Owning a home is seen as a smart financial investment. Firstly, you are buying an asset that gains value over time. Then, you pay off your mortgage, you are essentially giving money back to yourself.
While you may get a better return on investment if you were to invest in the stock market, purchasing real estate can give you a strong foundation on which to build wealth.
Buying real estate doesn’t have to be limited to purchasing a home. There are multiple ways to get into the real estate game, such as investing in farmland or purchasing commercial real estate.
You might be aiming to purchase your first apartment or home to live in. Or maybe you are looking at an investment property. This guide will take you through the different types of properties, the steps to buying and selling, and so much more.
Today's real estate market
The real estate market has been a bit of a whirlwind lately.
First, there was the rush for homes during the COVID-19 pandemic, as Americans sought more space. Home prices soared, not only in metropolitan areas but in suburbs and rural regions as well.
In early 2022, interest rates started to rise. For people locked in a low rate on their mortgages, they may have escaped unscathed. But for new homebuyers, this made getting a loan more difficult — and resulted in higher monthly payments. For people with an adjustable-rate mortgage, it meant immediately paying more money to the mortgage lender.
As interest rates inch up, home prices continue to drop, indicating that the market is cooling. While this might mean that home prices are more affordable, the higher interest rates may deter a lot of potential homeowners.
At the same time, some smaller markets — such as Cincinnati and Indianapolis — have seen housing prices rise. Your best course of action when buying a home is to determine what you can afford as both a downpayment and monthly mortgage payment, then find a home that best suits your needs.
While you may get a better return on investment if you were to invest in the stock market, purchasing real estate can give you a strong foundation on which to build wealth.
Despite all this, owning a home is still considered a smart financial investment. Not only are you purchasing a physical asset that gains value over time, but when you’re paying off a mortgage, you are, in effect, giving money back to yourself.
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Types of real estate
Whether you’re new to the real estate game or own multiple properties, knowing the types of real estate available to you can help you evaluate where to invest.
Like any investment portfolio, a mixture of assets can provide a strong foundation. Even if you think that investing in multiple real estate properties is beyond your means, you might be surprised at the options available.
Residential real estate
Residential real estate refers to an area that’s been developed to form a sustainable living space. These living spaces include houses, condo units, townhouses, duplexes, and co-operatives.
As the owner of real estate, you’re responsible for the maintenance of your property, and the associated fees. The fees include everything from monthly bills like hydro and water, to property, school, and municipal taxes.
With residential real estate, you can choose to live in the home on your own, or rent it out to another individual. For instance, you might own a condo but choose to rent it to someone else.
Residential real estate is generally the most accessible way of investing in real estate, as there are numerous properties available at any given time and their pricing is more in line with the cost of living.
The federal government also offers a variety of loans and incentives to make home ownership obtainable.
For instance, you might qualify for a USDA loan if you’re looking to live in a rural area, or a Veteran Affairs (VA) loan if you are a veteran. These two loans let you purchase a home with no down payment, while loans like an FHA loan require you to only put down 3.5% of the purchase price.
Commercial real estate
With skyrocketing inflation and the uncertain economy, you could be looking to diversify your investments outside of the stock market.
Commercial real estate has long been touted as a wise investment for adding stability to your portfolio. But commercial real estate has always been reserved for a few elite investors — until now.
Real estate investment trusts (REITs) offer an easier way to get into the commercial real estate game.
REITs manage properties and pass profits along to shareholders. That means you don’t have to worry about screening tenants, fixing damages or chasing down late payments. You simply sit back and watch the dividend checks roll in.
You can also invest through a crowdfunding platform that allows you to purchase a percentage of a physical asset. This can be a great way to earn passive income from commercial real estate.
You might also consider becoming a private lender. If you have underused capital, a risk tolerance greater than zero, and access to a good real estate lawyer, you can begin your journey to become a private lender.
Private lenders provide some or all of the capital needed to build, renovate, and develop real estate properties. The short-term nature of these projects means you can charge comparable interest rates to what mainstream lenders would offer. In the U.S, the interest on a private deal typically ranges from 6 to 15%.
Industrial real estate
Industrial real estate is any land or building developed to be used for production, manufacturing, assembly, warehousing or distribution. An Amazon distribution center, a car manufacturing plant, and a grocery distribution center are all examples of industrial real estate.
Consumer goods are always in demand, and with more and more production and manufacturing returning to the U.S., the opportunity to invest in industrial real estate can lead to a great return on investment.
While there might be great opportunity to build wealth with industrial real estate, it also takes money to get in the game. Generally, you require a large amount of capital to purchase all or even part of an industrial site or building.
Land
The stock market is subject to constant fluctuations. But one thing that is close to a sure-bet when it comes to investing is farmland.
Unlike stocks, whose value is dependent on a wide variety of factors, farmland’s returns are based on long-term global trends that aren’t likely to change.
Farmland is a favorite investment of billionaires like Bill Gates and Warren Buffet, who see the common sense in investing in an asset that will constantly be in demand and has a limited supply.
To get started in investing in farmland, you can try a publicly-traded real estate investment trust that specializes in farms, or try out an investing service that specializes in farmland.
How to invest in real estate
Investing in real estate may seem like a difficult proposition. Even with housing prices on the decline, rising interest rates mean higher mortgage payments, which might be a strain on your budget.
At the same time, real estate has historically been one of the most effective inflation-fighting assets, and being a landlord might be an attractive way for you to collect passive income.
If owning an investment property is out of reach for you, you can try one of these alternate ways to invest in real estate:
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Real estate investment trusts (REITs): REITs are companies that own income-producing real estate. REITs are publicly traded, and as an investor you’ll share in their dividends.
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Crowdfunding: Crowdfunding investment platforms let you purchase a percentage of physical real estate, everything from rental properties to commercial real estate to farmland. You ultimately will share in a portion of the rental income that the property makes.
- Exchange-traded funds (ETFs): ETFs are like a portfolio of stocks: they provide you with exposure to a variety of investments that either passively track an index or are actively managed. This will give you a diversified portfolio that will generally deliver a nice annual return.
More: Is now a good time to buy a house?
Is real estate a good investment?
Commercial real estate
For a lot of people, real estate represents a stable asset to provide balance to a financial portfolio. It generally appreciates over time, and can give a healthy return on your investment. For example, commercial real estate has outperformed the S&P 500 over a 25-year period.
But getting into the real estate investment game can take a lot of capital.
Crowdfunding has made it easier — and more affordable — to own property. However, if you’re looking to actually become a landlord or invest in commercial real estate, you’ll need a lot of money. For instance, if you use a loan to purchase a commercial property, you’ll generally need a downpayment of 25% to 30% of the purchase price.
- Investment can prove more lucrative than stocks.
- Demand for space can be greater than supply.
- Rental income can pay mortgage.
- Multi-unit properties can supply uninterrupted income.
- Opportunity for additional income by renting parking spaces, etc.
- Generally requires a large down payment.
- Requires hands-on maintenance or hiring property manager.
- Higher liability risk.
- Inspections and compliance can be costly.
- Can be more difficult to sell.
Residential real estate
When you buy a home, you’re making an investment in yourself. Not only are you purchasing an asset that appreciates over time, but as you pay off your mortgage, you’re increasing your equity.
But making the jump from tenant to homeowner can be difficult, especially if you don’t properly budget.
- Purchasing a functional asset that will appreciate in value.
- Any upgrades made to home will generally increase value.
- Opportunity to rent part of property for short-term or long-term rental income.
- Various loan programs available for low-income individuals, veterans, and others who might require assistance.
- “Hidden” costs like insurance and property taxes.
- Higher interest rates can make mortgage payments difficult, especially adjustable-rate mortgages.
- If you make less than a 20% down payment you will generally have to pay for monthly mortgage insurance.
- Routine repairs and upgrades around the home can be costly.
Farmland real estate
Farmland is limited, and the commodity it produces is always in demand. The fact that the demand outweighs the supply makes it a naturally attractive investment.
Over the last 47 years, the rate of return on farmland was 10.27% — better than average returns on other forms of real estate or stocks.
While you can invest in farmland through exchange traded funds (ETFs) or real estate investment trusts (REITs), you often require a great deal of specialized knowledge or investment capital to get into the game.
- Almost guaranteed returns.
- Less volatile than other investments.
- Can stabilize financial portfolio
- Longer term investment.
- Limited real estate to invest in and therefore fewer opportunities.
- Often expensive to get in.
Buying a home
A home is potentially the most expensive purchase you’ll ever make, so you want to know what you’re doing before you make an offer. You want to choose the right neighborhood, get a good price, and get the best mortgage rate.
The best time of year to purchase a house is usually the fall and winter. There may be fewer properties listed, but generally you’ll find more sellers willing to make a deal.
Here are some tips to help you out when you’re looking to buy a home:
- Know your budget: Determine how much of a down payment you can make, and use a mortgage income calculator to help determine what your monthly mortgage payments will look like.
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Account for additional costs: When creating a budget, keep in mind you’ll need to pay for things like closing costs, property taxes and home insurance.
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Know your credit score: Your credit score is a number between 350 and 850 that reflects how well you handle money and pay off your debts. For a conventional loan, you’ll need a credit score of 620 or above.
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Get mortgage pre-approval: Being pre-approved for a mortgage not only lets you know what you can afford when looking at a house, but it also shows sellers that you’re able to get financing. It also lets you lock into an interest rate.
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Know what type of mortgage you want: Are you looking at a fixed-rate or adjustable rate mortgage? A conventional mortgage or a Federal Housing Administration loan? Knowing what mortgages are available and which ones you qualify for are essential when home shopping.
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Shop around: Different lenders offer different interest rates, so you want to ensure that you find the best mortgage and lender that meets your needs.
Once you find a home you want to purchase, prepare to make an offer. If it’s accepted, you’ll need to submit a mortgage application for approval. An underwriter will check your financial background, and if everything is in order, you can close the deal on your home purchase.
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Selling a home
When selling a home, preparation can help you avoid making mistakes that could cost you better offers or a quicker sale.
While the housing market may be cooling, people are always looking for a home. Keep these tips in mind when selling your home to help draw those buyers to your doorstep:
- Find a real estate agent: Typically, real estate commissions cost about 5% to 6% of your home’s sale price, but having the right agent can pay for itself. A good agent will know the ins- and outs- of the housing market in your area, and will help set a price that draws multiple offers. They’ll also know how to market your home and negotiate on your behalf.
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Price your home to sell: Know what similar homes in your area are selling for, and use that as a benchmark to keep a realistic expectation of selling price.
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Set a timeline: Setting timelines for getting things like finding an agent, getting your home ready to sell, and staging your house helps make these tasks more manageable.
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Get a home inspection: While not necessary to sell a home, a home inspection can make selling your home faster and limit a buyer’s ability to negotiate to a lower price.
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Stage your home: You may want to hire someone to stage your home or stage it yourself. Decluttering your belongings and giving your home a deep clean can help sell your home faster and at a higher price.
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List your home and show it: Be certain to be out of your home when people come to view it. You don’t want your emotions about your home to influence potential buyers.
- Negotiate and close the sale: When an offer is made, work over the final details with the buyer and close the sale with the help of a lawyer.
How do real estate taxes work?
Real estate taxes, or property taxes, are taxes you pay on a home and the property it’s situated on.
Real estate taxes, or property taxes, are sometimes confused with personal property taxes. Personal property taxes apply to movable assets, such as vehicles. Meanwhile, real estate taxes (or property taxes) apply to immovable assets such as a home.
The money collected goes to pay for municipal and state services like police and fire departments, schools, infrastructure, and libraries.
Real estate tax is generally collected annually, and will vary depending on where you live and other factors.
Real estate taxes are based on the assessed value of your home, and the tax rate is determined by the city and state the home is in. The amount you will need to pay is determined by multiplying the value of your home by the rate established by your city.
The amount you pay in property tax can vary over time, based on the assessed value of your home. Tax rates can also fluctuate based on your local government.
To find out what tax rate is in your area, consult your local county government.
Capital gains tax on real estate
Since real estate has personal use as well as investment purposes, it’s considered a capital asset. If you sell your home for more than you paid, it is classified as a capital gain. If you’ve had your home for more than a year, it’s considered a long-term capital gain.
Generally, the tax rate on capital gains is no more than 15%, but may be as low as 0% if your taxable income is below $40,400 ($80,400 for married couples who file jointly or qualifying widow(er)s.)
If you made capital gains selling your home, you could qualify to exclude up to $250,000 of that gain from your income ($500,000 if married and you file jointly).
To qualify, you must have owned and lived in your home for at least two of the past five years before you sold it. You must make the claim for only one property, even if you sold multiple.
More: What is fractional homeownership?
Learn more about real estate
James Battiston has been writing personal finance articles for various websites for the past four years. He has a background in film and TV production, and can often be found consuming far too much coffee.
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