Over the past few years, I’ve flirted with the idea of investing in real estate. But the combination of my aversion to debt and the idea that real estate is too much work has kept me from taking the plunge.
A reader of the blog recently summed up my thinking in one sentence. She wrote, “I would love to participate in the real estate market, but don’t really want to become a landlord and publicly traded REITs are not ideal either since they are still stocks hence not enough of a diversifier in my opinion.”
So I reached out to my blogging friend and real estate investor Brian Davis and posed this dilemma to him. He summarized real estate investment options, from least to most effort, for those of us sitting on the fence considering whether or how to add real estate to our portfolios.
Take it away Brian….
(Disclosure: Can I Retire Yet? has no financial relationship with Brian or his company SparkRental.)
The Pros and Cons of Real Estate
Real estate comes with some impressive advantages for anyone looking to retire. From ongoing income to tax benefits, leverage, to inflation protection, investors can put their real estate investments to maximum use.
Real estate comes with its share of disadvantages too. Poor liquidity, diversification challenges, and high barriers to entry all come to mind.
But the amount of effort required ranks up there with the greatest deterrents holding would-be real estate investors back.
Still, not all real estate investments come with the same headaches or labor requirements. Below are the most common real estate investments, ranked from least to most labor-intensive.
1. Publicly-Traded REITs
Real estate investment trusts (REITs) trade on public stock exchanges. That makes them just as liquid as stocks — and just as volatile.
You can buy and sell them instantly, and they require no work on your part. They offer one of the few truly passive real estate investments available.
Additionally, they tend to pay high dividend yields compared to most stocks. The SEC requires them to pay out at least 90% of their profits in the form of dividends each year, but that comes with a downside as well.
It’s extremely difficult for REITs to grow their portfolios and buy more properties. Which in turn means weak growth potential for most REITs.
Another downside? Because REITs trade on stock exchanges they tend to move in disturbing synchronicity with stocks. That high correlation with stock movements largely defeats the purpose of diversifying at all.
Feel free to buy some shares in publicly-traded REITs for the dividends, but don’t expect substantial diversification benefits or outsized long-term growth.
2. Private REITs
Over the last decade, another type of REIT has risen in popularity: private company REITs…. more specifically private REITs funded through real estate crowdfunding.
These funds own real estate, or lend money against real estate, just like their publicly-traded counterparts. But they fall under different SEC regulations, and aren’t required to pay out 90% of their annual profits in dividends. That leaves them more flexibility to grow their portfolios over time.
They also don’t come with the same liquidity. While you can buy them instantly, you can’t sell them on the open market. The company will typically offer to buy them back from you at a discount, if you want to sell out your shares within five years of buying.
The upside is that they don’t have the same volatility as publicly-traded REITs.
Some private REITs pay high dividends, such as Streitwise. Others, such as Fundrise, offer different funds with varying dividend yields, and still others pay no dividends and put their profits back into growing their portfolio (such as Diversifund).
Do your homework before buying shares, but these companies do offer true diversification away from stocks and bonds.
3. Crowdfunded Loans
Another type of real estate crowdfunding involves putting money toward individual loans secured by real estate.
My favorite example is GroundFloor, which lets you pick and choose the loans you want to fund. And you can put as little as $10 toward any given loan, allowing you to spread money across many loans for easy diversification.
Another advantage with platforms like these is the shorter commitment. Many, including GroundFloor, specialize in short-term loans to house flippers. These are purchase-rehab loans with high interest rates, and as soon as the property is renovated the borrower sells it and repays the loan.
Like Streitwise and Fundrise, GroundFloor allows non-accredited investors to participate. Note that many crowdfunding platforms only allow wealthy investors, for regulatory reasons.
4. Private Notes
If you personally know and trust any real estate investors, you can always invest money with them by lending them a private note.
A “note” is the legal document that a borrower signs when taking out a loan. You lend money at a set interest rate, and collect regular payments.
Some investors require a lien against the property, by having the borrower sign a deed of trust (just like mortgage lenders require). If the borrower defaults, you can foreclose on the property. Just beware that the process isn’t fast or cheap, even for investment properties.
Ultimately, private notes come down to trust. If you know a real estate investor well, and they’ve established both personal trust with you and a track record of success with their investment properties, you might feel comfortable lending them money.
I have some money invested with a couple I know, and they’ve paid me 10% interest like clockwork. It’s a completely passive investment for me, with no repairs or tenant headaches.
But don’t lend your money lightly. Make sure you feel absolutely confident that the borrower will pay you back, with regular interest payments.
5. Real Estate Syndications
Rather than lend money to real estate investors, you can partner with them on deals.
Known as real estate syndications, an experienced syndicator will find a good deal on a property, then raise money for it from a series of partners. The partners each buy a percentage of the property, proportionate to the money they invested.
Unfortunately, these tend to only be available to accredited investors. The regulatory burden is too high for syndicators to raise money from middle-class investors.
If you qualify as an accredited investor, you can research real estate syndications online, but do your homework before committing money. Look into the syndicator’s track record and experience, and aim to get to know other investors in the field to build community trust.
6. House Hacking
In the classic house hacking model, you buy a duplex to move into one unit and rent out the other. Or a triplex or fourplex — they qualify for conventional mortgage loans as well.
The rent ideally covers your mortgage payment, and hopefully your maintenance costs as well. Which means you essentially score free housing, nullifying the rent vs. buy debate entirely.
Free housing also helps allay some of the fears associated with retiring. It drops your living expenses considerably, which also means you can retire with a smaller nest egg.
For that matter, there are other ways to house hack besides buying a multifamily home. You can bring in housemates, or rent out storage space, or rent out an ADU on Airbnb. My partner Deni even hosted a foreign exchange student, and the stipend covered most of her mortgage payment!
If you ever decide to move out, you can keep the property as a rental to boot.
7. Turnkey Rental Properties
Nowadays, you can buy turnkey properties anywhere in the country with minimal effort.
These properties require no renovations by definition. They are move-in ready, or may even be occupied by tenants already. Which doesn’t mean they don’t require any effort on your part.
You need to do your due diligence on the property’s condition, the state of the neighborhood, its trajectory, what kind of people live there, and so forth. You probably need to finance it with a rental property mortgage.
If it’s vacant, you need to market it for rent, and then inspect it regularly and maintain it. Rental properties offer some unique advantages for retirement income, but the income isn’t completely passive. Even if you hire a property manager, you still need to manage the manager.
Weigh the advantages against the risks and labor, and decide if the juice is worth the squeeze.
8. Raw Land
Raw land isn’t sexy or exciting. Which is precisely why the returns tend to be higher than other real estate investments.
Even so, it takes some time and effort to learn the business of flipping land. And I do mean business.
Investing in land involves researching markets, sending out daily mailers, and learning how the legal mechanics of buying and selling raw land work. This says nothing of learning how to market and sell a niche investment like land.
This strategy can create long-term income streams, even when you flip it. Many sellers offer owner financing, which generates interest on top of their profits from selling the land itself. Once sold and financed, land can provide passive income.
9. Flipping Houses
Everyone understands the house flipping business model. They don’t necessarily understand all the work and risks involved.
From finding good deals to financing, from managing contractors and renovations to hassling with government inspectors, house flipping comes with a slew of risks and headaches. And, when done properly, profits.
But there’s nothing passive about flipping a house. It’s hard work, and the most successful flippers approach it as a business.
10. The BRRRR Method to Build a Rental Portfolio
The only real estate strategy that involves more work than flipping houses is the BRRRR method of real estate investing.
As an acronym it stands for buy, renovate, rent, refinance, repeat. In other words, rather than buying a fixer-upper to sell after renovating, you keep it as a rental.
The BRRRR method comes with several enormous advantages to compensate you for your efforts. First, you can score a bargain on the property as a fixer-upper, then force equity through renovations, just as with flipping. Second — and here’s where things get interesting — you can pull out part or all of your original down payment when you refinance the property.
It works because the refinance is based on the after-repair value (ARV) of the property, post-rehab. So theoretically, you can recycle the same down payment over and over, all while building a portfolio of cash-flowing properties.
Aside from all the work involved in renovations and managing rentals, it does come with a risk. All too often investors pull out every cent of forced equity that the lender allows them to, even though it thins their cash flow…. sometimes to the point of negative cash flow.
I love the BRRRR strategy, but don’t start here. Cut your teeth on turnkeys to learn how to forecast rental cash flow, how to manage tenants, how to manage property managers, and how to manage handymen and contractors before committing to major renovation projects.
Diversification into real estate can limit your exposure to bear stock markets and help with your retirement tax planning. But depending on which investment strategies you use, it can also create extra labor for you.
If you’re new to real estate investing, start with real estate crowdfunding. Buy a few shares of private REITs. Spread a little money among crowdfunded loans. Get a sense for the returns and the risks.
From there, decide how much interest you have in real estate investing as a side gig or hobby hustle. If you only want to diversify, leave it at passive investments. But if you have a passion for real estate, start experimenting with some more direct, active investments.
You may just find you enjoy it enough to quit your day job.
How have you invested in real estate? What were your experiences? What’s holding you back from investing in the future?
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to email@example.com. Financial planning inquiries can be sent to firstname.lastname@example.org]
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