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Everybody needs a place to live and work. That makes real estate a more popular, intuitive, and easy-to-understand asset class than esoteric investments.
A recent study found that real estate is America’s favorite long-term investment. 31% of respondents said that real estate is the best way to invest money they wouldn’t be able to touch for ten years, compared to just 20% who chose stocks.
Besides it being intuitive, people choose to invest in real estate because it generates returns in very concrete ways.
Real estate investors can make money from appreciation, rental income, and profits generated by business activities, as well as interest payments earned from debt investments to fund real estate acquisitions and development.
Real estate can grow in value, but location is critical
1. Appreciation
Appreciation is the increase in the value of a property over time. It is the most common way in which real estate can generate profits.
You know conventional stock market wisdom—“buy low, sell high”? The same goes for real estate. Because the value is likely to go up, there is a good chance investors will earn a profit on the sale of the property if they simply hold it long enough.
The logical rebuttal is, “Well, what about the housing market crash in 2008?” Good question! The market is cyclical, and despite dips, most properties have not only regained the value lost in the crash of 2008, but have since realized an increase in value.
The chart below shows the median sales price of homes sold in the United States since 1963. You’ll notice that over time, that price trends up.
While time is usually the main factor in rising prices, there are other ways to drive property appreciation. Home improvement, such as remodeling a kitchen, fixing a roof, or putting in an extra bedroom or bathroom, is one way to increase the value of a property. This is exactly what you see in house flipping projects—a house flipper will acquire a property (likely at a discount), invest in home renovations, and look to quickly sell the property at a profit.
Appreciation is also largely affected by location, which is why you’ve probably heard the phrase “location, location, location” a million times in real estate. People want to be in the heart of a city or a neighborhood, otherwise known as “the intersection of Main and Main.” As a neighborhood evolves and gains convenient infrastructure like schools, shops, and transportation options, appreciation can accelerate. There is almost always demand for well-located properties, which in turn boosts the value of real estate in those areas.
Getting quality tenants isn't easy, but it's worth it
2. Rental Income
The second way investors earn profits from real estate is through rental income. Here’s how it works: an investor buys a property and leases it out to tenants. Rental payments provide a regular income stream and can offer the potential for passive income. However, it’s important to have reliable, creditworthy tenants—as a property owner, your investment depends in part on those steady rental payments.
Tenants usually pay a fixed rate per month, which may increase depending on inflation, demand, or other factors. Again, this is why real estate location is important. Well-located properties enjoy higher tenant demand and a higher likelihood of fetching market rate rents.
It can be a lot of work to own and manage a property—being a landlord is not for the faint of heart. Fear not: as an investor, you can access rental income in a number of hands-off ways. Two such options include investing in Real Estate Investment Trusts (REITs) that manage rental units or crowdinvesting on Republic, which aims to capture real estate growth opportunities through thematic investing strategies. By investing in companies or trusts that handle the management of the investment property, you can reap the benefits of real estate cash flow without doing the work. .
Commercial real estate is a diverse game, with many different business models
3. Business Activities
Though residential real estate is the world’s largest asset class, it is not the only type of real estate. Other types of property investments, especially commercial real estate, can be equipped with amenities that produce additional profits. This extra revenue can flow through to the investor, in addition to fixed rental payments.
Here are some examples of business activities that can generate returns to investors:
A hotel might make money from selling minibar snacks, charging guests a Wi-Fi fee, or charging for early check-ins, among other things.
An office building might make money from vending machines or charging additional fees for storage.
A shopping mall might make money from parking garages.
It’s no surprise why hotels upcharge for all their services and amenities…
Financing development is risky, but can be very lucrative
4. Interest from loans
In real estate, it is rare for someone to pay for a property up front, all in cash.
Most properties are financed with loans, or an arrangement where investors lend money to a real estate developer or owner and earn money from interest payments on the principal of the loan. This type of debt investment is commonly used by REITs, private equity firms, and real estate investment platforms.
There can be several types of debt within the capital stack. The capital stack refers to the organization of all of the capital from different investors that goes towards financing a real estate transaction. Importantly, it defines who has the rights (and in what order) to the profits and income generated by the property.
The capital stack can include equity, mezzanine debt, junior debt, and senior debt. Senior debt is the foundation of the capital stack, which means that investors in the senior debt of an investment are “more senior” to everyone else, so these debt holders will be repaid before any other capital contributors.
This brings us to another important concept: debt can be secured or unsecured. The distinction between secured and unsecured defines an investor’s rights in the event that the property is foreclosed upon or the loan defaults.
Senior debt is typically secured by a mortgage or property, which serves as collateral for the loan. This means that it poses the least amount of risk, and therefore, typically generates the lowest return in the capital stack. Unsecured debt usually has higher returns, but it has no collateral backing.
Investment income from loans is attractive to many investors because it can provide consistent cash flow in the form of passive income. As a debt investor, you do not gain any ownership in the company or property (in contrast to equity investment). Therefore, in this scenario, you are profiting from a property that you don’t own.
A note of caution
While we’ve elaborated on the ways investors can make money in real estate, like any investment, no thing is a sure thing. All investments have a risk/reward profile, and real estate has its own unique set of risks. There is always a chance that a property could need maintenance and repairs, a house could flood or even burn down, a tenant could miss rental payments, or a mall could close. All of these expenses get factored into the bottom line and could impact the return on your investment. Part of your job as an investor is to ensure that the sponsor of the transaction is well-equipped to deal with these scenarios and has experience managing such investments.
Conclusion
Real estate offers investors several proven methods for making profits—through appreciation, rental income, business activities, and interest payments from loans. For years, real estate has generated incredible wealth for people through these methods. Though the benefits of real estate are quite obvious, it can be expensive and a lot of work to manage on your own. The good news is that now, you don’t have to! You can invest in real estate with sponsors who will manage the investment right on Republic. Check out the latest opportunities today.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
