Real estate investing involves the purchase, management and sale or rental of
Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...
for profit. Someone who actively or passively invests in real estate is called a real estate entrepreneur or a real estate investor. Some investors actively develop
, improve or renovate properties to make more money from them.
During the 1980s, real estate investment funds became increasingly involved in international real estate developed. This shift led to real estate becoming a global asset class. Investing in real estate in foreign countries often requires specialized knowledge of the real estate market in that country. As international real estate investment became increasingly common in the early 21st century, the availability and quality of information regarding international real estate markets increased.
Real estate is one of the primary areas of investment in China
, where an estimated 70% of household wealth is invested in real estate.
Types of real estate investments
Real estate is divided into several broad categories, including residential property, commercial property and industrial property.
Real estate market
s in most countries are not as organized or efficient
as markets for other, more liquid investment instruments. Individual properties are unique to themselves and not directly interchangeable, which makes evaluating investments less certain. Unlike other investments, real estate is fixed in a specific location and derives much of its value from that location. Industrial real estate With residential real estate, the perceived safety of a neighbourhood and the number of services or amenities nearby can increase the value of a property. For this reason, the economic and social situation in an area is often a major factor in determining the value of its real estate.
Property valuation is often the preliminary step taken during a real estate investment.
In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other.
Information asymmetry creates an imbalance of power in transactions, which c ...
is commonplace in real estate markets, where one party may have more accurate information regarding the actual value of the property. Real estate investors typically use a variety of
real estate appraisal
Real estate appraisal, property valuation or land valuation is the process of developing an opinion of value for real property (usually market value). Real estate transactions often require appraisals because they occur infrequently and every pro ...
techniques to determine the value of properties prior to purchase. This typically includes gathering documents and information about the property, inspecting the physical property, and comparing it to the market value of similar properties.
A common method of valuing real estate is by dividing its net operating income by its capitalization rate
, or CAP rate.
Numerous national and international real estate appraisal associations exist for the purpose of standardizing property valuation. Some of the larger of these include the
The Appraisal Institute (AI), headquartered in Chicago, Illinois, is an international association of professional real estate appraisers. It was founded in January 1991 when the American Institute of Real Estate Appraisers (AIREA) and the Society ...
Royal Institution of Chartered Surveyors
The Royal Institution of Chartered Surveyors (RICS) is a global professional body for surveyors, founded in London in 1868. It works at a cross-governmental level, and aims to promote and enforce the highest international standards in the valu ...
and the International Valuation Standards Council
Investment properties are often purchased from a variety of sources, including market listings, real estate agents or brokers, banks, government entities such as
The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the N ...
, public auctions, sales by owner
s, and real estate investment trust
Real estate assets are typically expensive, and investors will generally not pay the entire amount of the purchase price of a property in cash. Usually, a large portion of the purchase price will be financed using some sort of financial instrument or
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
, such as a
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any p ...
collateralized by the property itself. The amount of the purchase price financed by debt is referred to as leverage
. The amount financed by the investor's own capital, through cash or other asset transfers, is referred to as equity
. The ratio of leverage to total appraised value (often referred to as "LTV", or loan to value
for a conventional mortgage) is one mathematical measure of the risk an investor is taking by using leverage to finance the purchase of a property. Investors usually seek to decrease their equity requirements and increase their leverage, so that their return on investment
is maximized. Lenders and other financial institutions usually have minimum equity requirements for real estate investments they are being asked to finance, typically on the order of 20% of appraised value. Investors seeking low equity requirements may explore alternate financing arrangements as part of the purchase of a property (for instance, seller financing
, seller subordination, private equity sources, etc.)
If the property requires substantial repair, traditional lenders like banks will often not lend on a property and the investor may be required to borrow from a private lender utilizing a short term
A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing. It is usually called a bridging loan in the United Kingdom, also known as a "caveat loan, ...
like a hard money loan
from a Hard money lender
. Hard money loans are usually short-term loans where the lender charges a much higher interest rate because of the higher risk nature of the loan. Hard money loans are typically at a much lower loan-to-value ratio
than conventional mortgages.
Some real estate investment organizations, such as real estate investment trust
s (REITs) and some pension funds
A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as shor ...
, have large enough capital reserves and investment strategies to allow 100% equity in the properties that they purchase. This minimizes the risk which comes from leverage but also limits potential ROI.
By leveraging the purchase of an investment property, the required periodic payments to service the debt create an ongoing (and sometimes large) negative cash flow beginning from the time of purchase. This is sometimes referred to as the carry cost or "carry" of the investment. To be successful, real estate investors must manage their cash flows to create enough positive
Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. Fo ...
from the property to at least offset the carry costs.
With the signing of the
The Jumpstart Our Business Startups Act, or JOBS Act, is a law intended to encourage funding of small businesses in the United States by easing many of the country's securities regulations. It passed with bipartisan support, and was signed int ...
in April 2012 by President Obama there was an easing on investment solicitations. A newer method of raising equity in smaller amounts is through real estate crowdfunding
which can pool accredited and/or non-accredited investors together in a special purpose vehicle for all or part of the equity capital needed for the acquisition. Fundrise
was the first company to crowdfund a real estate investment in the United States.
Sources of investment returns
Real estate properties may generate revenue through a number of means, including
net operating income
In accounting and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses (operating and non-operating) except interest expenses and income tax expenses.
Operating income and o ...
Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws.
Types of ...
build-up, and capital appreciation
Net operating income is the sum of all profits from rents and other sources of ordinary income generated by a property, minus the sum of ongoing expenses, such as maintenance, utilities, fees, taxes, and other expenses. Rent is one of the main sources of revenue in commercial real estate investment. Tenants pay an agreed upon sum to landlords in exchange for the use of real property, and may also pay a portion of upkeep or operating expenses on the property.
Tax shelter offsets occur in one of three ways: depreciation
(which may sometimes be accelerated), tax credits, and carryover losses which reduce tax liability charged against income from other sources for a period of 27.5 years. Some tax shelter benefits can be transferable, depending on the laws governing tax liability in the jurisdiction where the property is located. These can be sold to others for a cash return or other benefits.
Equity build-up is the increase in the investor's equity ratio as the portion of debt service payments devoted to principal accrue over time. Equity build-up counts as positive cash flow from the asset where the debt service payment is made out of income from the property, rather than from independent income sources.
Capital appreciation is the increase in the market value of the asset over time, realized as a cash flow when the property is sold. Capital appreciation can be very unpredictable unless it is part of a development and improvement strategy. The purchase of a property for which the majority of the projected cash flows are expected from capital appreciation (prices going up) rather than other sources is considered
In finance, speculation is the purchase of an asset (a commodity, goods, or real estate) with the hope that it will become more valuable shortly. (It can also refer to short sales in which the speculator hopes for a decline in value.)
rather than investment.
One source of investment returns is AirBNB rental arbitrage. This is the process that focuses on buying properties or leveraging other peoples properties by sub-leasing and then renting them out on websites such as AirBNB. There are pros and cons to this investment type. You have to find properties in high destination areas to ensure that you will have enough bookings to cover the recurring costs and initial investment. There is potential to make a much larger return when compared to simply renting out a property for a long term stays. However, there is much more upkeep and much more potential for damage and unwanted costs when doing short-term rentals due to the large amount of different people using the home constantly.
Some individuals and companies focus their investment strategy on purchasing properties that are in some stage of
Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan.
Formally, a mort ...
. A property is considered in pre-foreclosure when the homeowner has defaulted on their mortgage loan. Formal foreclosure processes vary by state and may be judicial or non-judicial, which affects the length of time the property is in the pre-foreclosure phase. Once the formal foreclosure processes are underway, these properties can be purchased at a public sale, usually called a foreclosure auction or sheriff's sale. If the property does not sell at the public auction, then ownership of the property is returned to the lender. Properties at this phase are called Real Estate Owned, or REOs.
Once a property is sold at the foreclosure auction or as an REO, the lender may keep the proceeds to satisfy their mortgage and any legal costs that they incurred minus the costs of the sale and any outstanding tax obligations.
The foreclosing bank or lending institution has the right to continue to honor tenant leases (if there are tenants in the property) during the REO phase but usually, the bank wants the property vacant in order to sell it more easily.
Buy, rehab, rent & refinance
Buy, rehab, rent, refinance (BRRR) is a real estate investment strategy, used by real estate investors who have experience renovating or rehabbing properties to " flip
According to Lima et al. (2022), in Ireland, the
Financialization (or financialisation in British English) is a term sometimes used to describe the development of financial capitalism during the period from 1980 to present, in which debt-to-equity ratios increased and financial services acco ...
of rental housing
, which includes the entry of
An institutional investor is an entity which pools money to purchase securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, government-linked ...
s into urban rental housing markets, contributed to structural factors that create homelessness
, directly, by worsening affordability and security in the private rental market, and indirectly by influencing state policy.