Real estate implies the land and the buildings on it. Also, this term covers the natural resources of this land and mineral deposits. The term should not be confused with “real property.” Real property is constructions, land, along with the rights of use of this land.
Real estate can be grouped into three main categories: commercial, residential and industrial. Commercial type is more expensive and stable, while the residential property is less valuable but more accessible. Real estate brings income through appreciation and cash flow from rent.
There are two common ways of investing:
- direct way – purchasing property or land;
- indirect way – buying shares in REITs (real estate trusts)
Categories of real estate
Real property can be divided into 3 major types according to its purpose.
- Residential real estate consists of houses, townhouses, apartments, condos, and undeveloped land. The buildings can be multi-family or single-family houses and also it can be rental or owner-occupied property.
- The commercial category includes offices, retail buildings, and warehouses. These constructions may be located in shopping malls or stand separately. The main purpose of commercial real estate is business issues. Commercial properties are grouped into four main classes: multifamily, industrial, office, and retail.
- The industrial category of real estate embraces business parks, mines, factories, and farms. The property in this category is usually larger and has access to transportation hubs.
Advantages of homeownership
Homeownership is a very common investing strategy. It needs a lot of responsibility but also provides many benefits.
The purchase of the property is usually financed through a mortgage loan. The interest of fixed-rate loans generally is higher than for mortgages with variable rates. Thus, fixed-rate mortgages are more expensive during a short period of time. Mortgages also include additional expenses like taxes and transaction fees. Below we will consider the main benefits of homeownership over renting.
If you own the house for a long time, the value of the property may increase and then you will gain a good return on your investment. This method of investing is based on the appreciation of the real estate, and we will describe it in detail later in this article. Before investing, consult with the real estate agent or realtor who may help you to define the most profitable property for investing and calculate your potential income and some expenses.
Also, the homeowning strategy is a good method of investing because it allows reducing the amount of annual taxes.
One more benefit of owning the house which you bought through mortgage is the positive addition to your credit history. When the person makes loan payments on time, he demonstrates that he is a reliable borrower. Then, in the future, if he wants to buy a car, upgrade the property or make some other valuable purchases, strong credit history will be very helpful in this matter.
Homeownership is a great opportunity to create the house of your dreams. You can make any changes in the living environment and you will not need the approval from the landlord, as in case of a rental property.
Profits of commercial real property
The commercial real estate embraces many types of properties, including shopping malls, restaurants, offices, and skyscrapers. In contrast to commercial property, industrial properties are often used mainly for practical purposes, basically, for the manufacturing of goods.
There is a great difference between buying residential and commercial property. Buying and renting out commercial property is a better investment and it is more likely to receive a stable income because this category of real estate requires a longer period of the lease. The investor may gain revenue from commercial real estate due to square footage rent. Also, the mortgage loan for commercial property is usually higher than for the residential category of property.
Investing in real property
The investor may choose various ways to gain profit via investing in real estate. He may either purchase property or land or receive revenue purchasing shares in real estate trusts or REITs.
If you buy some property from the dealer in order to start investing, then you will be able to earn money renting out the property or holding it and selling in some period of time – through appreciation of the value.
The main factors for successful investing are the location and neighborhood of the property. The value of the real property is affected by local factors like the level of economy in the area, employment rate, crime rate, infrastructure and property taxes. Look for areas that are close to major highways and public transportation – these properties are in demand among the tenants. If you are the first-time investor, it is better to purchase the property in your local neighborhood to keep an eye on your house. It is more convenient for the owner because he can permanently check the condition of the property.
- portfolio diversification;
- can be purchased with leverage;
- capital appreciation;
- steady income;
- large initial capital outlay;
- influenced by local factors;
- requires active management.
There are some major dissimilarities between commercial and residential types of property. Residential real estate is smaller than commercial, thus is it less costly and more affordable for buying.
On the contrary, commercial property has a long period of the lease, it provides a more stable income and it is often more profitable. You need to take into account that commercial real property has a wide range of regulations and these rules are different for various countries and cities.
Appreciation is the rise in the value of the property over time. It depends on different factors, like location, changes in the real estate market and improvements like repair. To calculate the appreciation you need to compare the value of your house with the value of similar properties in the neighborhood. There is a formula that helps you to calculate the future value of your property due to appreciation: FV = I * [(1 + R)T].
In this formula,
I – is the initial value of the property;
R – is the rate of appreciation that you expect the property to provide in the future;
T – is the time from now when you are going to receive the income.
The investor may achieve an appreciation of the property in various ways but the owner will gain the revenue from the property only in case if he sells it. The biggest potential for appreciation has raw land and some territories near the borders of the cities. Appreciation may also increase in case if the owner of the property finds some natural resources on the area, and due to the growth of marketing prices of the nearby territories.
Some locations with nice infrastructure, like good schools, are more likely to appreciate than lower-priced pieces of real estate like condos and apartments. Choose the properties in a solid neighborhood where the prices on the property tend to increase over time.
You have many opportunities to gain income from real estate. In most common cases, profit comes from the rent of commercial and residential properties. The investor may also receive the income from buying shares in property investment funds or REITs. Investing in REITs is similar to stocks – the owners of the shares receive dividends from their shares.
Investing in REITs gives you a great opportunity to diversify your investment portfolio. There are different types of REITs. Some of them purchase the properties and later rent this real estate to tenants, the others are focused on developing the properties. Some real estate investment trusts do not have the property in their possession, they manage the mortgages and other financial issues.
REITs are considered to be long-term investments due to the following reasons:
- Real estate funds may become a reliable source of stable income. This is based on the fact that most of REITs that own properties, lease the real estate during a long period of time.
- REITs are a nice way to diversify the investment portfolio. They are functioning like stocks, although they are real property assets that are not closely related to the stock market.
- Real estate investment trusts are an easy way to get started with investing. Note that this type of investment requires a lot of effort and time, even if you hire a property manager who operates your daily activities.
There are two main kinds of REITs – equity and mortgage. Equity real estate investment funds invest in properties, while mortgage trusts invest in mortgages.
Equity real estate funds typically have in their possession residential, retail, resort and hotel properties. Equity trusts typically acquire, renovate, manage and sell real estate. They gain income from rents. Mortgage-based real property investment funds receive returns from the interest of the mortgage loans. These trusts share out about 90% of their revenue to the shareholders.
Equity real property trusts are more popular among investors. There are specialized equity REITs that own certain kinds of properties and the other real property investment funds that own multiple types of properties. For instance, one real estate investment funds may pay particular attention to shopping malls, the other REIT may choose hotels. You can choose the most suitable type of REIT according to your preferences and requirements. Consider the following types of real estate funds: residential, office, industrial, retail, healthcare, infrastructure, hospitality real estate trusts and others.
The main advantage of REITs is the fact that they are likely to offer higher dividends, in comparison to the other investments. REITs usually pay about 90% of the income to the investors. Due to this reason, these dividend payments are quite high.
Investing in real estate is one of the ways to build your wealth, but you should weigh the risks and consult with the specialists in the industry before investing. Choose the most suitable type of investment – you may either invest in real property funds, or you can buy some kind of property – residential, industrial or commercial. You can gain profit in various ways – through stable cash flow from rent or via appreciation. In any case, you need to pay a lot of effort to calculate your budget. Besides the monthly mortgage payments, you need to add to your expenses come emergency costs and create the emergency fund. Also, do not forget about the costs of property maintenance and repair. The key factor which defines the value of the property is the location and neighborhood but you can also upgrade the apartment or the house to increase the final price.