Real estate investing is a great way to earn passive income and build long-term wealth. It may sound intimidating, but with some research and clear goals, it’s possible to start small with limited funds.
There are many beginner-friendly ways to invest in real estate, including: REITs, crowdfunding, mortgage-backed securities, and house hacking. These strategies can help you minimize upfront investment and maximize cash flow.
1. Real estate investment trusts (REITs)
Real estate investment trusts (REITs) are a great way to diversify your portfolio and earn steady income from dividend payments. They also offer exposure to a range of real estate sectors, which can serve as a hedge against inflation and have historically offered competitive long-term returns. However, potential investors should conduct thorough research and consider a REIT’s debt levels and performance history before investing.
REITs are public companies that invest in real estate assets and pay out dividends to shareholders. They operate like mutual funds and are a good alternative to direct property investments, which can be much more expensive. REITs are required to pay out at least 90% of their taxable income as shareholder dividends each year, which can be an attractive source of cash flow for new investors.
Some REITs track the overall performance of the commercial real estate market, while others focus on specific sectors, such as office buildings, healthcare properties or shopping centers. Investors can choose between publicly traded REITs, which are listed on the stock market and can be purchased through a brokerage account, or private REITs that don’t trade on the public markets and are available to high-net-worth investors only.
Investors looking to start small with their REIT investments should stick with publicly traded REITs, which can be bought and sold like stocks and are relatively liquid. REITs that aren’t publicly traded, on the other hand, are often illiquid and may have a more complex structure, making them less suitable for investors with limited time and resources.
Non-traded REITs, in particular, are difficult to sell and can be subject to fraud, so they’re usually best suited for experienced investors who have a large enough portfolio that it will take time to sell a position if the need arises. Newcomers to REITs should generally limit their investments to the price of a single share, although some brokerage firms offer fractional shares, so it’s possible to begin with as little as $1. REIT mutual funds and exchange-traded funds are another option for beginners to gain exposure to the real estate sector, but they can be expensive. They are also often available through employer-sponsored retirement plans, such as 401(k)s and 403(b)s, which allow automatic contributions via payroll deductions.
2. Crowdfunding
Investing in real estate may seem like a pipe dream for non-millionaires, but it is possible to add property to your investment portfolio without having a lot of money up front. You can buy physical properties, take a passive approach through REITs and crowdfunding platforms, or do both. Whatever you choose, it’s important to evaluate your goals and the amount of time and capital that you’re willing to dedicate to managing a property.
Equity-based crowdfunding allows business owners to receive funds from investors in exchange for a share of the company’s stock. This type of crowdfunding was made legal in 2016 by the JOBS Act. There are several crowdfunding portals External that can help you set up and manage your campaign, but it’s critical to find one that’s registered with the Securities and Exchange Commission and a member of FINRA.
Another way to invest in real estate without putting up a lot of cash is to rent out a room in your home or apartment. You can use sites like Airbnb to vet tenants and collect rent. This is a form of house hacking that could significantly reduce your housing costs and provide additional income.
3. Mortgage-backed securities (MBS)
Mortgage-backed securities (MBS) offer a unique way for investors to earn interest income from homeowner mortgage payments. However, they are sensitive to interest rate changes and prepayment risks that can impact their value. Investors can choose between agency and non-agency MBS, with the former considered more stable due to government backing.
The MBS market emerged in the late 1960s as a means for banks to sell mortgage loans and reinvest the capital into new mortgages. The creation of Ginnie Mae in 1970 and Freddie Mac in 1971 enabled private institutions to join the MBS market, expanding investment opportunities.
MBS are structured as trusts that collect monthly mortgage payments from borrowers and distribute them to investors. They are grouped into pools, with each pool consisting of mortgages with similar characteristics and pay-off schedules. Investors purchase a share of an MBS pool to receive the interest and principal payments over time. The term of an MBS varies from five to 30 years. However, the actual life of an MBS can be shorter than the stated maturity, depending on the principal payment schedule of the individual mortgages in the pool.
There are two broad types of MBS: pass-throughs and collateralized mortgage obligations (CMOs). The performance of MBS varies by the type of pool, interest rate exposure and broader economic trends. Agency MBS are backed by the guarantee of federally chartered entities such as Fannie Mae and Freddie Mac, which reduces investor risk. Non-agency MBS are backed by the credit of private issuers and generally have higher potential yields but also carry more risk.
A key consideration when investing in MBS is their duration risk. Because they have extended maturities, they pay fixed rates of interest and have significant price sensitivity to movements in interest rates. Moreover, they often have prepayment risks that can cause homeowners to refinance their mortgages before the end of their original terms.
In addition, the MBS market is fragmented, with different pools and tranches having distinct pricing and liquidity premiums. As a result, it requires specialized knowledge to accurately assess the performance of a specific MBS pool or tranche.
4. Real estate investment partnerships (REIPs)
Real estate is a stable investment that offers tangible assets, steady cash flow, and long-term appreciation potential. However, it’s also a large-scale investment that requires significant capital at the outset. For many investors, this isn’t feasible. However, a new type of investment vehicle called a RELP offers an alternative. RELPs are professionally managed investment opportunities that allow investors to participate in the growth and profitability of a larger property portfolio without the risk and hassle of direct property ownership.
To get started investing in RELPs, you can find them online on platforms that specialize in providing these opportunities. It’s important to conduct thorough due diligence before committing any money. The track record and expertise of the management team and their experience with RELPs will play a critical role in whether you should invest or not. The partnership agreement should clearly detail the full provisions of the business, including the investment structure, fees, return expectations, partner voting rights, and more.
RELPs can offer investors a number of benefits, such as diversifying their investment portfolio with commercial properties, accessing professional management, and gaining valuable hands-on experience in the real estate industry. However, the low liquidity of these investments can create a risk to overall portfolio stability. Additionally, the RELP structure can be difficult to navigate for novices and investors with little legal experience.
If you’re interested in pursuing a RELP, consider working with a firm like Tribevest to ensure that your partnership is set up properly. This will help you avoid any regulatory headaches down the road. It’s also best practice to file an LLC to formalize the partnership and keep your personal finances and investment funds separate.
Adding real estate to your portfolio can help you achieve financial independence, but it may not be possible if you don’t have the capital. Luckily, there are a variety of ways to start investing in real estate with little money, including REITs, crowdfunding, and RELPs. By taking these steps, you can start building a strong foundation for your future.
