We never met the man, but Lex Luthor’s father gave his son some very practical advice about real estate: “Son, stocks may rise and fall, utilities and transportation systems may collapse. People are no damn good, but they will always need land and they will pay through the nose to get it!” Investing in physical real estate gives you the same feeling as holding cash rather than looking at a bank statement.
One of the more important realities of owning physical real estate is that it takes time to buy and sell because of all the paperwork. Another reality is that because it is a physical asset its value can change for any number of reasons – a depressed buyer’s market (see Great Recession), a change in property values, natural forces (weather, earthquakes, etc.) or the physical deterioration of the property. And then there are the taxes and potential legal issues that require the owner’s attention.
If you don’t want to deal with all of these potential time and money suckers, you can still invest in real estate and make a decent profit. We are going to take a quick look at three of the more common investment vehicles so you have a starting point to begin your search. The good news is we are not going to be making any recommendations of specific investments or companies because we know you like to make your own mistakes.
1. The Real Estate Investment Trust (REIT)
Chances are you have heard of these at one time or another. Basically you can choose from 5 different types of REITs:
There are several legal requirements REIT companies must adhere to, but the most important one to you as an investor is that it must pay out no less than 90% of its taxable income as shareholder dividends. This sounds great. But the key point here you must do your homework on is taxable income. The more income a REIT can divert away from being considered taxable, the less you will get as a shareholder.
So the best REITs generally will have the fewest expenses. All REITs must invest a minimum of 75% of their assets in real estate holdings and receive 75% of their gross (before tax) income from rent on the properties they own or interest received from mortgages. As you can see, the issue of taxable income comes right back at you.
2. Non-REIT Qualified Businesses
There are a number of other requirements to be classified as a REIT, and some companies don’t like the restrictions placed on them. For the investor the profits are not as high, but the advantage lies in the fact that they are free to grow and expand without being tied down by regulations. As an investor your REIT may make $250,000 to be distributed between 100 shareholders, but only 10% of that can be used for expansion and growth. A non-REIT qualified business may choose to distribute half of that $250,000 but has more opportunity to grow and invest in future projects. If there are opportunities for expansion and the two competitors are a REIT and non-REIT business, it is a good bet the non-REIT is better positioned to take advantage of the opportunity and benefit its investors. RE/MAX is an example of a non-REIT company.
3. Home Construction Companies
This hands-off real estate investment is obvious, but the question for the investor is what return on investment can be expected from the average home construction company. A number of factors need to be considered, but the 3 biggest are:
The reality of the stock market where timing is everything is also true with home construction industry investment. One of the financial numbers often heard on the news is New Housing Starts. Economies that are humming along will report a greater number of new housing starts, and that is good news for the investor. Economies that come to an unexpected halt usually bring housing construction to a halt.
A home construction company that invests in growing metropolitan areas is more likely to turn a major profit than one in a rural area. Building homes in areas that are economically depressed or are projected to lose jobs in the future will keep the number of new projects low and new home prices low.
Management is key because an experienced management team has made their share of mistakes and (hopefully) learned from them. They have a better sense of timing and know where the best locations are to begin new projects. Investors need to take their time in evaluating management as the company’s bottom line profit is often tied to management making the best decisions.
There are those who are wondering what happened to mentioning real estate mutual funds. They haven’t been forgotten, but of the available choices this is the one that is less of a hands-on investment. A real estate mutual fund is a group of stocks focused on real estate companies. In effect, someone else is making the decisions about the composition of the portfolio. Then there is an assortment of fees to be aware of after you cash in your profit.
Which non-physical real estate investment is right for you will be determined by your investment goals and the makeup of your investment portfolio. While not a big fan of real estate mutual funds, they are ideal for conservative investors. Compared to owning actual real estate, all of these investments are less risky and still have the potential to generate a high return on investment.