What is Real Estate?
Real estate refers to land, the buildings on that land, and its natural resources, such as crops and minerals.
Real estate is property made of land and anything that is permanently attached to it, such as houses, buildings, and warehouses. The real estate market is grouped into four categories: residential, commercial, industrial, and vacant land. You can invest in real estate directly by purchasing property — such as a home, apartment building, store, or vacant field — or through REITs, real estate mutual funds, real estate ETFs, and real estate investment groups. Investing in real estate has benefits and risks.
A young couple buys their first home. The house itself, the land it sits on, and any buildings on the property — say a shed or guest house — are residential real estate. Years later, this young couple wants to open an ice cream on Main Street. They buy a store; this is commercial real estate. Many years later, they want to build an ice cream factory. They buy land far outside the town center and build their ice cream factory; that land and factory are industrial real estate.
Real estate is like an automobile (that you can’t move)...
There are many different types of automobiles — some for personal use, some for business, and some for industry. You can buy them, sell them, or hold them as an investment or for your personal use. Unlike a car, though, real estate is fixed in place in perpetuity.
Real estate is tangible property consisting of land and anything on it, including buildings and natural resources. On the other hand, real property includes real estate plus the legal rights attached to real estate.
You can touch real estate as it is tangible, whereas real property can be tangible or intangible. For example, real property — as opposed to real estate — may include the right to live in a building or on a piece of land (as opposed to referring to ownership of the land itself).
There are four broad categories of real estate: 1. Residential 2. Commercial 3. Industrial 4. Vacant land
Residential real estate: properties where individuals and families can live. You can buy residential properties to earn rental income. Single-family homes, condominiums, townhouses, duplexes, and vacation homes are examples of residential real estate.
Commercial real estate: includes apartment buildings, office buildings, shopping malls, hotels, and other businesses. Leases are generally shorter, and down payments are usually larger than for residential real estate. Profitability per square foot determines returns, unlike residential real estate. Commercial properties are often more valuable than residential properties. They also tend to be more regulated.
Industrial real estate: properties used for manufacturing, processing, warehousing, or retail purposes. Factories, warehouses, and research centers are examples of industrial real estate.
Vacant land: includes empty land, vacant lots, and reclaimed sites.
The real estate market consists of all properties available for sale in a given area. The housing market is a segment of the real estate market that includes residential properties only. Economic forces can cause properties’ value to rise (or fall) within a market.
Since the value of real estate tends to rise over time, people can often make a profit by buying and selling real estate. A real estate business buys, sells, manages, or invests in real estate properties.
The real estate industry has different areas:
Real estate agents have passed the required licensing exams in the state where they intend to work. They must work under a licensed broker in most states. Agents help people buy or sell homes by putting together buyers and sellers and negotiating on their behalf. They usually work on commission, receiving a percentage of a property’s sale price.
Real estate brokers are agents that have continued their education and obtained a broker license. Brokers can work independently or hire other agents. A real estate associate broker is an agent who works under a licensed broker and can share in profits beyond the usual agent’s commission.
Realtors can be agents or brokers. They are members of the National Association of Realtors (NAR) and must abide by the association’s standards and code of ethics.
There are many ways to invest in real estate. Here are some common examples: 1. Direct investment in real estate 2. Real estate investment trusts (REITs) 3. Real estate mutual funds 4. Real estate ETFs 5. Real estate investment groups
Here are the characteristics of each one:
Direct investment: You make a direct investment when you buy a property or a stake in one. Homeownership is the most common direct investment in real estate in the United States. A rental property is another direct investment. You buy a rental property to make a profit by selling the property at a higher price than the price you paid for it or to earn income by collecting rent. Buying properties to hold them for a short period and then selling them for a profit is called flipping — This technique requires buying undervalued real estate. As with all investments, returns are never guaranteed.
REITs: A real estate investment trust (REIT) combines the money of many investors to buy and operate real estate property. A REIT works something like a mutual fund. It allows small investors to own a share of the income produced by real estate properties, such as shopping centers or warehouses. You can invest in specialized REITs, such as retail REITs, residential REITs, and industrial REITs. REITs are very liquid assets, as you can buy and sell them on major exchanges, just like stocks. A REIT, by law, must pay at least 90% of its profits as dividends to investors. All investments carry risks.
Real estate mutual funds: These are mutual funds that invest primarily in securities offered by public real estate companies.
Real estate ETFs: ETFs give broad exposure to the real estate market. You can invest in REITs, real estate service firms, and real estate development companies with exchange-traded funds (ETFs). All investments carry risks.
Real estate investment groups: Members pool their money to buy rental properties. The company operating the group manages the units in exchange for a part of the monthly rent.
Real estate investing can be rewarding but comes with some risks. Here are the main pros and cons:
Leverage. When you buy a stock, you usually have to pay the full value when you place the order. But when you buy a house, you can put as little as 5% down, so you can control the property and its equity by paying only a part of the value.
Increase in value. You can benefit from increases in your property value by selling your property for a capital gain (sale price exceeds the price you paid). You can also use the built-up equity to buy more properties.
Steady flow of income from rent payments. When renting out a property, you collect rent from the tenants who live in it, to cover the mortgage loan and other costs. Rental income can be variable if tenants fail to pay.
Low-interest rates. Mortgage rates are currently low. Future rates will depend on market conditions.
Hedge against inflation. The mortgage, your primary expense, might remain flat, but you can sometimes increase the rent you charge.
Tax deductible. Mortgage interest and maintenance costs are deductible, subject to some limitations.
Indirect investing gives exposure to real estate with low capital. Indirect investments, such as REITs, usually require smaller amounts of capital and are more liquid than direct investing.
Properties aren’t liquid. Selling a property can take more time than you think. So, if you have to sell fast, you may have to sell for less than the property’s worth.
Fall in value. The real estate market might fall, making your property worth less than what you paid for it.
Rising tax rates. Tax rates may rise faster than you can increase rent.
Natural disasters. Insurance premiums may spike after a natural disaster.
Difficult tenants. You could end up with destructive or late-paying tenants.
Being a landlord is not that simple. As a property owner, you are responsible for handling repairs, finding tenants, collecting rent, insuring against liability, and so on. A solution is to hire a property management firm to take care of the day to day stuff, but it comes at an extra cost.
Less control when investing indirectly in real estate. You usually have no control and little knowledge about the investments that are made.
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