The real estate business is a multifaceted sector that encompasses a wide array of investments. A real estate investor has a plethora of strategies to choose from and the low barrier to entry ensures that anyone can get in on the action. But what exactly are the best real estate investments? And what is the safest approach to making money in real estate? In this blog, we will discuss two types of investments: Real estate notes and buying rental property. We’ll demystify everything about these investments and reveal which is the best option for you.
What Are Real Estate Notes?
Before delving into this investment strategy, we should first go over what real estate notes are. The concept of notes won’t be strange to you if you have some experience in the world of finance. In simple terms, real estate notes are debt securities that allow investors to collect payments from the original borrower. The investor doesn’t provide the initial financing to the borrower but merely invests in the debt security that grants him the right to receive payments on the loan.
There are several approaches to buying debts. You can either invest with the sole intention of generating income, or you can take a more borrower-oriented approach. Here’s a quick look at these two strategies.
1- Investing in real estate notes strictly for income
In this approach, generating income is the sole goal of note investing. The real estate investor buys the debt obligation of an investment property and receives payments in accordance with the mortgage structure that is already in place. Selling real estate notes for a profit shortly after acquiring them is also a viable option. Moreover, the holder of the note can foreclose on the property if payments are not made.
2- Investing to help distressed homeowners
The main focus of some real estate investors is helping homeowners increase their equity and retain their homes. Needless to say, foreclosure is not an option here. This is not to say that significant profits can’t be made with this approach. In fact, savvy and experienced investors can identify distressed yet reliable investments that can yield a great return on investment in the long-term.
The lure of real estate notes is fairly strong. The prospect of generating income without owning property sounds enticing, to say the least. However, it’s important to note that buying real estate notes comes with several drawbacks. Let’s discuss those in detail below.
The Disadvantages of Buying Real Estate Notes
There are several risks that come with any type of debt investment. The possibility of the homeowner defaulting is always high. Furthermore, the lack of control that you have over the property means that there is little you can do to pressure a homeowner who routinely misses payments. Here are some other inconvenient aspects of investing in real estate notes.
- Assessing the viability of the real estate investment can be quite difficult. The process requires an accurate estimation of the value of the properties, an in-depth look at the credit rating and payment history of the homeowners, and a thorough examination of the loans.
- The costs that are associated with note investing are relatively high. Some banks charge exorbitant fees which makes buying and selling notes on a short-term basis a costly affair.
The next investment strategy that we’re going to discuss is buying real estate. More specifically, buying rental property that generates consistent rental income.
Related: Ten Real Estate Mistakes Beginner Investors Should Avoid
Buying Rental Property as an Investment
Buying rental property is undoubtedly the most widespread real estate investment strategy. Investors have long appreciated the simplicity of this approach as well as its consistency with regards to generating passive and reliable income. An investment portfolio that consists of multiple rental properties can start generating positive cash flow within months of the acquisition. Let’s look at some of the advantages of buying a rental property.
1- Rental properties generate consistent income
This is the most obvious advantage of buying rental property. As long as you do proper tenant screening, you will be able to collect rental payments on a monthly basis. This is a more reliable way of generating income than awaiting payments from a distressed homeowner. It’s worth noting that the success of this strategy is heavily predicated on finding the best property to invest in. One way to find such properties is to use the Mashvisor property finder.
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2- Appreciation will boost the value of your portfolio
Even if rental income is your sole goal, property appreciation will end up adding a lot of value to your real estate investment. The great thing about appreciation is that it’s an organic value growth that occurs over a prolonged period of time. Your property’s value will naturally appreciate over time without the need for any additional investment.
Related: 6 Things to Know About Real Estate Appreciation
3- Owning a rental property gives you more control over your investment
Control is a key element when it comes to investing in real estate. As we mentioned when discussing real estate notes, having control over the property is essential when dealing with issues relating to payments. When you own physical real estate, you have rights to the investment property and the scope of what you can do to fix the situation is fairly wide. For example, you can take a non-paying tenant to court and have them evicted soon thereafter. This is where buying rental property differs greatly from investing in real estate notes. When holding notes, the process is slightly more complicated and the foreclosure proceedings can drag on for longer than a year.
4- Leverage is easier to obtain for physical real estate
Leverage is what allows real estate investors to take on larger investments and maximize their returns. Unlike note investing, obtaining leverage when buying rental property is quite easy. This is due to the fact that most lenders prefer to provide loans against physical assets.
Related: The Art of Using Debt to Buy Real Estate
The Verdict
After going over the main characteristics of each real estate investment strategy, it should be readily apparent that buying rental property is the way to go. Real estate notes are a niche market that comes with a steeper learning curve, less reliable income, and high default risk. At the end of the day, sticking to tested-and-trusted strategies like buying rental property will always be the key to generating great returns in real estate.
