A New Investor's Guide to the Types of Real Estate Investments
Many new investors are already inherently comfortable with real estate investing, even if they need a few pointers on how to invest in real estate. In fact, whether or not you've owned a stock or bond in your entire life, the chances are good that you simply get real estate investing. After all, at some point in your life, it is likely that you or someone you know has rented a house or apartment.
In real estate investing, there is no mysterious "Wall Street" to consider, only two parties: A landlord who owns a building and a tenant who wants to rent that building. For the right to use the property, the tenant is willing to pay cash to the landlord. As long as the hot water works and the rent arrives on time, both people are happy.
As a new investor, it is natural that you would consider real estate investing as one of your first choices. The opportunities are much more plentiful than simply buying a house, upgrading the kitchen cabinets and finding a tenant.
Before We Talk About Real Estate Investments ...
Before we dive into the different types of real estate investments that may be available to you, I need to take a moment to explain that you should never buy investment real estate directly in your own name. If someone hurts themselves and sues you, you are on the hook for anything above and beyond the insurance settlement. This could lead to personal bankruptcy or at the very least, significant financial hardship.
To avoid this, virtually all experienced real estate investors use a special legal structure known as a Limited Liability Company, or LLC for short, or a Limited Partnership, or LP for short.
These special legal structures can be setup for only a few hundred dollars, or if you use a good attorney, a few thousand dollars. The paperwork filing requirements aren't overwhelming and you could use a different LLC for each real estate investment you owned. This technique is called "asset separation" because if one of your properties got in trouble, you may be able to put it into bankruptcy without hurting the others (as long as you didn't sign an agreement to the contrary).
There Are Many Different Categories of Real Estate Investment
There are several ways investors can earn passive income from real estate investments:
Residential real estate investments are properties such as houses, apartment buildings, townhouses, and vacation houses where a person or family pays you to live in the property. The length of their stay is based upon the rental agreement, or lease agreement.
Commercial real estate investments consist mostly of office buildings. If you were to take some of your savings and construct a small building with individual offices, you could lease them out to companies and small business owners, who would pay you rent to use the property.
Industrial real estate investments consist of storage units, car washes and other special purpose real estate that generates sales from customers who temporarily use the facility. Industrial real estate investments often have significant "fee" and "service" revenue streams, such as adding coin-operated vacuum cleaners at a car wash, to increase the return on investment for the owner.
Retail real estate investments consist of shopping malls, strip malls, and other retail storefronts. In some cases, the landlord also receives a percentage of sales generated by the tenant store in addition to a base rent to incentivize them to keep the property in top-notch condition.
Mixed-use real estate investments are those that combine any of the above categories into a single project. I know of an investor in California who recently took several million dollars in savings and found a mid-size town in the Midwest. He approached a bank for financing and built a mixed-use three-story office building surrounded by retail shops. The bank, which lent him the money, took out a lease on the ground floor, generating significant rental income for the owner. The the other floors were leased to a health insurance company and other businesses. The surrounding shops were quickly leased by a Panera Bread, a membership gym, a Quiznos, an upscale retail shop, a virtual golf range, and a hair salon. Mixed-use real estate investments are popular for those with significant assets because they have a degree of built-in diversification, which is important for controlling risk.
Real Estate Investment Trusts or REITs trade like stocks and own a portfolio of underlying real estate or real estate mortgages. Understanding the differences, advantages, and drawbacks of REITs is so important that I wrote a five page article, Real Estate Investing through REITs to hep you understand them.
Technically, lending money for real estate is also considered real estate investing but I think it is more appropriate to consider this as a fixed income investment, just like a bond, because you are lending money with property securing the debt. You have no underlying interest in the appreciation or profitability of a property beyond the interest income to which you are entitled.
Likewise, buying a piece of real estate or a building and then leasing it back to a tenant, such as a restaurant, is more akin to fixed income investing rather than a true real estate investment. You are essentially financing a property, although this somewhat straddles the fence of the two because you will eventually get the property back and presumably the appreciation belongs to you.
