividend-paying stocks
  • Core assets are generally expected to be long-term, cash-producing leases
  • The leverage involved with usual rental real estate is not applicable.

5. Online Real Estate Platforms:

The first type of online real estate investing platform is for the investors who want to collaborate with others while investing in a bigger commercial or residential deal.

The investment is done with the help of online real estate platforms, which are also known as real estate crowdfunding.

Capital is still required for investing, however, less than that, which is required to buy properties directly.

Usually, these platforms let real estate developers connect with investors who can be able to finance their projects, in the form of debt or equity.

Investors expect a monthly or quarterly payment in exchange for the significant amount of risk they are getting involved with, and pay a fee to the platform for allowing them to make money.

Like most other real estate investments, these are speculative and consist of a lower amount of liquidity. This means you can’t easily withdraw your funds similar to the way you can withdraw from a stock.

Moreover, the fact is that you need money to make money. Most of these platforms are openly available for accredited investors.

This means, according to the Securities and Exchange Commission, people who’ve earned an income of $200,000 or more ($300,000 when considered along with a spouse) per year, in the last two years.

If not, the individual should have a net worth of around $1 million or more, while excluding their primary residence.

 There are certain alternatives for people who may not meet that requirement, such as Fundrise and RealtyMogul.

To put it simply, online platforms connect investors who are looking to finance projects with real estate developers. You can diversify your investments even when you don’t have a significant amount of money.

Another type of real estate platform includes peer-to-peer investment platforms.

If you’re aware of companies like Prosper and LendingClub, which allow borrowers to connect with investors willing to lend money for different types of personal needs.

There may be different purposes for acquiring such a loan like wedding, home renovation, etc.  Therefore, by lending to the people regarding their real estate needs, you will be passively dealing with online real estate investments.

Important aspects:

  • Access to invest in single projects or a wide range of portfolio of projects
  • Geographically diversified portfolio
  • Low amount of liquidity with lockup periods
  • Possibility of high Management fees

Some other unconventional types of real estate investment:

Rented properties – You can rent a property and rent out the free space that you aren’t utilizing. For example, you can rent a 4-bedroom apartment, and rent out 3 bedrooms, which you aren’t utilizing.

Yes, you can buy and rent out an entire real estate investment property. However, if you don’t want to deal with all the hassles related to maintenance and management, you’ll also need to hire a property manager.

Mortgage-backed securities – Another less-known option for investing in real estate is investing in ‘mortgage-backed securities (MBS)’.

However, MBS gained a lot of bad reputation because of its role in the mortgage meltdown, which was responsible for a global financial crisis in 2007-08. Nevertheless, MBS are still in existence and traded.

The easiest way for the average investor to invest in these products is with the help of ETFs. Similar to many types of investments, these products come with a high amount of risk.

Apart from that, they also act as an excellent means of offering portfolio diversification.

Investors must research the holdings to make sure that the funds prioritize investment-grade mortgage-backed securities, not the subprime category that was responsible for the crisis.

MBS Examples:

Two major ETFs that are accessible by common investors to invest in MBS are:

The Vanguard Mortgage-Backed Securities ETF (VMBS):

This ETF tracks the benchmark index ‘Bloomberg Barclays U.S. MBS Float Adjusted Index’, which is comprised up of MBS backed by the federal agency that has a minimum combined capital of $1 billion and a minimum maturity period of one year.

The iShares MBS ETF (MBB):

This ETF concentrates on fixed-rate mortgage securities and tracks the benchmark index ‘Bloomberg Barclays U.S. MBS Index’.

Its holdings comprise of bonds that have been issued or guaranteed by enterprises sponsored by the government like Fannie Mae and Freddie Mac, and henceforth, they are considered to be AAA-rated.

Serviced accommodation – Serviced accommodation refers to a fully furnished self-contained property that is available for both short- and long-term stays.

These usually offer services similar to those offered by mainstream hotels like regular cleaning, accessibility of the facilities (if there are any) such as the swimming pool, gym, etc.

Serviced apartments are generally residential buildings, which may or may not have staff available.

Therefore, the operator will take care of the aspects related to meeting guests at arrival, letting them have a safety deposit box and others. There might even be a possibility of a keyless entry in some instances.

Serviced accommodations are generally confused with ‘short term stays’, which can be set up using several types of legal agreements.

When the property serves as a serviced accommodation, the arrangements are similar to that of a hotel.

This type of accommodation is favorable to people traveling for business purposes or corporate relocations.

In general, these properties fall under the ‘apartment’ category on hotel booking websites, however, in reality, serviced accommodation varies a lot when compared with an apartment.

Serviced apartments are being considered as a robust and cost-efficient alternative to hotels.

They’re even considered as a perfect model of accommodation for longer stays. Especially, suitable for people who have all the facilities they have at home and have a lifestyle that is similar to that of a local person.

The serviced apartment sector has been growing rapidly over the past few years and has been replacing hotel room investments.

There was a report conducted by a global real estate agent named ‘Savills’, which concentrated on the market related to European Serviced Apartment.

Based on that report, it has been reported that serviced accommodations have been more productive compared to hotels during the pandemic, especially in terms of occupancy levels.

Whilst serviced apartments also faced problems related to the demand drop because of the Covid-19, this specific sector is bound to recover at a faster pace and expect a 41% rise in serviced apartment revenue per available room within one year.

Finally, the less operational costs along with longer average guest stay to provide support to the fact that serviced apartments as considered a good investment.

Fractional Ownership – Fractional ownership is a type of investment strategy through which the total price of an asset is divided between the individual shareholders who participate in it.

All the shareholders (part owners) divide the benefits of the asset among them, which include income, reduced rates, and usage rights.

In general, this type of investment is common for the purchase of assets like vacation homes, expensive properties, aircraft, etc.

Fractional ownership is a general investment strategy for expensive assets, and the main difference between fractional ownership and timeshare ownership is that fractional ownership allows an investor to own a part of the title instead of units of time.

With the help of fractional ownership, the value of the shares in the investment increases proportionally the increase in the total value of the asset.

Bottom Line:

Real Estate Investments can be a profitable form of investment, yet one must be highly wary of the circumstances, or else, they might end with losses.

If you need help with investment planning, asset allocation, or portfolio creation, then you can avail yourself of the financial solutions offered by us.

You can even learn to process investing and take care of all your investment needs with the help of ‘Adam Fayed Academy’.

That being said, we hope that you were able to find the necessary information in this article, for which you’ve been searching. We wish for you to have a bright investment career with maximum returns on all your profits.

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Financial Planner - Adam Fayed

Adam is an internationally recognised author on financial matters, with over 299.6 million answers views on Quora.com and a widely sold book on Amazon

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