Primer: Best ways to invest in real estate

June 20, 2018 - 5 min read

In this article:

Other investments don’t offer all the advantages that buying an investment property does:

  1. You can finance your investment at low-interest rates
  2. There are unique tax advantages
  3. While your property (usually) appreciates in value, you also receive cash flow (rent)

Rental properties can serve as a hedge against inflation because if prices rise, rents often do as well. And if you buy a two-to-four unit home, you can even live in one unit while earning income on the others.

Verify your new rate

Rental buildings can be good investments

Rental units can generate healthy incomes for landlords. That’s certainly true of well-managed properties in desirable locations. These units can command higher rents. They can provide a steady cash flow to owners. And that makes them a good investment. But buying an investment property isn’t easy.

Related: Complete guide to buying rental property

You’ll need to do your homework first. That means searching carefully for rental properties in areas with good rental demand. Prepare to shop around for the right financing. And you must choose who will manage the property, if not yourself.

Weigh your options. Check out rental properties for sale. Find out what loans you qualify for. Armed with answers and research, you’ll be able to make a more informed decision.

Ponder the benefits

Purchasing a building or single-family home as a rental property has its plusses.

“The main advantages are the potential for cash flow and property appreciation. Plus, you build equity as you pay off your mortgage,” says Joshua Harris, clinical assistant professor of real estate at NYU’s Schack Institute of Real Estate.

There can be tax benefits, as well. Per the IRS, landlords can deduct some rental expenses on their tax returns, including mortgage interest, property taxes, operating expenses, depreciation, and repairs. Also advertising, utilities, insurance and supplies.

Related: Guide to becoming a landlord

What’s more, the Tax Cuts and Jobs Act gives landlords a 20 percent deduction on the income generated from their rental property.

To qualify, your total taxable income from all sources cannot exceed $157,500 if you are single or $315,000 if you’re married. You also must operate your rental business through a pass-through entity. This means as a sole proprietor, limited liability company (LLC), partnership, or S-corporation.

Review the risks

The main challenge to being a landlord? It’s “the need to secure renters and actively manage the property,” says Robert R. Johnson, principal at Fed Policy Investment Research Group. “This isn’t a passive investment like stocks and bonds.”

Suzanne Hollander, real estate attorney, broker and instructor at Florida International University, agrees.

“If a toilet breaks or a tenant has a leaking roof, you or someone you hire must fix it—right away. Plus, vacancies can take time to fill. During that time, you must still pay the mortgage, taxes and insurance,” she says.

“Also, landlord compliance with changing tenant laws may be very expensive. A ‘rainy-day ' cash reserve should be kept for these contingencies.”

Also, there’s the risk of obsolescence. “Your property may become outdated and not meet tenant demands. Then, you’ll have to invest capital to make upgrades,” says Hollander.

Be a live-in landlord

There’s a strategy that could reduce your risks: be a live-in landlord. This requires buying a two- to four-unit building and living in one of the units. With this option, you can oversee your property more closely. And you can respond quickly to tenant needs.

This option “protects against the risk of vacancy,” says Harris. “You can live at free or greatly reduced costs, subsidized by rents paid by the other tenants.”

Related: Finance your rental building as a primary residence

The downside is living next to renters you may not like. “Also, a multi-unit property may not appreciate as much as a single-family home,” adds Harris.

Hollander notes that it’s safer to buy a four-unit vs. two-unit building.

“If there’s one vacancy in the two-unit building you occupy, there will be no income,” she says.

Best candidates for landlords

Owning a rental property isn’t for everyone. But if you’ve got the right stuff, it could be a wise investment.

“A good candidate is someone with excess funds to invest,” Harris says. “You should have stable income. You need sufficient reserves to cover times of vacancy and necessary repairs. And you should have emergency funds saved. And any high-rate debt should be paid off.”

Holland’s criteria include creditworthiness.

Related: Tips for landlords: How to set your rent

“You should have good credit so that you can obtain a loan,” she says. “But should also have extra time for learning. This includes learning how to manage the property, select tenants and control expenses.”

You can avoid headaches by hiring a person or company to handle these tasks.

“But you can save money if you can manage it yourself and make even minor repairs,” Johnson says.

Finding and financing a property

To locate a worthy rental building for sale, start watching your local market.

“Track rental property sale prices to get to know values. This will help you spot a good deal,” says Hollander.

“Work with a real estate lawyer and broker in your area who can help. The old adage, ‘location, location, location’ is really true. You need to get to know a specific location to know the values and vacancy rates.”

The good news about seeking a mortgage loan for an investment property? Overall, interest rates still remain relatively low.

Related: Tips for landlords: Consider a blanket mortgage

But the tricky part is that you may pay a higher rate and larger down payment than you would for a mortgage on a primary residence. Most lenders will require you to have extra cash reserves, too.

“It’s harder to obtain financing for a rental property. That’s because the buyer must put more money down. The lender also looks to the income generated by the property. They want to be sure it will cover your debt,” says Hollander.

Your best move? “Contact as many lenders as possible. Then, compare rates and terms carefully,” she adds.

Do the REIT thing

Buying a rental property isn’t the only way to invest in real estate. In addition or instead, consider investing in a Real Estate Investment Trust (REIT). A REIT is a company that owns, manages or bankrolls real estate that produces income. REITs work like mutual funds. You put your money into a fund that invests in many different properties.

“REITs offer the advantage of professional management. They diversify across properties and provide consistent payouts. And they require no active management from you,” says Johnson.

Plus, “there’s no risk of default with a REIT as there is when signing on an investment property mortgage,” Harris adds.

Related: Tips for landlords: Beware of tenants who are identity thieves

Note that investing in a REIT doesn’t make you a property owner.

“You will not have title or ownership,” Hollander cautions. “And there is no guarantee that the REIT won’t go out of business.”

Time to make a move? Let us find the right mortgage for you

Erik J. Martin
Authored By: Erik J. Martin
The Mortgage Reports contributor
Erik J. Martin has written on real estate, business, tech and other topics for Reader's Digest, AARP The Magazine, and The Chicago Tribune.