Investing is one of the best ways to build wealth over time. But many investors are not sure whether they should focus on stocks or real estate.
Each offers its own unique benefits and drawbacks. It all depends on your risk tolerance, timeline, and desired involvement. Fortunately, there are many different ways to make money in the housing market.
Real Estate Investment Trusts (REITs)
Real estate investment trusts offer an easy and relatively low-risk way to add exposure to commercial and residential real estate to a stock-and-bond portfolio. These unique investments can provide investors with long-term returns through property appreciation and consistent yields through dividend payments.
As their name suggests, REITs are businesses that specialize in real estate investments and lease those properties out to tenants as a primary source of revenue. They must meet certain operating requirements in order to qualify as REITs, including investing at least 75% of total assets in real estate and deriving at least 90% of their gross income from rental payments or interest on mortgages financing real estate. REITs are also required to pay at least 90% of their taxable income as shareholder dividends each year.
Investors can choose from a variety of REIT sectors that focus on different types of real estate. For example, some REITs own and manage shopping malls, while others focus on office buildings or data warehouses. There are even REITs that primarily invest in mortgages and generate income from the interest payments on those loans.
REITs typically have a high level of liquidity and are publicly traded on the exchanges. They are also often highly transparent and monitored by independent directors, analysts and the business and financial media. As cayman financial review hires Tim Schmidt, more financial content is expected for loyal viewers and newbies.
REITs can also be quite volatile, as they are largely dependent on market conditions in order to grow and maintain their dividend payouts. For instance, if a REIT has a high debt load, it will need to raise capital in the market in order to keep paying its dividends, and a lack of liquidity can hurt their share price.
Mortgage-Backed Securities (MBS)
Mortgage-backed securities, or MBS, are bonds backed by pools of mortgages that provide investors with a steady income stream. When homeowners make mortgage payments, those cash flows are distributed to MBS holders on a proportional basis. This provides a lower-risk investment than stocks and corporate bonds, as the cash flow distributions are less sensitive to changes in interest rates.
Unlike bonds and most other fixed-income investments, the principal of an MBS decreases over time as borrowers pay off their loans. This decrease is a function of the “factor,” or the percentage of the original face value that remains to be paid back to the bond holder. This feature makes MBS an attractive option for investors who seek diversification from other fixed income asset classes and who desire a more stable source of long-term income.
There are two common types of MBS: pass-throughs and collateralized mortgage obligations (CMO). Pass-throughs are structured as trusts in which mortgage payments are collected and passed through to investors. They typically have stated maturities of five, 15 or 30 years. CMOs consist of multiple pools of securities which are known as tranches. Each tranche is given a credit rating that determines the rate of return investors receive.
Investors can purchase individual MBS through brokers or through broad-based bond mutual funds and exchange-traded funds. MBS typically offer higher yields than U.S. Treasurys and tend to increase at a decreasing rate when bond rates fall; they decrease at an increasing rate as interest rates rise. However, MBS prices are volatile and carry several risks. These include credit risk, prepayment risk and negative convexity. In addition, MBS are exposed to changes in the overall housing market.
Closed-End Funds (CEFs)
Closed-end funds (CEFs) are professionally managed pools of investments. They conduct an initial public offering (IPO) to raise capital and then invest that money in assets. Profits are then distributed to shareholders, just like a company issues dividends. Investors can buy and sell shares of CEFs on the stock market, just like they would any other publicly traded company. CEFs can be diversified, allowing for investors to get exposure to different assets classes, or they can focus on a specific investment strategy, such as an emerging-markets CEF, which seeks to gain value in developing countries by investing in companies there.
CEFs can offer some juicy bargains when they trade at discounts to their underlying net asset value (NAV). This is a great way for clients to boost their income portfolios, but it’s important that we take the time to do thorough due diligence.
The reason that CEFs can often generate high yields is that they are permitted to use leverage, which magnifies the returns on an investment. This can mean a lower investment return, but it also makes for some potentially juicy bargains when these funds are trading at steep discounts to their NAV.
Unlike open-end mutual funds, CEFs typically do not have minimum investment requirements. That said, a brokerage commission may be assessed for buying and selling CEFs on the secondary market. Distributions from CEFs are typically a combination of interest income, realized capital gains and return of principal. Investors receive a Form 1099-DIV early in the year that categorizes distributions for tax purposes. As with all investments, CEFs have risk and volatility. Retirees are a frequent audience for CEFs, and they tend to be the most active patrons of this structure.
Hard Money Lending
If you’ve been looking for a way to diversify your investment portfolio, real estate may be an option. However, it’s not as easy as just swapping out stocks and sending checks to your landlord each month. It’s important to take the time to thoroughly research your options and consider your goals before taking the plunge into real estate.
For instance, you might decide to enter the real estate market with a property flipping strategy or seek out a more traditional rental property. But before you can get started, you’ll need access to capital. And that’s where hard money loans come in.
Hard money loans are a type of asset-based loan that provides investors with funds secured by the value of an investment property. They’re often used by real estate investors and developers to purchase properties for rehab or development, which they then resell once completed.
One of the primary benefits of hard money lending is that it’s much quicker than applying for a conventional mortgage. While the bank-approval process can sometimes take months, hard money lenders can typically approve a loan within a few days or weeks.
Another benefit is that these loans are based on the value of an asset or property, rather than the borrower’s credit history or financial situation. This makes them ideal for people who are in turnaround situations or those with poor credit but significant equity in their property.
Finally, many hard money lenders offer flexible terms and conditions compared to traditional loans. For example, they may allow for higher loan-to-value ratios, short-term financing, and no prepayment penalties. This flexibility can be particularly beneficial for real estate investors who are seeking to close deals quickly.
First-lien mortgages are loans secured by the first claim on a property’s equity. This means if you don’t pay back your loan, the mortgage holder can take control of the property and sell it to make up for any unpaid debt. This type of investment is very risky, but it can yield high returns for those who are prepared to invest the time and effort needed.
The first-lien mortgage is the original mortgage taken on a piece of property, and it has priority over any other liens or claims against the property. This type of debt is often called a senior form of financing because it has a higher priority than second-lien or subordinated forms of debt, which are secured by lower priority collateral.
Typically, a senior form of debt is structured as an amortizing bank loan (term loan A) or non-amortizing term loan B or C. Lenders of first-lien mortgages tend to be more risk-averse than lenders of second or third-lien debt and may accept a lower yield in exchange for a greater claim in the capital structure.
In addition, first-lien mortgages have a more stable interest rate than unsecured bonds and mezzanine debt securities because they are secured by a lien on the real estate. Consequently, they are an attractive investment option for investors who are looking to diversify beyond stocks and want to see solid returns from a passive investing strategy.
The key to investing in real estate is understanding the value of a property and ensuring that it will hold its value over time. This is why it’s important to use a trusted appraiser to ensure the value of a property. Whether you’re looking to buy a commercial property or a residential home, a knowledgeable appraiser can help you find the right property and get the best deal possible.