Investing in real estate is often touted as a way to earn extra income and help build wealth over time. However, there’s more than one way to achieve that goal. The good news is that you don't have to be a mogul to get started.
4 ways to invest in real estate:
1. Purchase a home
For many people, their home makes up the biggest portion of their net worth. For example, suppose you have $300,000 of equity in your home and an investment portfolio worth $200,000 (with no other assets or liabilities). In this case, real estate makes up 60% of your net worth.
Pros
- Build equity. Homeowners often build equity over time as they pay down their mortgage. Any potential increase in your home’s value after you purchase it can add to the value of your equity.
- Potential inflation hedge. As a homeowner, you may benefit from any potential increases in your home’s value. Although it’s never guaranteed that real estate will rise in value over time, over long periods it has historically been a strong hedge against inflation.
- Potential tax advantages. You may be able to deduct mortgage interest on your taxes (provided you itemize your deductions). If your home rises in value, there are also tax rules that you can benefit from when you sell. To learn more about taxes when you sell your home, read Fidelity Viewpoints: Could you face a tax bill on your home sale?
- Security and peace of mind. The nonfinancial benefits of owning a home can be substantial. Owning where you live means you don’t have to worry about a landlord raising rent or not renewing your lease. It can also mean more predictability in your housing costs if you have a fixed-rate mortgage, and more power and control over the place you call home.
Cons
- High up-front cost. Buying a home can take a lot of money, and the difficulty of getting a large enough down payment keeps many people from seeking homeownership. To learn more about down payments, read Fidelity Viewpoints: How much to down payment do you need for a house?
- High ongoing costs. High mortgage rates have made homeownership more expensive for new buyers in recent years. Additionally, unlike renting, property taxes, maintenance, and repairs add to the bill and are the owner's responsibility.
- No guarantees in your home's value. If a downturn occurs when you need to sell, it's possible you won't recoup your original purchase price.
Is buying a home right for you?
Not only is purchasing a home an investment decision, but it's also one that affects your budget. Whether it’s right for you may depend on your finances, how long you’re planning to stay in one place, the cost of buying versus renting in your area, and other factors.
To learn more, read Fidelity Viewpoints: Should I buy a home or keep renting?
2. Invest with REITs
Real estate investment trusts (REITs) are similar to mutual funds. They're companies you can invest in that own and operate commercial property sectors such as apartment buildings, shopping centers, and hotels—many, but not all, trade on exchanges like stock.1 They offer a way to put real estate investing within reach of everyday people.
Pros
- Straightforward business model. Companies generate income by leasing space and collecting on its rent, then pay out to investors as dividends.
- Low up-front cost. Buying one share of a REIT is much more achievable for many investors than buying an entire property. If you invest with a broker that offers fractional shares, then you may be able to start with little money. To learn more, read more at Fidelity Viewpoints: Fractional shares in focus.
- Potential to earn ongoing income. Although REITs are generally set up to pay out regular dividends to their investors, beware that those dividends aren’t guaranteed. (A REIT can always reduce its dividend payments.)
- Professional management. By investing in a REIT, you can access the potential benefits of real estate investing without the headaches of management. Matters such as what properties to buy, what to do if a tenant is missing rent payments, or what to do if a property floods are in someone else’s hands.
Cons
- Requires research. If you’re going to invest in individual REITs, you may need to do some work to understand the REITs universe and choose specific investments.
- Subject to potential market volatility. Because REITs trade on exchanges like stocks, they can be subject to market fluctuations in the same way that stocks are.
- Taxation of the dividends. Most corporations face “double taxation,” because the company pays taxes on its income, and investors also pay taxes on their dividends and gains. REITs, however, qualify for special tax rules that most often allow them to pay no corporate income tax2 (although REIT investors still generally owe taxes on any dividends and gains).
- Comes with liquidity risks. Changes in real estate values or economic downturns can have a significant negative effect on issuers in the real estate industry. You may not get back what you paid.
Is investing in REITs right for you?
Investing in REITs might be right for you if you want to take a hands-on approach to real estate investing, but don’t have the financial means or interest to buy investment properties. Investors interested in learning more can explore Fidelity's real estate investing resources.
3. ETFs or mutual funds
ETFs and mutual funds are professionally managed portfolios that combine your money with other investors to buy investments.
Pros:
- Diversification. Both—ETFs and mutual funds can help everyday people diversify their portfolio by owning a variety of different investment types within the real estate sector, and in some cases with a small amount of money.
- Professional management. With a mutual fund or ETF, one or more professional portfolio managers handle the work of choosing the actual underlying REITs in the portfolio, and in the case of actively managed funds, monitor the portfolio and make changes as needed.
- Potential liquidity and tax advantages. Both offer some form of liquidity and some form of tax benefits similar to REITs.
Cons:
- Requires research. You may need to do some work to understand ETFs and mutual funds (and even their relation to REITs).
- Depends on fund management team. As with buying individual REITs, with ETFs and mutual funds, a lot of the control is out of your hands. Because ETFs are premade funds, you don't get a say in what they invest in.
- Cost. The management associated with and ETFs and mutual funds aren't free—typically an expense ratio (that can vary widely) comes out of your investment.
Is investing in real estate mutual funds or ETFs right for you?
Both can offer a diverse portfolio of real estate investments—at a cost, and might be the right fit for you if you're just getting started investing. Investors should pick the best choice for their specific investing needs, whether an ETF, mutual fund, or a combination of the two.
If you invest with Fidelity, you have many options to choose from including mutual funds and ETFs managed by Fidelity. You can also research mutual funds and ETFs offered by all providers, not only Fidelity.
4. Become a landlord
In the context of real estate, becoming a landlord relates to owning and renting property to tenants. It's an investing decision that requires financial resources, managerial skills, knowledge of rental laws, and more.
Pros:
- Build equity. Renting out your property offers you the ability to build equity over time as you receive rental income and apply it towards paying down the mortgage. Similarly, any increases in the property’s value may add to your equity.
- Potential inflation hedge. Owning an investment property provides this same possible inflation-hedging benefit as owning your home.
- Potential tax advantages. While rental income is generally taxable as ordinary income, there are tax deductions for a wide range of items—possibly including mortgage interest, property taxes, repairs, and depreciation that can help reduce the tax bill.
- Long-term potential for cash flow. Rental income can be a source of an additional stream of income.
Cons:
- High initial cost. You’ll need to build enough funds for a competitive down payment, and show your finances are strong enough to get approved for a mortgage.
- Lack of access to your cash. If something changed in your finances and you needed to free up cash, it might be hard to tap into the money that you have invested in your properties.
- High initial and ongoing effort. In addition to the work of finding, buying, and maintaining your property, there’s the work of finding and vetting tenants, managing your relationship with them, and making sure you’re abiding by any applicable laws and regulations.
Is becoming a landlord right for you?
Becoming a landlord might be the right choice for you if you're financially secure, you understand and are willing to accept the risks involved, and have the time required to successfully manage all the ongoing commitments and relationships that are involved in buying an investment property.
Is real estate investing right for you?
While there are several pros and cons, real estate investing can be rewarding, profitable, and can come with risks.
To learn more, read Fidelity Viewpoints: How to start investing, and 3 tips for choosing investments.