Starting to build your real estate empire can be daunting. Whether you want one or two investments to supplement your income and retirement planning or you aim to replace traditional employment entirely, you have to start somewhere. The most basic question is, “What should I buy?” Let’s examine four of the most profitable types of direct real estate investment to see the upsides and challenges of each.
1. Commercial Real Estate
This category covers industrial buildings, warehouses, retail spaces, medical facilities, parking lots, and more. Most commercial properties are more expensive than the other options on our list, meaning the risks are higher. Your loan payments are much larger, making it far more challenging to float them when you have a vacancy.
Speaking of loans, it can be more challenging to finance commercial property. Your application will receive more scrutiny. You may also need to come up with a larger down payment and pay higher interest rates. Many commercial property loans have variable or floating interest rates, which means when rates rise, as we’ve seen them do dramatically in 2022, your payments increase while your rent collection stays the same.
An economic downturn can also hit commercial real estate hard. During the height of Covid, both retail and office spaces had higher vacancies as shops closed, and people switched to working from home. In a recession, property values can drop, leaving you unable to fill your space and forcing you to either sell for a loss or make payments on empty buildings. When times are good, you can see significant rent growth and fantastic profits, but when they are bad, your bottom line can land in a scary place.
Commercial real estate can be profitable for those willing to take these risks. Rents tend to be higher than residential properties, and if you buy in an area that sees significant growth, your appreciation numbers can be fantastic.
2. Single-Family Homes
There’s a reason that Utah real estate investors think first of single-family homes when they consider investing. While there is still some risk, just as there is with any investment, the market for family homes is relatively stable compared to other property types. People will always need places to live, and as a provider of homes, that works in your favor. That helps mitigate some of the risks.
Single-family homes are typically the least expensive real estate types on our list. You will likely also put down less money and have a lower, fixed interest rate, which means your payments will be more manageable.
The most significant risks with single-family homes are bad tenants and buying bad properties. You can address the former by properly vetting your tenants or working with a property manager. The latter requires special attention. Taking your time and researching properties and neighborhoods can prevent nasty surprises. Seeking advice from a real estate investment company allows you to use someone else’s labor and expertise to help you avoid troublesome neighborhoods and unprofitable deals. It can be well worth the modest fee you pay to address the risk of owning a property you struggle to rent.
3. Multi-Unit Properties
Apartment buildings and other residential properties with multiple units share aspects of both commercial and single-family properties. Like their commercial cousin, they are more expensive, and loans can be challenging, with less attractive terms. They share many of the same risks as single-unit properties, though because you own multiple units in the same neighborhood, your investment is more subject to changes–good or bad–in local valuations.
With single properties, you can geographically diversify, owning homes in different neighborhoods, cities, or even states. All your money is invested in one block if you buy an apartment building. If a desirable retail space is built nearby, you could see incredible appreciation and rent increases. On the other hand, if a trash dump goes in one block over or a major employer leaves the area, your value and profits can be devastated. That makes a multi-unit property less stable than several single-family homes in different areas.
4. Fixer-Uppers and Flips
Thanks in large part to a glut of TV shows about flipping homes, most people are aware of this approach to real estate investment. As those shows demonstrate, there is a potential for jaw-dropping profits. However, those shows are about as real as most reality TV, which is to say, ‘not very real at all.’
If you don’t have relationships with contractors and you aren’t able to offer them multiple jobs, your projects’ prices will likely be higher. If a painter or tile installer has to choose between your one home or a project from a large-scale developer with dozens of projects every year, your flip is the one that gets bumped when there is a scheduling conflict. The TV stars make it look easy, but the reality is generally one of the delays, supply-chain issues, cost overruns, and other headaches.
If real estate prices tank while you are working on your project, you could face selling at a loss. Flipping relies on timing the market. When real estate prices are stable or increasing, that’s good for flippers. However, short-term market decreases that are almost meaningless to longer-term investors can be highly problematic for someone needing to sell quickly.
Profits from buying a home and quickly reselling also suffer from tax inefficiencies. Because you hold them for a short time, the tax rates on your gains are higher than for longer-term investments.
Buying a fixer-upper does require less money up front since you’ll be purchasing a home that needs work. However, you need to have enough cash set aside to complete all your projects, so it may not take less money out of your pocket by the time you finish. You will also need to devote significant time to your flip. House flipping is a full-time job, not a passive investment.
If your flip isn’t affected by a market glitch and you avoid problems with contractors and suppliers, you may see a nice profit. Just make sure you do enough research to ensure your show has a happy ending and doesn’t end up as a cautionary tale.
These four types of real estate investment can all be profitable. Determining which option to pursue requires evaluating your budget, risk tolerance, and the time you want to spend on your investment. For most people, when they consider those factors, the answer tends to be single-family homes, thanks to their stability, lower entry costs, low time commitments, and the ability to diversify.