Historically low mortgage interest rates and rising home values are just a couple of reasons why investors may be drawn to real estate investing. Not only does real estate have the potential to provide a steady income stream, but it can help diversify an investment portfolio and act as a hedge against inflation.
If you are new to investing in real estate, there are a number of questions you should ask yourself to choose the best real estate investments for your needs.
Do you want to be an active or passive owner?
When choosing a real estate investment, you first need to decide how much you want to be involved. Are you interested in investing in a single-family dwelling, multi-unit property, or vacation property for rental income? Buying rental property and managing it yourself will involve time and effort unless you hire someone to manage it for you. If you’ve never been a landlord, be sure to talk with other landlords to get a sense of the potential rewards and pitfalls.
Other real estate investments, such as real estate limited partnerships and raw/unimproved land, demand less day-to-day involvement. If you’re investing simply to diversify an investment portfolio, these types of real estate investments may satisfy your needs without the challenges of managing a property.
Are you investing for tax benefits?
There are a number of tax benefits associated with investing in certain types of real estate. For example, operating expenses for a rental property are typically tax deductible, and you may be entitled to deductions for depreciation. In addition, any profit from the sale of real estate is generally taxed at favorable capital gains rates. You may also be able to postpone your tax liability with other tax planning strategies, depending on the type of real estate investment.
If tax benefits are your primary reason for investing in real estate, be sure to consult a tax professional to see what specific tax benefits you may be entitled to based on the real estate investment you choose.
Are you investing for income, capital appreciation, personal use, or a combination?
Real estate investments offer the potential for all three, but there is often a trade-off among them. For example, raw land may have development potential, but it likely will not provide any return until it is fully developed. You may be able to earn income from rental property that has the potential to increase in value over time, but your ability to use the property yourself will be limited if you want to enjoy a rental’s tax benefits. Ranking your priorities can be useful.
Are you looking for a quick return or a long-term investment?
Real estate speculators have been known to earn high profits from buying distressed property, fixing it up, and reselling it at a profit, especially in a buyers’ market. However, the real estate market is notoriously cyclical, and there are no guarantees. If you’re speculating, hoping for a quick return on your capital, the liquidity of a real estate investment will be important to you; so will making sure you don’t overpay to begin with. If you have a longer time frame, you may have a wider range of investing options.
Is real estate investing going to be a full-time job for you or a hobby?
Some real estate investors find that what they intended as a hobby or retirement diversion quickly becomes more than they can handle. Think about how much time and capital you’re prepared to devote to your real estate investments, and how much of a cushion you have in case things don’t work out as you expected.
Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss. There are inherent risks associated with real estate investments and the real estate industry that could have an adverse effect on the financial performance and value of a real estate investment. Some of these risks include: a deterioration in national, regional, and local economies; tenant defaults; local real estate conditions, such as an oversupply of, or a reduction in demand for, rental space; property mismanagement; changes in operating costs and expenses, including increasing insurance costs, energy prices, real estate taxes, and the costs of compliance with laws, regulations, and government policies. Real estate investments may not be appropriate for all investors.
Limited partnerships are subject to special risks such as illiquidity and the risks inherent in the underlying investments. There are no assurances that the stated investment objectives will be reached. At redemption, the investor may receive back less than the original investment. Individuals must meet specific income and net worth suitability standards, which vary by state. These standards, along with the risks and other information concerning the partnership, are set forth in the prospectus, which can be obtained from your financial professional.