When you invest in real estate, it is important to consider many different factors that could turn a good deal into a loss. The realized profit or return on real estate investments must cover all the investor’s expenses: taxes and ownership costs (like ordinary maintenance or insurance), as well as the related risks.
Here are five helpful tips for investing in real estate.
Plan how you will earn income from your real estate investment
There are various ways to earn income from your real estate investment. Planning ahead of time the best way to earn income is crucial in order to choose the right property.
Property appreciation
This is when a property rises in value thanks to physiological changes on the real estate market or changes in the property itself: for example, if a large shopping centre opens nearby or if improvements are made to the property. Property appreciation is risky because it is unpredictable and tied to factors that are beyond the owner’s control. However, it is also the most profitable way to generate income from a real estate investment.
Regular income
Another way to earn income from your real estate investment is through property management, which typically means renting it. Many different types of properties can generate cash inflows: in addition to flats and houses, you can buy and rent garages, offices, shops and more.
Profit from sale
This type of profit is usually generated by real estate specialists, like brokers, who earn money from commissions on the properties that they helped buy or sell, or by property management companies, which earn a percentage of the rent.
Pick the right way to invest
There are different ways to invest in real estate: you can buy the property directly, take out a mortgage or lease a property, or you can sign a rental agreement with a purchase option at the end. Obviously, only investors who already have the full amount can buy a house and pay for it up front. Using a financial service to buy a property is very useful for those who do not have the full amount, although it presents some added risk. Choosing the right method is crucial to making a good investment.
Invest through a company
To better manage risk, you might consider holding real estate investments through special legal entities like companies limited by quotas, rather than holding the investment yourself. We recommend discussing this approach with your lawyer to consider the risks and benefits that a choice like this could entail.
Evaluate the pros and cons of a real estate investment
When considering a real estate investment, it is also important to understand whether it is effectively the best way to earn a profit.
The advantages of real estate investments
- They present lower risks than equity investments because the real estate market is not subject to the same volatility as the stock market, but the potential returns are lower as well.
- They offer continuous cash flows, so if you own more than one rental property, the flow of income is steady.
- The tax benefits are good: property owners can deduct all sorts of expenses from their taxes, including interest on mortgages, depreciation, property taxes and more.
- Long-term returns are generally positive because most properties increase in value over time.
The disadvantages of real estate investments
- The potential returns are not as high as those for investment in the stock market. For example, in the United States, from 1991 to 2019, the S&P 500 gained over 600% while housing prices rose by only about 160%.
- Real estate investments can be very challenging: investors who want the security of steady flows of income will need to invest substantially in purchases, renovations, agency commissions, taxes. etc.
- Property is not a liquid investment: this means that you cannot rapidly convert it into cash, like an equity.
- Managing a property is challenging and filled with unexpected events (e.g., unpaid rent, leaky roof, faulty wiring, and much more).
Consider investing in a real estate fund
Real estate funds invest at least two-thirds of their assets in real estate, real estate rights and equity investments in real estate companies. These types of funds have been available in Italy since 1998.
They are an interesting alternative to traditional investments, especially during market cycles in which progressive interest rate cuts have made investments in real estate extremely attractive, given their ability to retain value over time.
The main advantage that real estate funds offer investors is that they are non-traditional financial instruments independent of other indices or markets. However, the disadvantage is that they are medium to long-term instruments and, therefore, investors should, at least theoretically, buy them at issue and hold them to maturity if they want to be certain of earning a profit.