Deciding how to invest in real estate means analyzing property types, strategies, potential risk, funding sources, average returns, and timelines. We’ll review the most common ways to invest in real estate, including flipping houses, rental properties, buying vacation rental property, and purchasing commercial real estate. In other words, this is real estate investing 101.
4 Common Types of Real Estate Investing
|Fix-and-Flips||Short-term investors who want to purchase, renovate, and sell a property.|
|Rental Property||Long-term investors, portfolio investors, and landlords who purchase real estate with the goal of building equity.|
|Vacation Rental Property||Investors who want to offset some of their vacation costs and build equity with rental income.|
|Commercial Real Estate||Business owners and/or experienced investors.|
1. How to Invest in Real Estate Fix-&-Flips
Fix-and-flip investing is best for experienced, short-term investors wanting to purchase, renovate, and sell a property quickly. Flippers look for distressed properties with equity potential that can be flipped in 12 months or less for an average gross profit of 15% to 20%.
Who Fix-&-Flips Are Right For
Fix-and-flip real estate investing is best for real estate professionals such as realtors, brokers, and contractors, as well as experienced rehabbers. That’s because flips, especially leveraged deals, require careful selection of properties, targeted renovations, and efficient project execution in order for them to be lucrative. Novices risk low profits or potential losses when flipping.
As a rule of thumb, fix-and-flip real estate investing is best for investors with two to three or more past rehab projects. However, fix-and-flippers are sometimes inexperienced rehabbers who instead rely on licensed contractors to help them with renovations. When this is the case, the contractor provides the scope of the rehab work as well as a bid for the expected overall cost.
Fixing-and-flipping properties is the right real estate investment strategy if you have the following:
Contractors, real estate professionals, and investors who don’t mind doing minor renovations themselves may be well suited for fix-and-flip real estate investing. For more information on investing in real estate through fix-and-flips, read our ultimate guide on how to make money flipping houses.
Costs of Fix-&-Flip Investing
There are four costs on a fix-and-flip investment: acquisition cost, renovations, holding costs, and sales cost. Subtracting these four expenses from a property’s after repair value will allow you to estimate the profits on your flip. These costs should be carefully considered before purchasing a property to ensure your offer price leaves room for a respectable return.
Costs to anticipate in a fix-and-flip investment:
Managing fix-and-flip costs and timelines significantly impacts your bottom line. Delays cost money; they should be expected and budgeted for when planning a fix-and-flip project, especially if you’re new to flipping houses. If your investment is financed and delays arise, lenders may extend a loan’s repayment terms for additional penalties and fees, but this further adds to the holding costs and reduces the net profit of any fix-and-flip investment.
Funding for Fix-&-Flip Real Estate Investments
Fix-and-flip investing is typically financed with short-term loans called hard money loans. These are interest-only loans that can be used to cover both the purchase and rehab of a flip. Hard money lenders generally lend up to 75% ARV with rates between 7.5% and 12%, fees of 1.5% to 2.5%, and repayment terms of three to 12 months.
Hard money loans are the most common type of fix-and-flip financing. But some investors pay for their fix-and-flip investments using all cash, often by using funds from a self-directed IRA. Cash allows investors to purchase houses quicker as compared to rehab loans, and also result in lower holding fees and closing costs, thus increasing an investor’s potential profit.
Average Return of a Fix-&-Flip
The average gross return on a fix-and-flip is approximately 20%, calculated by taking the average fix-and-flip gross profit of $30,000 and dividing it by the average sale price of $150,000. The net return is the profit left after all expenses are paid. Returns will vary significantly based on the project and whether you’ve identified good properties to flip or not.
When reviewing your profits, budget for taxes on each fix-and-flip project. Profits for fix-and-flips are ideally earned within a 12-month period, creating a short-term capital gain and taxed at your ordinary income bracket.
Potential Risks of Fix-&-Flips
While the reward is high, there are potential risks in fix-and-flip real estate investing. If you’re new and want to learn how to invest in real estate fix-and-flips, it’s recommended that you work with a licensed contractor to gain experience managing rehab budgets and timelines. Overruns in cost and timelines are the biggest risk.
Specifically, fix-and-flip investors are exposed to:
Average Investment Timeline for a Fix-&-Flip
The average timeline for a fix-and-flip project is six months. Hard money lender terms are typically around 12 months. The faster a rehab investor can sell a fixer-upper, the fewer monthly holding costs and likelihood of penalties, thus increasing potential profit.
Processes that affect an investor’s timeline:
As investors gain experience flipping properties, and assemble teams of contractors, realtors, and lenders they can rely on, they will gain efficiency and reduce this timeline. If the market’s suitable, they may decide to make the most of that experience and efficiency by starting a house-flipping business.
Where to Get Fix-&-Flip Financing
Hard money lenders offer the best route for fix-and-flippers, and LendingHome is our top recommended lender. They can close in as little as five business days, and you can apply online and get approved in minutes.
2. How to Invest in Rental Properties
Investing in rental properties (aka buy-and-hold real estate investing) is best for investors planning to own the real estate long term and plan to manage or outsource management. Buy-and-hold investors look for rental income, market appreciation, and tax benefits. Lenders offer rental owners rates starting at 5% with up to 30-year terms and 80% LTV.
Who Rental Property Investing Is Right For
Rental property investing is best for passive long-term investors looking to purchase residential rental property, and it is a popular strategy for real estate beginners. Long-term rentals offer better financing options and lower equity requirements, making entry into these investments easier. These properties include single-family homes, apartment buildings, and multifamily units.
Common forms of buy-and-hold investors:
Costs of Rental Property Investing
Costs associated with a buy-and-hold property are property maintenance, marketing for tenants, and managing the property. A good rule of thumb for estimating maintenance is 1.5 times the monthly rent per year, and management fees range from 8% of ongoing monthly gross rent to one full month’s rent for new tenant signup.
Additional costs associated with a buy-and-hold real estate investment include:
Funding for Rental Property Investing
Buy-and-hold investors who are not paying cash rely on conventional mortgages to fund their investment purchases. Some buy-and-hold investors start as rehabbers, relying on hard money loans to renovate a property; once rented, they refinance to a conventional mortgage.
Terms of a conventional investment property loan can include:
Average Return on Rental Property Investments
The average return on a buy-and-hold property is currently 9% ROI. This average takes into account the investment’s annual net income and the annual equity build or loss from market appreciation or depreciation. This variable return is driven by the local real estate market, the property’s ongoing expenses, and the property’s vacancy rate.
An investor can increase returns by purchasing a property under market value. REO properties and foreclosures may offer higher equity opportunities. In addition, keeping monthly expenses and the vacancy rate low ensures a stable cash flow. A vacancy rate of 5% is considered good, meaning a property is vacant only 5% of the year.
Potential Risks of Rental Property Investing
The risks to consider in buy-and-hold real estate investing are a low occupancy rate, damage to the property, increasing taxes and insurance, late pays and eviction rates, and price depreciation.
Ways to mitigate the potential risks of buy-and-hold investing:
Average Investment Timeline for Rental Properties
The holding time for a buy-and-hold investor is between five to 30-plus years. The benefit of holding a property for 30 years is the opportunity to capture long-term growth, build wealth through equity and property appreciation, and avoid short-term capital gains.
Keeping a buy-and-hold property until it reaches a certain value, say in five years, is another way to create wealth. This strategy relies on the real estate market to dictate timelines. When the market peaks, buy-and-hold investors will sell their properties, realize the gains, and get the cash ready for the next buyer’s market cycle.
Where to Get Rental Property Financing
Getting a great mortgage for your rental property has never been easier. Fill out a short form on LendingTree and let multiple lenders compete for your loan. Their online marketplace enables you to quickly compare rates, offers, and find a good fit. Take a few minutes and see your options.
3. How to Invest in Real Estate with Vacation Rentals
Vacation rental property is a property an investor buys to use as a vacation home and also to rent out to offset the costs of ownership. It’s typically purchased in an area that has tourist attractions and amenities. Most investors hire a management company to handle marketing, scheduling, upkeep, and rent collection. Conventional financing terms are available for most second home rentals.
Who Vacation Rental Property Is Right For
Investing in vacation rental property can be a good option for experienced investors and new investors alike. It’s a great way for real estate beginners because you get the benefit of using the property yourself and renting it when you’re not using it.
Vacation rental property benefits:
Costs of a Vacation Rental Property
Typical costs of investing in a vacation rental property include:
Vacation rental property typically generates higher rents than a buy-and-hold real estate investment, but the costs such as insurance, cleaning, and maintenance are generally higher too.
Funding for a Vacation Rental Property
Investors typically fund a vacation rental property with a conforming loan. Lenders will lend up to 90% of the sales price to prime borrowers with up to 30-year terms and conforming loan rates.
An investor may use a portfolio loan if they don’t meet the personal qualifications for a conforming loan.
For more information on portfolio loans, check out our in-depth guide to portfolio loans.
Multifamily Loan for Vacation Rental Property
An investor will generally use a multifamily loan to finance a vacation rental property with two to four units. There are four types of multifamily loans: conventional mortgages, government-backed loans, portfolio loans, and short-term multifamily financing. Each type of loan has its own lending criteria.
For more specific information on multifamily loans, check out our in-depth multifamily loan guide, which includes things like where to find multifamily loans and how to apply for them.
Average Returns on Investing in Vacation Rental Property
Returns on a real estate vacation rental property vary based on the purchase price of the property, the location, operating expenses, and the occupancy rate. Typical returns on a vacation rental property are similar to a buy-and-hold investment and are usually around 9% to 12%.
Factors that affect your vacation property ROI are:
Potential Risks of Investing in Vacation Rental Property
The major risks in investing in vacation rental property are extended vacancies, not being able to carry the costs associated with the property, and hurricane damage if it is located near the beach.
Some risks of investing in a vacation rental property include:
– Chris Dowler, Founder & Owner, Dowler Construction Services
Average Timeline for Investing in Vacation Rental Property
Investors typically keep vacation rental properties for more than five years, making them a buy-and-hold investment strategy. Some investors keep these properties in the family for long-term wealth, while others sell when they can no longer enjoy them.
For more information on buying vacation rental property, check out our in-depth guide on how to buy a vacation rental property, which includes things like what to look for in a vacation rental property and what areas to buy in.
Where to Get Vacation Rental Property Financing
Finding the right lender for your vacation rental property doesn’t have to be a headache. Fill out a short form on LendingTree and let lenders compete for your business. Their online marketplace lets you quickly compare rates, offers, and find a good fit. See your options online in minutes.
4. How to Invest in Commercial Real Estate
Commercial properties are purchased by investors and leased out to companies, and include office spaces, restaurants, and retail stores. Commercial real estate investors are mostly long-term investors looking for monthly lease income and price appreciation. Commercial investors can use traditional long-term loans or commercial hard money lenders for fix-and-flips.
Who Commercial Real Estate Investing Is Right For
Commercial real estate investing is right for business owners who want to own the property their business is located on and for well-funded experienced investors. Commercial real estate can be more complicated and cash intensive than investing in residential real estate. Most lenders require 20% to 25% down, and charge rates between 8% and 10%.
The most common types of commercial real estate investors include:
Costs of Commercial Real Estate Investing
Commercial real estate is cash intensive, lender rates are higher and less flexible, taxes are generally higher, and insurance is typically more expensive than residential. However, commercial property owners can pass many of these costs over to the tenant with a triple net lease.
Commercial real estate investment costs generally include:
Some commercial real estate costs, such as property taxes, maintenance, and licenses, are generally paid in part or in full by the tenant as part of the terms of their lease.
Funding for a Commercial Real Estate Investment
Commercial mortgages are funded by traditional banks, SBA loans, and hard money loans with loan terms between 12 months and 25 years. Interest rates are fixed or variable, typically between 6% and 10%. Commercial loans require commercial appraisals, which are expensive, and some lenders have prepayment penalties.
Commercial loans come in four different types:
For more information on the different commercial mortgage options, check out our article on the types of commercial real estate loans.
Commercial real estate investors also rely on hard money loans to fund their investment purchases. If a commercial real estate investor wants to renovate a property, either to sell or to lease out long term, they can use a hard money lender upfront and then a traditional lender for the long-term take-out mortgage.
Average Return on Commercial Real Estate Investing
The 20-year average return on commercial real estate is approximately 9.5% gross return on investment (ROI). Commercial real estate investors earn a return on monthly lease income as well as on price appreciation when they sell.
The return is gross and therefore doesn’t include any costs, such as:
These expenses, similar to buy-and-hold residential investors, eat into the profits of a commercial real estate investor. Investors can increase their returns if they find a commercial real estate foreclosure or if they buy a property at auction.
Potential Risks of Commercial Real Estate Investing
Commercial real estate investors generally face the following risks:
Average Investment Timeline for Commercial Real Estate Investing
The average investment timeline of a commercial real estate investment is more than five years. This is because the financing terms are typically between five years and 25 years, and many investors hold commercial real estate properties longer than the maximum financing term.
The average lease for a commercial real estate property is also between three years and five years. Commercial real estate investors, therefore, have longer-term tenants than the tenants of residential properties. This extends an investor’s average investment timeline and makes commercial investors more likely to buy-and-hold.
Where to Get Commercial Real Estate Financing
You can find a commercial real estate loan at your bank, credit union, or through an online lender like Patch of Land. Patch of Land lends on commercial properties such as apartment buildings, mixed-use buildings, office buildings, and retail buildings. They can usually get you funded in as little as 10 business days.
3 Alternative Real Estate Investing Options
There are several alternative ways of investing in real estate. These generally include real estate crowdfunding, investing in real estate investment trusts (REITs), and tax liens. Each of these alternative investments have their own risks and rewards and are generally right for different kinds of investors.
Real estate crowdfunding companies provide opportunities to invest in loan-backed, single-family homes, apartments, condos, and multi-unit properties. REITs are corporations that own or finance income-producing real estate. They typically own a portfolio of real estate within a specific sector and generally pay out 90% of annual profits to investors.
The most popular alternative real estate investments are:
Investing in Real Estate Crowdfunding
Real estate crowdfunding pools money from multiple investors to fund a project or portfolio of projects. Real estate crowdfunding is right for passive accredited and non-accredited investors who want to invest in a project that would otherwise be out of their price range or geographic location.
Real estate crowdfunding websites use pools of accredited investors’ cash to fund loans to various borrowers, and average returns of 6% to 10% for both short-term and long-term opportunities. LendingHome, for example, lists average returns for accredited crowdfunding investors at 7.25%. Returns from crowdfunding investments come as a portion of the interest rate charged to the borrower.
Since real estate crowdfunding investments are individual loans, there is the risk of the borrower not making their monthly payments and not being able to repay the loan in full when due. The real estate crowdfunding loan duration is typically one to five years.
Real Estate Investment Trust (REITs) Investments
REITs are corporations that own or finance income-producing properties. REITs give investors more liquidity and can be traded like a stock without the investor acting as a landlord. They have a lower buy-in amount, so it’s generally cheaper to invest in a REIT than to buy a property.
Other important details about how to invest in real estate REITs include:
REITs can be a good way to start investing in real estate if you have cash, want to diversify your real estate holdings, and don’t want to manage projects or properties. For more information on REITs, read our in-depth guide to investing in REITs.
Tax Lien & Tax Deed Investing
Purchasing properties with tax liens is real estate investing where investors purchase properties with delinquent tax balances. Investors pay the delinquent tax and earn interest and fees on their investment. They’re right for investors who have cash, want to earn interest and penalty income, and possibly acquire a property for below-market value.
The return on tax lien investments varies by state. Each municipality gives the delinquent homeowner a redemption period. This is the time the owner has to pay their tax balance in full plus penalties and/or interest, and that time can be months or years. For more information, check out our guide to tax deed investing.
Bottom Line: Real Estate Investing 101
Real estate investing can offer income and equity opportunities, diversification, and tax benefits. The most common investments are rental property, vacation rentals, fix-and-flip projects, and commercial real estate. However, investing in REITs, crowdfunding, and tax liens can also be good options. As with all investments, the right option for you will depend on the size of investment you’re looking to make, the return you expect, and the amount of risk you’re comfortable with.
If you’re ready to obtain financing for your next real estate investment, get pre-qualified in just a few minutes with LendingHome. They’re a reputable, online, nationwide lender that offers competitive rates for prime borrowers who want a hard money loan for a fix-and-flip project.