Real Estate Investing: Risks and Benefits
If you plan to allocate some of your investment dollars to real estate, you’ll find several options in the marketplace. Each type of investment has its own benefits and risks, and you should fully educate yourself on those before you write the check. Below are details on a few of the more common real estate investment types.
Individual direct ownership
This category of real estate ownership covers buying properties on your own (maybe with a spouse) and handling everything related to operation — such as maintenance, leasing and management of the property — yourself or hiring a property manager to do the job.
Benefits: You would make all decisions, earn all profits (if any) and directly control the asset.
Risks: You could face the possibility of bad tenants and other management hassles, making a poor financial choice, losing money on the sale of the property and assuming full liability past insurance coverage.
Partnerships with close or well-known associates
You could also partner with a friend, a small group of like-minded investors or family members. Hopefully you know your co-investors well and their financial position, motivation, work ethic and desire to share in the management of the property. Two big suggestions here: Have a written agreement between the parties, and one party should be responsible for management of the property (or managing a property manager) and be paid for handling the management. This eliminates disputes over who handles the problem if a major issue arises during a holiday or the Super Bowl.
Benefits: You would share decision making and profits, and all partners directly control the asset. Having partners can be a plus as long as all partners are on the same page.
Risks: You might choose partners who don’t have the financial wherewithal needed to handle major issue, or partners whose strategies for renting, managing and/or improving the property are not aligned. Plus all the risks in the individual direct ownership category above.
General or limited partnerships
These investments — including tenant-in-common investments and private real estate investment trusts (REITs) — are pitched in newspapers, at real estate clubs, by some financial institutions and by investment groups. In these investments you are totally trusting someone else, the “sponsor,” to handle a huge portion of your net wealth. The biggest issue with these is that most investors don’t do even the most basic due diligence on the investment sponsor, and even if they want to it’s hard to do. Few investors, for example, review a sponsor’s credit report, detailed investing history and tax returns on past deals. Nor do most investors contact banks, check criminal or civil litigation histories or consult lawyers and others the sponsor has dealt with in past real estate deals.
Benefits: You could get a fair return on investment for the risk. You wouldn’t deal with management hassles, and the sponsor probably has more investment experience than you do.
Risks: You would have no control and potentially could face dealing with unscrupulous sponsors, personal guarantees and liability, low investment returns and loss of your investment.
Publicly traded real estate investment trusts
These are really investments in a big company that is involved in the business of buying and generally owning property. A REIT buyer is investing in the ability of management to make good decisions on the shareholders’ behalf. There are many well-known publicly traded REITs with long-term operating histories and audited financial statements. So you’d want to look at a particular company’s results and dividends before making a decision on whether that company is a good investment for you.
Benefits: You’d have no management responsibility, no liability past your initial investment, experienced management investing your money and liquidity in selling the shares.
Risks: You could lose your total investment. Shares and company value are subject to regional, national and stock market influences and risks, which could diminish share value even if the company is relatively strong and well managed.
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Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.