Investing in real estate can be a great method to build wealth. Wealth grows by compounding, which implies investing money in something with the intention of receiving more money later. Real estate has traditionally been a constant compounder for one simple reason: there is only so much land to build on!

Real estate harnesses the power of supply and demand and channels it into your portfolio. Fundamental rules of supply and demand tell us that a limited supply of something in high demand must result in higher prices. You’ve probably seen the power of supply and demand play out with the value of your primary residence. For example, the US national home price has increased 441% since January 1987 and rebounded 207% since the post-2008 financial crisis low, as of December 2021.

Fortunately, you don’t have to be extremely wealthy to get started in real estate investing. Long ago, policymakers recognized the potential of real estate as a conduit to wealth accumulation, paving the way for the development of different ways for all investors to put their cash to work. This article will briefly discuss seven of the most popular ways to invest in real estate; however, it is not an exhaustive list.

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1. Invest in a Private Equity Fund

Investing in a private equity real estate fund is exchanging your funds for an equity stake in the firm founded to develop, operate, or manage a single asset or portfolio of commercial properties. Private equity funds provide real estate projects throughout the development cycle. You should be able to locate an investment that meets your investment goals, risk tolerance, and time horizon. Private equity real estate funds often fall into one of four risk profiles: core, core plus, value-add, or opportunistic.

Core/core-plus private equity deals share characteristics with REITs. These properties already produce income from high-quality tenants, are in the nice parts of town, and typically have low amounts of debt. Core/core-plus may be appropriate if you’re looking for income-generating investments and have lower risk tolerance.

Value-add private equity deals are just another way of saying “renovation jobs.” Basically, the private equity manager uses your capital to fix up a property or portfolio of properties. Then, the manager may choose to keep the property and pass the income from the tenants back to you (called “DPI” or “distribution of paid-in capital”) or sell it and pay out the proceeds of sale according to your equity position (called an “exit multiple”). You trade access to your capital for anywhere from two to five years (or longer) in exchange for DPI or an exit multiple. These deals offer the potential for higher returns—either through income or exit multiple—than core deals but come with higher risk.

Opportunistic private equity deals are ground-up development projects: you trade access to your capital to build something new. These deals can include redevelopment (tear-down jobs), land acquisition, and new builds. Opportunistic deals offer the highest potential exit multiple with the highest potential risk. These deals may be appropriate if you want to complement existing income-generating or low-risk investments with a high-risk/high reward growth-oriented investment.

Typically, Qualified Opportunity Zone Fund investments can land both in the Opportunistic and the Core/Core Plus categories, depending on what stage of development, or property management process the parcel is undergoing.

2. Invest eligible capital gains in a Qualified Opportunity zone

The Tax Cuts and Jobs Act of 2017 created Opportunity Zones (“OZs”) to spur real estate development, ideally in underserved or economically disadvantaged areas. Here, you invest unrealized capital gains in opportunistic development deals. In doing so, you can potentially:

• Defer taxes – By investing in an opportunity zone fund, you may be able to defer the taxes due on your initial gain until 12/31/2026, while earning an investment return on your deferred tax along the way.
• Earn a signficant tax benefit – Pay no tax on growth in the value of your investment for your entire holding period, assuming a minimum of a 10-year hold.
• Help qualified communites revitalize by generating both socio- and econmic- opportunities through commercial real estate projects.

Depending on the project, you may also realize a potentially attractive exit multiple upon the sale of the property.

Opportunity Zones are most appropriate for accredited investors with a high-risk tolerance and a long time horizon. In addition to taking on development risk, you must wait ten years and follow a strict timeline to realize the tax benefits.

You can unlock impressive tax incentives (USA) on your recent capital gains from the sale of a business, stocks, crypto, stock options, property, or other investments.

3. Invest in a REIT

REITs are a popular way to invest in real estate. A real estate investment trust (REIT) is a firm that owns, operates, or funds income-producing real estate. Congress established REITs in 1960 to allow investors to own shares in these corporations without being engaged in the day-to-day operations or monitoring of the physical properties. Congress structured REITs after mutual funds, thereby democratizing access to the stock and bond markets.

Read Also: Top 19 Income Growth Strategies

To be eligible for REIT status, the corporation must meet a number of requirements. Specifically, 75% or more of the portfolio must be invested in income-generating real estate, with 90% of the money generated by these properties paid out as dividends to shareholders.

REITs come in two flavors: publicly traded and non-traded.

Publicly traded REITs trade on exchanges like the New York Stock Exchange. Anyone can invest in the REIT. You can either purchase the specific stock yourself or a commingled vehicle like an exchange-traded fund (“ETF”) or a mutual fund that owns a basket of stocks.

Publicly traded REITs are highly liquid, meaning you can buy or sell the shares quickly on the exchange. Liquidity can be good if you need to quickly access your capital. REIT prices often fluctuate with the general direction of the stock market, regardless of the value of the properties in their portfolio. For example, when the S&P 500 lost 52% of its value during the Financial Crisis of 2008, REIT stocks saw 68% of their value evaporate over that same period.

Non-traded REITs are subject to the same requirements as their public counterparts but are highly illiquid. Investing in a non-traded REIT means locking up your money for two to five years, typically, in exchange for potentially higher dividends. Since non-traded REITs don’t trade on the exchanges, their prices reflect the value of their property portfolio rather than market sentiment. It also means that non-traded REITs appear much less volatile than publicly traded REITs.

Non-traded REITs aren’t illiquid forever. Eventually, the management company operating the REIT must decide to take the REIT public or dissolve the company and pay shareholders the proceeds. As the expected public conversion grows nearer, investors may receive solicitations to sell their shares in a secondary market transaction before the REIT goes public.

REITs may be a good fit for a dividend-based way to grow your retirement account rather than provide growth via price appreciation. Generally, REIT company’s focus on managing their properties to pay the dividend first and seek to grow their stock price second. While that usually means higher quality properties in the portfolio, that also means a lower potential for price appreciation.

4. Complete a 1031 exchange

When Congress passed the Revenue Act of 1921, it updated the Internal Revenue Code to incorporate 1031 transactions. The 1031 exchange is frequently referred to as a “like-kind exchange.” Its origins can be traced back to farmers looking to trade fallow land for cropland. According to the IRS, if a farmer exchanges one tract of land for another of comparable value, their economic situation remains unchanged. As a result, the farmer may defer the taxes indefinitely. When the farmer dies, the farmer’s estate receives an increase in cost basis, thus negating the accrued gains. Currently, there is no restriction to the amount of exchanges an investor can execute.

Completing a 1031 exchange is one of the most popular ways to build wealth through real estate. The regulations stipulate that the swapped property be used solely for investment purposes (it cannot be your personal residence) and that you exchange it for a new property of equal or better worth.

A 1031 exchange is complicated by the numerous restrictions, timelines, and procedures that come with it. Aside from those stages, the principle is straightforward: swap one property for another and defer capital gains taxes indefinitely. 1031 exchange properties may be excellent for someone in a high tax bracket looking to build wealth for their estate or diversify an existing real estate portfolio.

5. Invest in a syndicate

Syndication is a well-established means of acquiring cash for the acquisition of a single property. You exchange access to your capital for an equity stake in the general partnership created to buy an existing property. You are a limited partner who earns passive income but has no supervision or management responsibilities.

One of the more well-known syndication transactions occurred in 1961. New York developer Harry Helmsley gathered $33 million (about $282 million in current currency) from nearly 3,000 individual investors to purchase the Empire State Building. The average investment was approximately $10,000.

Like a private debt fund or core/core-plus deal, a syndicate can diversify your current source of income or replace an existing investment for one with a higher yield.

6. Participate in a “mini-IPO”

Title IV of the JOBS Act eliminated the accredited investor requirements previously required for entrepreneurs to solicit outside investment in their company. Now, anyone may invest in a private company in what’s known as a “Reg A+” offering or “mini-IPO.”

Regulation A+ allows a private corporation to raise up to $50 million from the public. Like a regular IPO (“initial public offering”), the corporation must register with the SEC for permission before marketing the Reg A+ offering to the public. Unlike a standard IPO, the fees and continuous disclosure obligations that the private firm would be required to meet under Reg A+ are significantly less burdensome.

The JOBS Act legislation is good news for investors who wish to engage in private real estate transactions but do not fulfill the income or net worth eligibility requirements. Nonetheless, approach these investments with caution, as investing in early-stage enterprises or real estate development projects can carry significant risk.

7. Invest in a private debt fund

Private debt funds pool your capital along with the other LPs in exchange for an equity position in the company formed to lend money to finance real estate projects. Investors in these types of funds are looking to diversify their source of income or replace an existing investment for one with a higher yield. These funds may be more attractive than equity funds if you have a shorter time horizon and a lower risk tolerance.

How to Get Started in Real Estate Investing for Wealth Creation

With a strategic approach, real estate can offer significant financial returns and long-term wealth-building opportunities. Here are five general things you can do to get started:

• Educate yourself: Begin by educating yourself about the real estate market. Understanding market trends, property values and investment strategies can help you build a portfolio. Read books, attend seminars and follow reputable real estate blogs to build a solid knowledge base.
• Prepare your finances: Determine how much capital you can invest and explore financing options. This might include personal savings, mortgage loans or partnerships. Having a clear budget and financing plan is essential for making informed investment decisions.
• Create an investment strategy: Choose an investment strategy that aligns with your financial goals and risk tolerance. Common strategies include buying rental properties, flipping houses or investing in REITs. Each approach has its own set of advantages and challenges, so it’s important to select one that suits your preferences and resources.
• Do market research: Conduct thorough market research to identify lucrative opportunities. Look for areas with strong growth potential, high rental demand and favorable economic conditions. Understanding local market dynamics will help you make informed decisions and increase the likelihood of a successful investment.
• Build a network: Networking is vital in real estate investing. Connect with other investors, real estate agents, contractors, and financial advisors. Building a reliable network can provide valuable insights, support and opportunities for collaboration.

Building wealth through real estate needs meticulous preparation for both immediate and long-term financial gains. Investors can generate a consistent income stream and enhance their net worth over time by investing in rental properties, taking advantage of tax breaks, and capitalizing on property appreciation. Real estate also protects against inflation and diversifies investment portfolios, potentially lowering overall risk.