What Is Investment Real Estate?

Investment real estate is real estate that generates income or is otherwise intended for investment purposes rather than as a primary residence. It is common for investors to own multiple pieces of real estate, one of which serves as a primary residence while the others are used to generate rental income and profits through price appreciation. The tax implications for investment real estate are often different than those for residential real estate.

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Introduction To Investment Real Estate

Key Takeaways

  • Investment real estate can provide opportunities for investors to build wealth, increase income, and diversify an investment portfolio.
  • Residential investments typically involve homes, townhouses, and condominiums.
  • An investment in commercial real estate might involve the ownership of retail stores, office buildings, or storage facilities and warehouses.
  • Investment real estate can create capital gains for investors due to increases in property value as well as provide rental income.

Understanding Investment Real Estate

Investment real estate can provide opportunities for financial gains to investors. Owning investment properties can help build wealth, increase income, and help diversify an investment portfolio. Although there are many types of properties in the real estate market, primarily, most properties can be broken down into two classifications.

Residential

Investment real estate can include residential land and properties. Residential investments typically involve homes, townhouses, and condominiums. Residential properties can be multi-family or single-family units.

Commercial

An investment in commercial real estate might involve the ownership of retail stores, office buildings, or storage facilities and warehouses. Investment in commercial real estate is typically more involved and costly than residential investments. Commercial property leases can be longer than a residential rental agreement. Both the costs and profitability are usually measured on a per-square-foot basis.

Benefits to Investment Real Estate

The benefits of investing in real estate are numerous and can vary depending on the goal of the investor. How much money to invest in a real estate property can depend on the investor's risk tolerance. Also, an investor's time horizon is important to consider when making such a large purchase or investment. 

Some investors invest in real estate to diversify their money away from the stock market. Other investors want their money invested in physical assets instead of securities, such as equities or bonds. Two of the primary benefits of investing in real estate, both residential and commercial, include:

Capital Appreciation

Investment properties can realize capital gains for investors due to property value increases over time. A capital gain is a profit that results from the difference between the original purchase price and the sale price of the property. Of course, investors can only realize the capital gain after they sell it. 

However, prices have risen dramatically over the last few decades as demand for housing has increased. Both supply and demand play a role in earning capital gains from real estate. If there are fewer properties in a geographic region or less supply, property prices tend to appreciate–all else being equal.

Rental Income

Many investors buy real estate for the steady stream of income that it provides. Whether it's a residential or a commercial property, renters or occupants pay the owner each month until the rental agreement or lease expires. This revenue stream can offer a stable income for retirees and others who are looking for an alternative source of income besides income from holding investment securities such as bonds or stocks. Income from real estate can also act as a hedge or protection against stock market downturns and rising prices of consumer goods.

Ways Investment Real Estate Can Be Managed

Leveraging investment real estate can follow numerous paths. An investor might join a real estate investment group that pools its funds to acquire properties. The owner or owners of investment property may hire property managers to oversee the day-to-day upkeep and rent collection for a piece of real estate or an entire portfolio.

A real estate investor could also look to serve on the lending or funding side of projects with an expectation of a return on their investment. For example, investors could be the lenders behind hard money loans for real estate. The borrower in such an instance will likely pay higher interest rates to receive the funds and will need to repay the loan in short order. The lender might agree to the loan in the hopes of taking ownership of the property should the borrower default especially if the property has the potential for greater resale value.

Investment real estate can take the form of a piece of property that is in disrepair, or otherwise underdeveloped that is refurbished with the intent to rent the space for a long-term return. The owner of the property might seek financing to cover the cost to improve the real estate and make it more attractive to tenants.

A real estate investor could acquire a property based on an expectation that demand for space will increase because of external factors. New attractions such as a sports arena or infrastructure development, such as a highway extension, could make neighboring properties highly desirable. For example, a real estate investor might buy a commercial property next door to the site for a new theater that is under construction. The assumption is that there would be increased foot traffic passing by the purchased property, which would make the location a prime choice for retailers. The increased demand could provide the owner with the opportunity to alleviate rent prices as well.

Risks to Investment Real Estate

Real estate can involve a significant amount of upfront capital and debt in the form of borrowing from a bank. Also, it doesn't provide an immediate financial gain, meaning it can take many years to make a profit or get back the initial investment.

Economic downturns can cause difficulty in finding tenants, particularly with commercial properties. If businesses are going out of business or losing money, they may be unable to pay their rent. In a recession, it can be quite difficult to find tenants for commercial properties. As a result, the owner would have to pay for the upkeep of the property and any mortgage payments to the bank for buying the property.

There are also risks to investing in residential properties. Difficult situations can arise with managing the tenants. Cost overruns for refurbishing or repairs can occur, which the investor may need to commit additional funds. Tenants can always have an emergency in the middle of the night, which can lead to more time spent managing the property.

The good news is that real estate investors can hire a property manager to manage and oversee the repairs and collection of rent payments. However, the cost of a property manager will eat into the monthly income received, which would translate into a longer time before the property turns a profit, and the investor gets the initial investment back.