Is there a safe way to invest in real estate?
You have decided to invest in real estate. Now what?
Real estate has been a hot commodity lately, generating outsized returns. But there are so many options: buying local property, crowdfunding sites, index funds and more.
Which option is right for you? And what does silver expert Clark Howard have to say on the subject? Read on to find out.
Break down the 3 most important real estate options
1. Buy rental properties
|• You control the timeline, transactions and usage.||• Buying a property can be very expensive.|
|• You will have the opportunity to earn passive income.||• There is a good chance that you will have maintenance and management problems.|
|• The underlying asset can increase in value while generating income.||• A single rental property represents a concentrated (risky) bet.|
You probably know someone who owns and operates at least one rental property. It is a common way to invest in the real estate market. And that includes those two magic words: “passive income”.
However, it may require a lot of upfront capital (or a large loan) to acquire a rental property. Depending on your overall financial situation, this can be a disproportionate portion of your wallet. In other words, you run the risk of lacking diversification.
2. Invest through crowdfunding sites
|• These sites offer the potential for higher returns than a REIT index fund or ETF.||• These investments tend to be quite illiquid.|
|• Depending on the site, you can choose your own projects or invest more widely.||• Sometimes crowdfunded real estate sites require you to be a qualified investor.|
|• These investments may appear more interactive and provide a level of enjoyment to participants.||• The fees charged by these sites can be extreme.|
I’ve seen dozens of social media and content website advertisements for these types of investments over the past few years. They have manifested themselves more and more frequently.
Names like Fundrise, Crowdstreet, DiversyFund, and others have seen massive growth in the real estate crowdfunding space. Clever ads and modern websites include phrases like “Invest like an insider” and “Built to help smart investors invest smarter”.
There is no single version of these investment vehicles. But they often charge high fees and lock your money up for years.
In some cases, you’ll have the opportunity to select specific projects or interact with a community of like-minded people, all trying to identify the best choices. In this sense, it is therefore more participatory than a traditional stock market investment.
But in many cases, as Clark likes to say, it’s better to be bored when it comes to investing for the long term.
3. Index funds of REITs and ETFs
|• This option generally offers much lower fees.||• Your chances of getting outsized returns are probably minimal.|
|• It’s easy to get your money in and out whenever you want.||• Many people may find it a less attractive investment.|
|• Well-diversified options are easy to find.||• You will have less control.|
Some of the most respected investors of all time have preached low fees, diversification, and a long-term approach.
REIT index funds and ETFs offer it all. (REIT stands for Real Estate Investment Trust.)
Just like real estate crowdfunding, this option gives you a number of choices as a consumer. Some REIT offerings are concentrated in very few properties. Others offer exposure to a variety of different properties and locations.
Instead of locking in your money for years, you can buy and sell REIT stocks anytime the market is open. There is no penalty for early sale.
This is a less risky approach than some of the other options. But the returns with REITs, while unsecured, can still be great. According to the Nariet Index of Listed REITs, they outperformed with annual returns of 11.6% for the 20-year period ending December 2019, compared to 6.1% for the S&P 500.
Clark’s Warns of Hidden Downsides of Crowdfunded Real Estate Investments
One of Clark’s podcast listeners recently asked what the crowdfunding options were and if crowdfunding was a good investment idea.
Clark’s biggest caveat: the outsized fees these companies often charge. They are generally at least 1%. Compare that to the Vanguard Real Estate Index Fund with an expense ratio of 0.12%, or almost 1 / 10th the cost (with a 10-year return of 11.5%).
You will often have to pay hefty penalties on top of these fees if you need to withdraw your money early. Many of these projects require you to lock in your funds for years.
“The real problem, anytime you get into a real estate partnership, is what are the underlying expenses you have to pay to be part of it,” says Clark. “There should be a backgrounder available to you that specifies that. I really want you to dig in and see what the underlying expenses are.
“The other thing is that when you get into any of these things, it’s called ‘illiquid’, which means if you need the money at some point during the cycle that you have accepted, the money is not available to you. “
Why Clark Approves REIT Index Funds and ETFs
Clark made his preferences clear on a recent podcast. If you are considering investing in real estate, investing money in a REIT index fund or ETF is the least risky option.
“There are choices you can enter [that are] Ultra low cost where you diversify into smaller chunks of all types of real estate with the ability to get in and out at will, as you wish, ”says Clark.
He points out that often the fees you pay determine your future wealth more than your annual returns. And even if you are investing for retirement decades away, being able to access your money without incurring financial penalties (beyond paying income taxes) can give you peace of mind.
Is It Safe To Invest In Real Estate?
By nature, investing is risky. In theory, you could lose every dollar you invest. The money is not protected as if it were in a savings account with FDIC insurance.
However, inflation combined with today’s low interest rates mean that keeping all of your money in the bank will erode the purchasing power of your dollars over time.
For most people, investing is an important part of being financially prepared to support themselves in retirement. But there is a huge difference between putting every penny you earn into an ultra speculative penny stock and spreading your money over a number of full index funds or ETFs.
Clark often says that we should invest in the future of capitalism rather than in the future of individual companies. Real estate assets aren’t necessarily businesses, but the same ideas apply.
Across your portfolio, you can invest every dollar invested in a target date fund, never think twice, and prepare well for retirement. So, in Clark’s mind, for most people, investing in real estate is an unnecessary complication. At the same time, there is nothing wrong with it in moderation.
Within real estate investing, it is less risky to invest in a large basket of properties via an index fund or ETF than it is to put all your real estate funds in a single property or project.
It is difficult to offer general statements about investing. Your specific goals, financial situation, tolerance for risk and other factors are very important in determining which investment vehicle is right for you.
If you really need investment advice, consider hiring a financial fiduciary advisor, even on a temporary or hourly basis.
That said, if you only consider one factor when evaluating real estate investment options, prioritize paying as few fees as possible.
Clark’s advice on real estate investing is very close to his philosophy in the stock market: Avoid fees, reduce your risk through diversification, and aim for as much time as possible in the market.