5 Questions to Ask Before Investing in Real Estate
When you are thinking about investing in real estate, the factors to consider depend on the type of purchase and your reasons behind it. The reasons for buying real estate will affect how you choose to invest. Below are some of the questions you'll need to ask yourself before considering an investment in real estate:
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 is playing an active role. It involves significant time and effort, so be sure to talk with other landlords to get a sense of the potential rewards and pitfalls. Passive real estate investments, such as REITs, exchange-traded funds, or mutual funds, demand less day-to-day involvement. If you are investing simply to diversify an investment portfolio these products may better suit your needs.
Are you investing for income, capital appreciation, personal use, or a combination?
Real estate investments can offer the potential for all three, but there is often a trade-off. 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 the property may be limited if you want to enjoy the rental's tax benefits. Before you invest in real estate think about why you are investing.
What is your timeframe?
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. Passive real estate investments are more liquid than active investments. If the real estate market changes course it is easier to sell an exchange-traded fund (ETF) than a house.
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 you expected.
Are you investing for tax considerations?
Operating expenses for rental property can be tax-deductible if you do not use the property yourself or use it only minimally. Profit from the sale of real estate generally is taxed not as ordinary income, but at the lower rates for capital gains. Also, remember that tax laws can change. If tax considerations are your primary focus, be sure to consult your financial professional and evaluate which types are most appropriate.