You’ve likely heard that investing in real estate is one of the most profitable financial endeavors you can undertake; real estate is responsible for many self-made millionaires, and is often found as a component of diversified investment portfolios.
The problem is, “real estate investing” can refer to one or more of several strategies, each of which have advantages and disadvantages, and a different potential level of profitability. So if you’re interested in making the biggest profit, which one should you choose?
The Major Options
Let’s start by defining the major options:
- Buying for long-term value. The first option is to buy property with a focus on long-term value. The idea here is to purchase homes or buildings in neighborhoods with a high propensity for growth. If you buy a piece of real estate at a relatively low cost, wait a few decades, and sell, you’ll probably make a sizable return on your investment. Whether explicitly considered or not, this is a goal for many homeowners.
- Rental properties. With rental properties, the goal is to collect more in rental income from occupying tenants than you pay on your monthly mortgage payment. Ideally, with minimal vacancies, you’ll make money every month. When you’re done with the property, you can sell it—hopefully for a profit—and move on to other endeavors.
- House flipping. Some people also attempt to “flip” houses. In these cases, a prospective owner will purchase a property in poor condition, or one selling for an exceptionally low price, or one in a questionable neighborhood, and attempt to improve it through contract work and DIY projects over the course of a few months. The goal is to sell the home after a short period for a sizable profit.
So how do these options stack up to one another?
There are a few ways to think about profitability, and one of the most important concepts is cash flow. Rather than focusing on an eventual gain, prioritizing cash flow gives you the ability to collect a consistent stream of revenue. This is advantageous because it will help you offset the ongoing costs of owning and managing a property, and give you more insight and control over your eventual profitability.
For example, let’s say your monthly payments (including mortgage principal, interest, taxes, and home insurance) amount to $1,200, with $100 set aside for maintenance and repairs. Assuming your property remains occupied with a rent of $1,600, that nets you a monthly profit of $400—all while you’re building equity in the home itself.
This is one reason why rental properties are one of your best options—especially if you’re not experienced in real estate investing. However, there’s always the possibility that your property remains unoccupied, or that you won’t be able to charge enough rent to offset your costs.
You can also choose to focus on long-term gains. Housing prices fluctuate with some volatility, but overall, the trend moves upward at a steady rate. The past few years have seen price increases of 5 to 7 percent per year, and that’s an overall average—the rates in some fast-growing areas is far higher than that.
Assuming you’re making an optimal decision and waiting a decade or longer before selling, it’s not unreasonable to double your money (or triple it) on a single investment. Of course, you’ll also need to consider the additional costs you’ll incur with things like insurance, maintenance, and improvements over time.
The real key to profitability here is choosing the right property to invest in; areas with growing job prospects, improving schools, and attractive neighborhoods are good bets, but only if home prices haven’t caught up to the appeal. Look for homes below market price in these areas.
The Risk Factor
Different types of real estate investments come with different levels of risk, too. Long-term investments are generally safe, but take a while to pay off, while short-term investments are riskier but could pay off substantially and immediately.
The big risk strategy here is “flipping” houses; with this tactic, you’ll buy a house for a very low price, spend time and money fixing it up, and then sell it for a profit. The trouble is, many house flipping efforts end up far less profitable than they originally seemed. It’s difficult to gauge how much a home’s value can increase with any given upgrade, and it’s even more difficult to accurately estimate the cost of the repairs and improvements before you actually begin. Accordingly, only the most experienced real estate investors end up able to turn a profit with any kind of reliability—and even then, profits are limited.
Other Variables to Consider
There are also other variables you should consider when choosing a real estate investing strategy:
- In general, adding more properties to your portfolio is going to increase your profitability and mitigate your risk.
- The more experienced you are in buying and selling real estate, the better you’ll become at finding good deals and timing the market. Even after a few investments, you should have a better sense of future market trends.
- Timing is everything, no matter what type of property you’re investing in; missing the mark by even a few weeks can interfere with your return.
- Even the most experienced real estate investors know the results of their decisions are based at least partially on luck—it’s too hard to concretely predict where the housing market is headed.
The Most Profitable Approach
The most profitable approach is one that strikes a balance between short-term gains, long-term gains, and risk: investing in attractive rental property with the propensity to grow in value over the next several years. Of course, managing a rental property takes more effort than you might think; in fact, many landlords end up seeking a property management firm to help them with their core responsibilities. If you’re interested in getting started as a landlord and generating cash flow on your property, contact Green Residential to learn more about your property management options—and how to remain profitable while avoiding as much stress as possible.