Real estate is the single most significant component of wealth in our society. Because of its magnitude, it plays a crucial role in shaping the economic condition of individuals, families, and firms. It can substantially influence a family’s ability to finance its children’s education, health care, and other essential needs. Changes in the value of real estate can dramatically affect the wealth of individuals and businesses and their capacity to grow.
Real estate has been estimated to represent approximately one-half of the world’s total economic wealth. In addition, it is often viewed as an important symbol of strength, stability, and independence. The prominence of real estate means that decisions about it are also important. For an individual, firm, and region, prudent decisions about creating and using real estate assets would bring greater productivity, incredible wealth, and a better set of choices for life.
Use of the Term Real Estate
The term real estate is used in three fundamental ways:
- First, its most common use is identifying the tangible assets of land and buildings.
- Second, it denotes the ‘bundle’ of rights associated with the ownership and use of the physical assets.
- Finally, real estate may be used to refer to the industry or business activities related to acquiring, operating, and disposing of physical assets.
Types of Real Estate Investments
Residential Real Estate
Residential real estate is designed for individuals and families to live in and is generally used for rental income. The real estate investor becomes the landlord and leases his home out to a tenant, who pays a monthly rent to live there. This is a reasonably safe investment because the rental units generate monthly income. The rent money covers expenses and repairs, with some leftover as a profit.
There are a few things that can go wrong. If a tenant does not pay rent, it could be difficult challenging the tenant and lose rental money. However, this situation may be completely avoidable with proper rental documentation. Property taxes and insurance may increase the burden and reduce the rental cash flow. An intelligent investor will forecast for increases and set rent amounts accordingly.
Some investors choose to own commercial real estate, like office buildings or large apartment complexes. The concept is similar to residential real estate in that the investor becomes the landlord. Still, the tenants are businesses or many individuals instead of one private individual. What attracts investors to this type of property is the profit margin. With multiple rents coming in each month, the investor stands to make more money by receiving rent payments from multiple tenants. Of course, commercial real estate costs more than a single-family home or apartment, but if we consider the economy of scale, the more rented units, the more money flows in each month.
Real Estate Investment Trusts
If you are not a hands-on investor and do not want to manage a property, a real estate investment trust or REIT may be the way to go. A REIT is a managed fund that invests in commercial real estate and uses investor money to operate the properties. It is very much like owning stock in a mutual fund scheme. As a REIT owner, you are an investor in a commercial real estate company and earn dividends as the REIT profits.
Flipping involves purchasing a house, usually below market value or even foreclosure, making some renovations, and reselling it for a profit. Sometimes the investor does the renovations himself to save money. However, the investor may put a contractor in charge of the work on the more significant flips.
Real estate investing in good markets can be lucrative, but there are risks. If the real estate market turns sour, it may be challenging to unload properties. The investment is not liquid like having cash in the bank. Maintenance and repairs can be costly. Nevertheless, a savvy investor who makes informed choices might find investing in real estate a rewarding road to financial security.
Conclusion: Real Estate as an Alternative High-Risk Asset Class
Investing in real estate can be a financially rewarding experience. Whether buying and renting single-family residential homes or a large commercial apartment building or office complex, there can be plenty of money to make.
Some investors may not want all the responsibility of managing real estate operations. For those, a real estate investment trust or REIT may be the way to go. This is similar to owning units in a mutual fund scheme. Investors become unit holders in a fund scheme that owns large commercial real estate properties and receive dividends on their investment. For those who enjoy renovating homes, flipping may be a good option. Flipping a house involves buying a property at a low price, fixing it up, and then selling it for a profit.
Investing doesn’t come without risks. For example, the market can change, your property may eventually need repairs, or its value may decrease. However, if you use good judgment and choose investments wisely, you may find real estate investing makes good financial sense.