Investing in Real Estate: What to Know Before You Buy
Deborah Adeyanju, CFA, Senior Advisor & Impact Strategist
Many of our clients already are or would like to start investing in real estate. Usually their motivation is twofold: to create a stream of passive income, and to build wealth they can pass on to the next generation. Real estate is not the only way to achieve these goals — but it is one of the largest contributors to household net worth in the U.S. It also has some distinctive features that make it especially appealing.
What makes real estate a compelling asset class?
#1. Physicality. Because it’s tangible, you can see and touch it, investing in property seems more straightforward for most people than other types of financial investments.
#2. Returns. Real estate investments haven't typically moved in sync with financial markets. From an investment return perspective, real estate has tended to produce solid returns even when taking inflation into account.
#3. Diversification. Building a diversified portfolio — one that holds a variety of assets, from stocks to bonds to real estate to alternatives like commodities — means investment returns will have low correlation with each other. That’s important because diversification can reduce your overall risk. When one or two types of investments in your portfolio are doing poorly, others may be holding up, or even doing great.
#4. Leverage. Real estate investments can offer financial flexibility — to borrow against and build equity. They also come with special tax breaks. These advantages can amplify returns, helping to drive long-term wealth accumulation.
#5. Tax Advantages. The 2017 Tax Cut and Jobs Act greatly expanded the deductions available to owners of real estate owned and used for business purposes. In addition to increasing deductions for depreciation and certain expenses, the law also introduced a new pass-through income deduction for certain types of business owners of 20% of their “qualified business income.”
Where to start investing
For physical properties, once you figure out your wish list and non-negotiables, evaluate price – how much you can afford, and what that gets you. You should also review prices of comparable homes, to get a sense for where the market is and may be going price-wise.
Next, as they say is, location, location, location. Are the properties you’re looking at in areas with amenities you want now and in the future? Are there any potential deal breakers like noisy construction, or environmental hazards?
You also want to consider the potential for price appreciation, or, for rental properties, current and future income potential.
Buying physical properties isn’t the only way to access real estate though. It’s actually a high-friction way to do it, because of all the steps and parties involved. There are buying and listing agents, mortgage providers, appraisers, inspectors, title agents, insurers, and in some states, lawyers. Each party in the chain takes their cut. And if you’re buying an investment property, you’ll need a lawyer and most likely a property manager too.
So what can you do if you’re determined to invest in real estate but don’t want to put down a large chunk of change all at once, or go through a lengthy, paperwork-intensive, and potentially competitive buying process?
Invest in funds. Real Estate Investment Trusts (REITs) are funds that own real estate and/or loans secured by real estate. You won’t be able to pick the individual properties your money is invested in, but you can choose from different types of REITs (for instance, some specialize in commercial properties or specific sectors like retail, while others target residential properties) or real estate-focused mutual funds.
However you choose to invest in real estate, keep a few things in mind.
Your long-term investment objectives. Being clear on why you’re investing and what role real estate will play in getting you there will help you choose the most appropriate investment strategies and vehicles.
Your investing strategy. How will you invest? Through funds or in physical property? What type of real estate – commercial or residential, single-family or multifamily, are you most interested in? Deciding these things upfront gives you focus and can help you stay on course when you hit bumps in the market and get tempted to pull out or dial down your exposure.
How much you can afford. Every investment has a risk of loss. On top of that, some, like physical property, are less liquid than others. Decide how much you can afford to part with before you get started. You might know this number off the top of your head. If you don’t, your financial advisor can go over your budget and cash flow with you, taking into account your financial obligations and priorities to come up with an amount you can afford to dedicate to investing.
Your entry and exit points. Before you invest a single dollar you should know at what price point you want to get into the market and where you’d like to sell. These may change over time, of course. But setting them upfront will help you stay disciplined, and reduce the chance of your emotions overriding your investment decisions when the market is hot, or when it’s struggling.
At GRID, we help clients set their investment allocation, choose appropriate investments, manage cash flow, and build long-term wealth. We also help guide them through the process of purchasing physical properties—whether it’s exploring how much house they can afford, considering financing scenarios, or helping them prepare for and then protect their investment properties. Whether you’re looking at real estate to put a roof over your head and build long-term equity, generate passive income, or build generational wealth, it pays to make the decision thoughtfully.
GRID 202 Partners is an African-American and woman-owned Registered Investment Adviser (RIA) specializing in fee-based, comprehensive financial and investment planning for individuals, couples, businesses and institutions. We serve successful, ambitious professionals and business owners, mission-driven organizations, and households that are committed both to creating wealth for themselves and future generations and to aligning their financial assets with their social impact objectives.