Here are some of the questions you’ll need to ask yourself:
Do you want to be an active or passive investor?
Investing in real estate can be as active or passive as you choose. Buying rental property and managing it yourself will involve time and effort unless you hire someone to manage it for you. If you’ve never been a landlord, be sure to talk with other landlords to get a sense of the potential rewards and pitfalls. Other real estate investments such as real estate investment trusts, exchange-traded funds, mutual funds, real estate limited partnerships or raw land demand less day-to-day involvement. If you’re investing simply to diversify an investment portfolio, those may satisfy your needs without the challenges of owning property.
However, bear in mind that the same factors that can influence the value of a direct real estate investment – the negative impact of a drop in real estate values generally, economic downturns, rising interest rates that affect the cost of obtaining a mortgage, changes in property taxes or zoning laws, demographic changes, natural disasters and many other factors – can also have a significant negative effect on REITs, mutual funds and ETFs.
Are you investing for income, capital appreciation, personal use, or a combination?
Real estate investments can offer potential for all three but there is often a tradeoff among them. For example, raw land may have development potential, but it likely will not provide any return until that potential is realized. You may be able to earn income from rental property that has the potential to increase in value over time, but your ability to use it yourself will be limited if you want to enjoy a rental’s tax benefits. Ranking your priorities can be useful.
Are you looking for a quick return or long-term
Real estate speculators have been known to earn high profits from buying distressed property, fixing it up, and reselling it at a profit, especially in a buyer's market. However, the real estate market is notoriously cyclical. If you're speculating, hoping for a quick return on your capital, the liquidity of a real estate investment will be important to you; so will making sure you don't overpay to begin with. If you have a longer time frame, you may have a wider range of investing options.
Is real estate going to be a full-time business for
you or a sideline?
Some real estate investors find that what they intended as a hobby or retirement diversion quickly becomes more than they can handle. Think about just how much time and capital you’re prepared to devote to your real estate investments, and how much of a cushion you have in case things don’t work out as expected. The bottom line: don’t rule out real estate in your investment mix. Make an appointment with a local certified financial planner to discuss whether a real estate investment makes sense for you.
Joe Jackson is a Certified Financial Planner™ with Highland Financial Management.