On the highest-effort end of the spectrum, you can invest in residential or commercial real estate property to lease out or sell for a profit later. The benefits can include tax advantages, a steady stream of passive income, and the potential for long-term security and high returns. On the other hand, realizing returns may take a while, maintaining rental property takes time and money, and you run the risk of declining market value and occupancy demand.

Many investors go for the much lower-effort and lower-barrier option of purchasing shares in a Real Estate Investment Trust (REIT), which can help you diversify your portfolio by gaining exposure to the real estate industry without having to buy any rental property. Other options for real estate investing include using an online real estate platform, renting out a spare room, or house flipping. Depending on the amount of time and money you want to put in, you may find a real estate investing strategy that works for you.

In this article, we’ll cover:

• Buying REITs
• Online real estate platforms
• Renting out a room
• Buying rental property
• Flipping houses

1. Purchase a REIT (Real Estate Investment Trust)

Effort required: Low

A REIT, short for Real Estate Investment Trust, is a company that owns, operates, or finances income-producing real estate. Types of residential or commercial real estate may include a wide array of properties such as: 

• Apartments
• Office buildings
• Shopping malls
• Hotels, resorts
• Self-storage facilities
• Warehouses
• Hospitals
• Infrastructure

You can also invest in mortgages on those properties. The company earns money from renting or leasing the rental property it owns or, in the case of mortgage REITs, from interest on mortgages and mortgage-backed securities. REITs work similarly to mutual funds by pooling the capital of many investors. When you buy shares in a REIT, you can then earn dividends from the shares you own without having to purchase, manage, or finance property yourself. Most REITs are registered with the Securities and Exchange Commission and publicly traded, which can allow more people to get exposure to the real estate sector. If you’re looking for the easiest way to diversify your portfolio with real estate investment, a REIT or an exchange-traded fund (ETF) that includes REITs may be worth exploring. 

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2. Use an online real estate platform

Effort required: Low

Online real estate platforms connect real estate developers with individual investors who want to finance projects, either through debt or equity. You might think of them as crowdfunding platforms specifically for real estate. Generally, investors pay a fee to the platform and take on a significant amount of risk with the hope of receiving monthly or quarterly distributions. While online platforms make real estate investing a bit more accessible to investors who don’t want to own or maintain property directly, the income requirements may be prohibitive. Many of the platforms are only open to accredited investors, people who’ve earned more than $200,000 in each of the last two years, or who have a net worth exceeding $1 million. However, there are some alternative platforms with lower account minimums available to nonaccredited investors. You may be able to get started with $1,000, $500, or even as little as $10.

3. Rent out a room in your house

Effort required: Medium

If you already own a home, you may consider renting out extra space to generate income. Rental income from a spare room, basement apartment, or converted garage can help offset the cost of your monthly mortgage payment. Knowing that you’ll be sharing expenses may also make the prospect of financing a more expensive property feel within reach. But unlike splitting rent with a roommate, when you own the home, the person living with you is your tenant. That means your passive rental income stream comes with obligations like tenant management, property maintenance, and adhering to strict landlord-tenant laws. You may also wish to keep in mind that living with a stranger may be uncomfortable or pose safety risks, especially for vulnerable people who are often the targets of hate-based violent crime. 

4. Buy a rental property 

Effort required: High

While this option may not be accessible to most average investors, purchasing a property specifically for rental to long-term tenants or short-term vacationers definitely gets you into the real estate market. If you’ve got the financial means and the inclination to be a fair and responsible landlord, buying a rental property might be the right investment for you. Long-term, single or multi-family rentals can generate monthly passive income from rental contracts. Short-term rentals, properties typically rented for vacations or stays of less than 12 months, are also passive income generators. But your passive income stream won’t come without the hard work of property maintenance and tenant management. There are also risks like damage to your property, low demand leaving the space sitting vacant, and the inability to quickly and easily sell if you want to convert your investment to cash. 

5. Try your hand at house flipping

Effort required: Highest

If you’re a truly adventurous investor, you may want to try your hand at flipping houses. House flipping involves buying a property, holding onto it for a short time, and selling it for profit. Sometimes the flip involves renovating a fixer-upper before selling, but it may be as simple as holding the property until you can sell it for more than you bought it. In either case, the goal is to buy low and sell high, usually within a year. House flipping generates active income rather than passive, and it’s a classic spend-money-to-make-money scenario: you’ll need to pay the costs associated with buying and selling a house, which can eat into your return. This kind of real estate investment can turn into a full-time job before you know it; even if you don’t renovate the property, it’s a lot of work to find the right house, secure a mortgage, make the purchase, maintain the property, and get it sold. You’ll need a strong knowledge of the local real estate market, but at the end of the day, you could be set to make a tidy profit if you make smart moves. 

Real estate investing within reach

Investing in real estate can take a significant amount of capital and credit, so options like purchasing a rental property or flipping a house may not be accessible to all investors. It’s also worth noting that financial barriers aren’t the only challenges to buying investment or rental property; discrimination against marginalized populations can make it harder to get a mortgage loan for some people, and growing public concern about the effect of house flipping on home prices in historically lower-income neighborhoods can make that route unappealing to some.

Lower barrier options like investing in REITs or using an online investment platform make it easier to dip your toe into the real estate market and diversify your portfolio. When you’re deciding how to invest in real estate, you might look for options with the lowest barriers to entry, like REIT ETFs that offer fractional shares, to get you started. 

As with any type of investing, the real estate investing strategy you choose should align with your risk tolerance, time horizon, current financial state, and future financial goals. If you’re ready to start investing, consider building a diverse portfolio that includes multiple types of investments and focus on building wealth for the long term.  

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Individual investors, like yourself, can buy shares in a REIT, which allows you to earn dividends, or a share of the company’s income. Since many everyday investors aren’t likely to have the cash to purchase, lease, and manage properties, REITs can allow more people to get exposure to the real estate sector in their investment portfolios. 

In this article, we’ll cover:

• How REITs work
• Types of REITs
• Pros of REITs
• Cons of REITs

How do Real Estate Investment Trusts work?

There are two primary ways people invest in the real estate sector: buying property or buying shares in a REIT. Congress established REITs in 1960 to lower the barrier and allow individual investors access to large-scale, income-producing real estate. Before 1960, that kind of investment was only available to those who could afford direct real estate investment through purchasing properties, such as wealthy individuals or companies, often using large financial intermediaries. 

With REITs, investing in real estate is more accessible to the average individual. REITs work similarly to mutual funds by pooling the capital of many investors. Investors buy shares in a REIT, and can then earn dividends from the shares they own without having to purchase, manage, or finance property themselves. 

Criteria to qualify as a REIT

REITs enjoy some special tax benefits, and real estate companies must meet several criteria set by the IRS to qualify as a REIT. First, REITs must primarily buy and operate properties as part of their investment portfolio, versus “flipping” real estate by purchasing, developing, and then reselling the properties. Further, a REIT must have the majority of its income and assets connected to real estate investments. 

From there it gets a bit more complicated. Additional criteria for a REIT include:

• At least 90% of its taxable income must be distributed as dividends to shareholders annually 
• At least 75% of its total assets must be invested in real estate and cash
• At least 75% of its gross income must be derived from real estate-related sources, including rent and interest on mortgages
• At least 95% of its gross income must be derived from real estate sources and dividends or interest from any source
• No more than 25% of its assets may consist of non-qualifying securities or stock in taxable REIT subsidiaries
• No more than 50% of its shares can be held by five or fewer individuals
• It must be an entity that would be taxable without the special REIT tax treatment
• It must have fully transferable shares
• It must have a minimum of 100 shareholders after its first year as a REIT
• It must be managed by a board of directors or trustees

Types of REITs

There are a few different types of real estate investment trusts. Most are publicly traded REITs, registered with the SEC and available for trading on major stock exchanges, similar to mutual funds. Others, known as non-traded REITs, are registered with the SEC but are not publicly traded. Finally, private REITs are neither registered with the SEC nor available on securities exchanges. REITs are further divided into three asset types: 

1. Equity REITs: The majority of REITs are publicly traded equity REITs that own or operate income-generating real estate
2. Mortgage REITs: Also known as mREITs, these REITs hold mortgages on real property and earn income from the interest on those investments 
3. Hybrid REITs: This type of REIT takes a diversified approach, investing in both mortgages and properties

Equity REITs can be broken down even further based on types of property; it’s common for REITs to specialize in one type of property. 

• Office REITs
• Industrial REITs
• Retail REITs
• Hospitality REITs
• Healthcare REITs
• Residential REITs
• Timberland REITs

Office REITs

Office REITs own and operate office real estate and rent space in those properties to businesses. The properties can range from office parks to skyscrapers. Some focus on specific types of tenants or markets as well. For example, an office REIT might primarily lease offices to biotech firms in suburban areas.

Industrial REITs

Industrial REITs own and manage industrial real estate spaces like warehouses and distribution centers. They generate income by renting out space in those properties. Industrial REITs are playing an increasingly important role in e-commerce and the demand for rapid delivery. Companies like Walmart and Amazon rely on industrial REITs for their delivery and distribution operations.

Retail REITs

Retail REITs focus on managing and renting space in outlet centers, large regional malls, strip malls, grocery-anchored shopping centers, and power centers that feature big-box retailers. For example, Tanger Outlets is one of the largest retail REITs in the U.S. The company’s shopping centers rent space to well-known retailers like Gap, H&M, and Nike.

Hospitality REITs

Hotels, motels, luxury resorts, and business-class hotels may all be owned and managed by hospitality REITs. They generate income by offering accommodations, conference venues, meals, beverages, and other services people need for large gatherings or when they travel. Many well-known hotel brands, including Hilton and Marriott, operate out of REIT-owned real estate.

Healthcare REITs

Hospitals, senior living facilities, medical offices, and skilled nursing facilities are among the properties developed, owned, and managed by healthcare REITs. Tennessee-based REIT Community Healthcare Trust, for example, has 161 properties across 34 states in its portfolio, including surgical centers, hospitals, physician clinics, and behavioral specialty facilities. Healthcare REITs may tend to generate a stable revenue stream due to the consistently high demand for healthcare-related services. 

Residential REITs

These REITs specialize in apartment buildings, single-family homes, student housing, vacation homes, and manufactured homes. They generate revenue by renting space to tenants in those properties. Some residential REITs focus on specific geographical markets or property classes, such as high-rise buildings in urban areas or suburban, single-family family dwellings. 

Timberland REITs

While other REITs concentrate on owning buildings or other facilities, timberland REITs focus on owning and managing land used to grow, harvest, and sell lumber. They sell to lumber mills and wood product manufacturing facilities owned by the REIT or a third party. Timberland REITs may also maximize the value of their land holdings by selling portions for other uses like housing or conservation.

Pros of investing in REIT stocks

The wide variety of REIT investment opportunities appeals to a lot of investors. And they allow you to diversify your portfolio by investing in the real estate sector, which is known for delivering steady income over time. Another upside for investors comes from the special tax advantages REITs enjoy. They’re allowed to deduct all the dividends they pay to shareholders from their taxable income, so they usually pay out 100% of their taxable income, which benefits both the company and the shareholders.

Additional benefits of investing in REITs include:

• They can be an accessible way to diversify your portfolio with real estate holdings, which can help protect your portfolio if other investments underperform
• They’re typically listed on national exchanges, making them accessible to investors
• They may help to protect your returns if other investments in your portfolio underperform during certain periods
• They’re known for generally paying healthy dividends and helping you build a passive income flow 
• Unlike other stocks, which can choose whether or not to pay dividends, REITs are required to distribute profits via dividends

Cons of investing in REIT stocks

As with any type of investment, there are potential downsides to investing in REITs. In addition to the typical risks of investing, such as potential market volatility, REITs are subject to some variables specific to the real estate sector, such as the possibility that property values will decline or demand for rental space will fall. The way REIT dividend income is taxed may also be a deterrent, which is why some investors prefer to hold REIT shares in tax-advantaged retirement accounts. 

The cons of investing in REITs include:

• REITs are especially sensitive to interest rates; when interest rates are high, REIT returns might fall because the company may depend on borrowed money to finance its real estate purchases 
• You usually have to pay ordinary income tax on dividends, unlike other investments that may allow you to pay a lower capital gains tax rate 
• REITs may have high up-front fees or sales commissions, along with annual management fees that can put a dent in your returns
• REITs are typically subject to the same risks as the real estate market, including fluctuations in property value and geographic demand
• Income is dependent on occupancy levels and the underlying business or industry that leases the properties

Diversifying your portfolio with REITs

When you’re looking for ways to diversify your portfolio, REITs could be one avenue to putting your money into another sector, giving you access to the expansive real estate market without buying or managing a property yourself. Diversification can be an important strategy for protecting your overall investments because losses in one asset class or sector can be balanced by gains in another. Many investors also appreciate earning passive income in the form of dividends. 

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Frequently asked questions about investing in REITs

How do you make money with a REIT?

Real estate investment trusts generate income for investors by distributing their profits in the form of dividends to shareholders. They earn profits either through renting space in the properties they own and manage or, in the case of mortgage REITs, through interest payments on the mortgages they own. 

Is a REIT a good investment?

REITs can be a good way to invest in the real estate market if you don’t have the funds, time, and expertise to purchase and manage a property yourself. Some investors also put their money into REITs due to the typically healthy dividends. However, as with any investment, there are risks to consider.

Do REITs have to pay 90%?

Yes; to qualify as a REIT, the trust must distribute at least 90% of its taxable income to its shareholders.

Is a REIT better than stocks?

In the eyes of many experts, the value of REIT shares tends to be more stable than stocks. REITs have also outperformed stocks on 20-to-50-year horizons, as well as in the latest full year of data.

Why are REITs better than stocks?

Neither security is necessarily better or worse; it all depends on your investing goals. Many investors opt for REITs because they are guaranteed to pay dividends. Stocks, on the other hand, are not required to pay dividends, and even those who do may opt not to do so at times. 

Do REITs have tax advantages?

REITs themselves enjoy special tax treatment; the company can deduct all of the dividends it pays to shareholders from its corporate income tax. For investors, however, there’s usually no tax advantage, and you may even pay more in taxes because REIT dividends are usually taxed at your normal income tax rate instead of the capital gains rate. That’s why some investors prefer to hold shares of REITs in tax-advantaged retirement accounts, like an IRA.

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