Investing Unit 4: Real Estate

November 13, 2008 Print Friendly and PDF




This very popular investment alternative includes land, the permanent structures on land, and accompanying rights and privileges, such as crops and mineral rights. A home is generally the single largest asset that most people have. Other ways to invest in real estate include owning rental houses and land for potential housing or commercial development. You can also invest in real estate indirectly by purchasing units in a real estate limited partnership or shares in a real estate investment trust (REIT). Since direct ownership of real estate is so common, we will begin by discussing it.

When you purchase real estate, the costs of purchase include:

  1. Real estate commissions (which may technically be paid by the seller, but do influence the total cost of the property)
  2. Transfer and recording fees charged by the state and/or local government
  3. Attorney fees
  4. Title search fees
  5. Appraisal fees
  6. Surveying fees
  7. Inspection fees (these may be optional)

There are also ongoing costs to owning real estate. These vary according to the type of structure and the location. The property must be maintained and protected through the purchase of insurance. When you purchase real estate, ongoing costs include:

  1. Cutting grass, raking leaves, removing snow, or painting
  2. Roof or furnace replacement
  3. Homeowners insurance to protect the structure and your liability related to it
  4. Annual property taxes

Home ownership is encouraged through our income tax system which provides an income tax deduction for mortgage interest and property taxes and through generous tax exemptions on the increase in value realized when homes are sold. However, tax benefits of ownership should not be the only reason for buying a house.

Real estate is fairly high in the investment risk pyramid. It is not a liquid investment. Although real estate can sometimes be quickly turned into cash, it can also take a long time to find the right buyer at the right price. Nor can you control the condition of the property next door. A public change, such as a power line or road, or some other event, may also increase or decrease the value of your property.

You may receive regular or intermittent income from real estate including rent for structures or the land itself, income from sales of crops such as timber or from gravel or minerals in the land. Costs are associated with each form of income. You can also make money on the sale of real estate if you can sell it for more than you paid for it and the costs of the sale. Real estate agents often say that the key to success in real estate investing is "location, location, location." Where your investment is and what is near it will greatly influence its value.

You can also purchase real estate indirectly through

  1. Real estate limited partnerships
  2. Real estate investment trusts (REITs)
  3. Mortgage ownership

Thoroughly investigate these investments before purchasing them.

Investors in real estate limited partnerships buy shares for unit costs of $500 or $1,000. The partnership invests in land or commercial real estate such as shopping malls and apartment complexes. A pro-rated share of rental income is passed on to investors as taxable income. When a partnership is liquidated or sold, any profits are distributed as capital gains.

When you buy shares in a real estate investment trust (REIT), the company manages various real estate investments. It may own real estate (e.g. apartment complexes and offices) and make money by renting the property or by making loans to others who own and manage property. Like a mutual fund, REITs provide diversification and professional management. They are required to distribute almost all of their annual income as dividends to investors. If the REIT portfolio is not properly managed or there are changes in the market, the principal investment may lose value.

You can select from over 300 REITs for investors. REIT shares, typically costing up to $40 each, are bought and sold through brokerage firms and traded like stock on major exchanges. Additional information about REITs can be obtained from brokerage firms or the National Association of Real Estate Investment Trusts Web site: www.nareit.com/.

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This work is supported by the USDA National Institute of Food and Agriculture, New Technologies for Ag Extension project.