Originally posted February 2017
Edited April 2024
Real Estate Investing for Beginners - Real Estate 101
Real estate accounts for 60% of the world’s mainstream assets — and a significant portion of all national, corporate and personal wealth. With that in mind, real estate investing clearly deserves consideration from any individual or business looking for asset classes in which to invest a portion of their capital. 1
But before you can make informed decisions about whether or not to invest in real estate and which of the many types of real estate might make the most sense for you, you first need to understand real estate investing basics.
This page is designed to provide you with a broad introduction to real estate investing, beginning by answering a question that few people, even some seasoned real estate investors, cannot fully answer: What is real estate?
(Note: If you are looking for an advanced-level discussion of real estate investing in general or real estate crowdfunding in particular, we suggest you visit our Knowledge Center for a wealth of informative articles and web pages on these topics.)
What is Real Estate?
When they hear the term real estate, many people think of land, or homes, or other types of buildings and structures. Those are components of real estate, but they are far from a complete definition.
Here is how the Uniform Standards of Professional Appraisal Practice (USPAP), the industry guidebook for real estate appraisers, defines real estate: “An identified parcel or tract of land, including improvements, if any.” That reference to improvements is key to your understanding of real estate, because it underscores the fact that real estate also includes anything fixed or permanently attached to the land — a far broader category than most people realize.
Improvements, as understood in the real estate context, can include a home, store, office building or other type of structure built on the land. But it can also refer to anything else permanently affixed to that property, including fences, roads, streams, trees and even the utility systems on the land. Finally, real estate can also include several rights inherent to a piece of property — such as air rights, water rights and the mineral rights to any natural resources in the ground under the land.
This is why USPAP also includes a definition in its guidebook for real property, which it explains is often used interchangeably with real estate. USPAP defines real property as “The interests, benefits, and rights inherent in the ownership of real estate.” 2
What is a Real Estate Investor?
With that all-inclusive definition of real estate in mind, we can now define a real estate investor as an individual (or business or other entity) investing in the real estate market by purchasing, leasing or otherwise acquiring rights to a piece of real estate or any of the rights inherent in a piece of real estate.
This is why we stated in the introduction that there are so many types of real estate investing. Investing in real estate often consists of those categories of investments that most people immediately think of when they hear the term — such as owning residential or commercial properties and renting those properties out, or purchasing such properties to quickly improve and resell for a profit. But it can also refer to a myriad of other investment opportunities, including purchasing and then leasing the mineral rights to a parcel of land, or investing in a Real Estate Investment Trust. And today, real estate investing can even include participating directly in a large deal through a real estate crowdfunding platform.
What are the Potential Benefits of Real Estate Investing?
No type of investment can offer a guarantee of a profit or even protection of the principal. Real estate investing offers several possible benefits generally not associated with other types of investments. Here are just a few of those benefits.
Leverage
One of the most powerful opportunities real estate investing offers is the ability for investors to leverage their capital several times over. In other words, real estate investors can use borrowed funds to invest in a piece of real estate they could not afford to purchase outright, but then realize all of the potential profit from ownership of that property. It is also important to point out, however, that with increased leverage comes increased risks.
Tax Advantages
Real estate can also provide several types of tax benefits. For example, the government treats real estate profits as capital gains, which are taxed lower than employment income. Additionally, the tax basis of your investment properties can decrease with time, because the tax code allows you to depreciate your real estate every year. Also, if you are generating cash flow from a rental property, you can potentially enjoy those profits free of self-employment taxation.
Control
Another aspect of real estate investing that some people find valuable is the increased control they enjoy over their investments. When you purchase stocks or mutual funds, you must then simply wait passively for those assets to increase in value. Unless you are a major shareholder in those companies, you will not have much say in their operations, which often means that there is essentially nothing you can do to directly improve the value of your investments. When you invest in real estate, however, you can enjoy some control over almost every variable — acquiring knowledge or negotiating skills to secure a better deal on the purchase, improving the property, finding creative ways to generate additional revenue (adding laundry machines to your apartment complex, for example), etc.
There are many other possible benefits of real estate investing — it can protect your capital against inflation, provide tax write-offs against your other income, etc. For more insights on this, we recommend you visit our Knowledge Center.
Real Estate Investing Risks
Of course, no discussion of real estate investing would be complete without also discussing the risks involved. As with any investment, real estate carries the risk of loss of invested capital. In the case of investing actively in real estate, such as buying a residential property to rent out, you carry the ongoing risk of vacancies, which will lead to a lack of income on that property, as well as a downturn in the real estate market, which can reduce your equity in the investment.
There are also risks involved in passive real estate investments — such as owning stock in real estate-related businesses, owing shares in Real Estate Investment Trusts (REITs), or investing in deals through real estate crowdfunding platforms, all of which we will discuss below. In the case of these investments, the value of these assets might decrease over time. For these reasons, both active and passive real estate investments will require you to do your own due diligence and research beforehand, just as you would do with any other type of investment.
What are Real Estate Investing Companies?
Up to this point we have been discussing individual real estate investors, but a significant portion of all real estate is owned and controlled by real estate investment companies. These are generally companies organized as traditional businesses — corporations, LLCs, LLPs, etc.
Real estate investment companies are essentially groups of investors who raise capital from other investors and deploy this capital to purchase real estate, either for long-term cash flow and appreciation or for short-term turnaround and profit.
These companies invest in real estate in much the same way as individual investors do — although the bigger and more sophisticated companies generally invest in deals that are far larger or more complex than an individual real estate investor could manage. Some of the larger real estate investment companies even purchase land and then develop the real estate — apartment buildings, shopping centers — themselves.
But because establishing the business (for legal and taxation purposes), finding capital and then finding the right real estate deals are the only prerequisites to operating a real estate investment company, individual investors can do this as well.
What Do Real Estate Investing Groups Do?
Within the broad category of real estate investment companies are a subset called real estate investment groups. These organizations perform a very specific function — they purchase or build a group of properties, and then sell them to other investors, who can rent them out. Because they are generally highly sophisticated and knowledgeable, these real estate investment groups also help the investors find tenants and act as property managers, in exchange for a percentage of the rent.
How Can I Invest in Real Estate with Little Money?
Although most people think of real estate as an investment only for affluent individuals or those with a lot of capital to invest, the reality is that you can invest in real estate with very little money.
For example, many large real estate companies are publicly traded, and you can simply purchase stock in such companies — real estate brokerages, real estate development companies, construction companies, etc.
You can also buy into a real estate investment trust (REIT), which we will discuss in more detail below.
Additionally, one of the newer forms of real estate investing, which allows individuals to participate in deals without investing much capital, is real estate crowdfunding.
What is Real Estate Crowdfunding?
Real estate crowdfunding is a platform that connects individuals who want to invest in real estate with real estate businesses and property owners who need to raise capital for their projects.
These real estate businesses in need of capital can structure their investment opportunities as either debt or equity financing. This means that investors researching real estate crowdfunding opportunities can find deals offering them either debt-based investments (repaid with interest in fixed installments or at the end of a predetermined period) or equity investments, where they can participate in the upside profit on the real estate deal.
Is Real Estate Crowdfunding a Safer Investment?
No investment is guaranteed, and there are risks with all investing including Real Estate Crowdfunding. However, the more sophisticated crowdfunding platforms complete a formalized diligence review of every real estate deal as well as the team behind it before making it available on their sites for investors.
Real Estate Crowdfunding for Non-Accredited Investors
Although crowdfunding platforms offer investment opportunities to non-accredited investors, generally prospective investors will need to meet certain criteria, such as minimum net worth or household income.
For many of the real estate investment opportunities available on a crowdfunding platform, however — particularly those that are not publicly advertised — non-accredited investors will be eligible to participate.
Real Estate Crowdfunding Statistics
Even though real estate crowdfunding it still a relatively new means of investing in real estate, it is already a multibillion-dollar industry. 3
For more educational content on this topic, visit our Knowledge Center.
What is a Real Estate Investment Trust (REIT)?
A Real Estate Investment Trust — typically called a REIT — is a real estate company that models its business somewhat like a mutual fund, by pooling capital raised by investors to purchase real estate (either for ongoing income or for resale).
Most REITs specialize in one or more categories of property — such as office buildings, apartment complexes or self-storage properties.
Although most REITs are publicly traded and anyone can purchase shares in them as they would any other stock, some REITs are private and available only to accredited, sophisticated investors.
How Does REIT Investing Work?
The simplest and most widely available way to invest in a REIT is to purchase shares in a publicly traded REIT company or in a REIT mutual fund. Any individual with a stock trading account can invest in REITs this way.
But both accredited investors, typically high-net-worth individuals who meet certain minimum financial criteria based on income or total assets and non-accredited investors, can also invest in private REITs. These are not publicly traded and are not registered with the Securities and Exchange Commission, which means they do not have the same regulatory requirements regarding periodic disclosure of their financial performance. This is why investment opportunities in private REITs are typically open only to accredited investors.
How Do I Know What Real Estate Investment Companies to Trust?
Even if you are a high-net-worth individual who would qualify as an accredited investor, if you are new to REITs the safest way to begin investing in these companies is to start with those that are publicly traded.
Why? Because the stock-exchange-traded REITs are subject to the same financial disclosure rules as any other publicly traded company, which means you should be able to find out more about these companies and their investments than you would with if you were researching a private REIT.
Another reason it might be wise to opt first for a publicly traded REIT is that these companies are followed and rated by stock analysts just as businesses in any other industry. This means you can find detailed analysis about public REITs at any of the major stock analysis outlets such as MorningStar or TheStreet.
Sources:
- Savills 2016 World Real Estate Research Report:
http://www.savills.co.uk/_news/article/72418/198559-0/1/2016/world-real-estate-accounts-for-60--of-all-mainstream-assets - Uniform Standards of Professional Appraisal Practice:
http://www.uspap.org/#14 - Forbes:
http://www.forbes.com/sites/vanessagrout/2015/03/24/with-2-5-billion-in-investments-predicted-for-2015-real-estate-crowdfunding-is-open-for-business/#1ee3ad66737d