Before you can start to invest in real estate, you need to first ask yourself how much risk is acceptable. I know, I know, that’s one of those vague questions they ask you when completing some 401k enrollment form, but it’s even more important when it comes to real estate investments as the money you invest will not be liquid.
Basically, the most liquid of all investments is cash. When you have $1,000 in your bank account, it can be exchanged for $1,000 in cash or exchanged for goods or services worth $1,000 any time just by visiting an ATM. Stocks and bonds are also relatively liquid as you can sell them at any time for cash. Say you buy 100 shares in AETX Company for $10 in November. It’s now January and you want your money back. AETX is now trading at $9 a share so you can sell your 100 shares at $9 and you’ll get $900 of your initial investment back. However, if you were to wait another year, the stock might be worth $15. That’s a risk you take when investing in securities (see Understanding Liquidity).
With real estate and other tangible assets, your investment is the opposite of liquid — called illiquid (see Is Real Estate A Liquid Investment). Basically that means it’s much harder to get your money out of a real estate investment. So if you buy a house for $100,000, you can only get that money back once you sell it. Plus there are barriers to selling real estate, such as needing to list the property, sales commissions, and title fees that all eat into your profit.
Before going out and buying any real estate, it may be easier to start with professionally managed real estate investments like real estate investment trusts (REIT), mutual funds mutual funds, and exchange traded real estate funds. REITs can be great because your risk is balanced. However, by balancing your risk, it also means your returns are also somewhat capped (see How to Invest In Real Estate Without Buying a House). Another option is to look to a professional mutual fund investment company like Fidelity or T. Rowe Price. (see Fidelity Real Estate Investment Portfolio). You will pay a little to the company for its advisors to buy and sell assets on your behalf, but the investment is relatively liquid. Another options is to buy an exchange traded fund focused on real estate (see Real Estate ETFs). The difference here is this fund in not actively managed — rather each one has a specific formula for what it buys (such as all residential real estate, all commercial, only hotels or a mix of everything).
This is not to discourage investing in real estate — just to understand that whatever money you invest in real estate, it’s important that you don’t need it to buy groceries next week. And there are ongoing costs to consider with real estate, such as maintenance and taxes. There are ways to balance risks, such as going in on an investment with several partners. Called real estate syndicates, this helps balance the risk while giving you a better chance of higher returns. However, your money is still illiquid, and then there is a risk of being in business with anyone else. However, it would allow you to start with a smaller investment and learn from professionals along the way (see What Is Real Estate Syndication?)
