How does investing in real estate work?

Ellington / Ellington Properties Dubai Blog / How does investing in real estate work?
November 21, 2019

For many, real estate investments are unknown territories. Unlike stocks and bonds, often referred to as “traditional assets,” real estate was until recently considered as an “alternative asset” that is historically expensive, difficult to access, and repayable.

Directly investing in real estate can be an unknown investment opportunity, however, it does not mean it should be avoided. When properly managed, real estate can be a cost-effective and reliable way to generate substantial short- and long-term benefits. Real estate can create a steady stream of revenue by integrating your portfolio with unique benefits, including upside potential, portfolio diversification, and tax benefits.

Despite the apparent benefits, the real estate sector may seem daunting without an obvious starting point. However, it is not necessary. In the course of this piece, we will try to explain the fundamentals of real estate investments, including different ways to start immediately.

So, first of all: what is real estate investing?

What is a real estate investment?

Investing in real estate means buying, owning, renting, or selling land or real estate to earn money. The real estate sector is generally divided into four categories: residential, commercial, industrial, and land.

  • Residential Real Estate: Residential buildings consist of single-family, multi-family, townhouses, and condominiums. Houses with more than four units are generally considered commercial properties.
  • Commercial Properties: Commercial properties are properties used for commercial purposes. Commercial buildings are classified as offices, retail spaces, land, or multi-family dwellings. Some examples of commercial buildings include commercial offices (offices), restaurants (retailers), farmland (earth), and large apartment buildings (multi-family dwellings).
  • Industrial real estate: as their name indicates, these properties have a commercial and industrial vocation. Some examples include transportation depots, warehouses, factories, and power plants.
  • Land: Land is generally composed of undeveloped properties without structures. There are restricted ways to earn money from the land as an investment.

In addition to the types of real estate, there are three main ways to make money with real estate investments: interest on loans, appreciation, and rent.

  • Interest on Debt: a mortgage is a contract by which investors lend money to a real estate developer and earn money by paying interest on the capital of the property loan. Investment in debt can provide regular cash flow to an investor.
    • Appreciation: like any property, real estate allows the investor to earn money through the sale of this property. Evaluating or increasing the value of a property over time is the potential gain available to an investor when selling the property.
    • Rent: An investor who owns a property can earn an income by renting this property. Like the income from an investment in debt, rental income can generate regular income.

Each category and type of real estate investment has its own set of risks and benefits.

Ways to invest in real estate

There are diverse methods to invest in real estate with different amounts of money and varying degrees of time, capital, investment horizons, risks, and potential for profitability. Some have an income and a surplus-value; others only earn income. Real estate investment options fall into two main categories: active and passive investments. Here are some ways to invest in real estate, with options ranging from intense efforts to effortless effort.

Property Flipping

  • House Transformation: Moving is the most effective and practical way to invest in real estate. In a house change, an investor buys a house, makes alterations and renovations to improve the market value, and resell it at a costlier price. Moving is usually a short-term investment. The more the investor owns a home, without renting it to a tenant, the more his expenses are added.
  • Wholesale: Another option to change the property is wholesale. An investor signs a contract for the purchase of a property whose price, in his opinion, is below market value, then sells it quickly to another investor at a higher price to make a profit.

Most of the time, wholesalers look for buildings to renovate and sell them to homes that want to renovate them to add more value to the sale at a higher price.

Property for rent

  • Leased properties: Leased properties also require practical management, but unlike housing changes, they have a long-term investment horizon. Any real estate (residential, commercial, or industrial) can be a rental property. Landlords receive regular, usually monthly, cash flow in the form of rent paid by tenants. This can provide investors with a stable and reliable revenue stream, but it also requires a lot of work or delegation of responsibility to ensure smooth operations.
  • Short term rental: Short term rentals allow residents to rent their homes every night, usually as an alternative to a hotel. Short-term rentals are similar to rentals, but are limited to residential properties and are generally only available for short periods.

Bottom line

The real estate sector has a good reputation. Real estate investments offer the potential to generate significant earnings and provide significant diversification to the portfolio. If managed intelligently, it can become a valuable source of cash flow in the investment portfolio. As with any investment, real estate investing requires understanding and assessing the risks and potential benefits before you begin. Depending on how you choose to invest in real estate, you will need different lengths of time, initial capital, knowledge, and patience.