Types of Real Estate Investing: Which Is Best for You?

Building long-term wealth often requires thinking outside the box. While the stock market attracts many investors, there are other options like real estate investing that can also help you generate income streams and profitable returns. Within the housing and commercial markets lies a world of possibilities. To harness them, you just need to find the right investment strategy for your goals and risk appetite.

Within the world of real estate investing, there are many types of investments to choose from, meaning you can be as hands-on or passive as you'd like. Will you buy an income-producing rental property to manage yourself, find fix-and-flip projects to renovate and sell for profit, or do you want to passively fund projects with more experienced investors on larger apartment buildings and hotels? Every approach has its own pros, cons, and financial realities. 

By better understanding the different real estate investment types available, you can determine which path may work best for your situation. Let's dive in and discuss the paths you can take to become a successful real estate investor.

What is real estate investing?

Real estate investing involves purchasing and managing properties as investment assets to generate profit. Investors aim to make money from their real estate in two main ways:

1. Appreciation: Earning a profit by selling the property for more than the original purchase price as its market value increases over time.

2. Cash flow: Generating ongoing income from the property on a monthly or quarterly basis, typically from rent payments if it is a rental property.

Successful real estate investors buy properties to maximize the potential for both long-term appreciation and consistent cash flow in the form of rental income. They use leverage through financing to purchase the assets., and they manage risk by diversifying across different types of properties, markets, and strategies.

Active real estate investors take on management responsibilities themselves for higher control and profits, while passive investors use vehicles like REITs and crowdfunding platforms to benefit from real estate without hands-on work. Real estate can be an attractive addition to investment portfolios, because it has historically outperformed inflation over time.

Types of real estate investing

There are several main categories of real estate you can invest in, each with its own pros, cons, and investment strategies. Let's explore some of the most common options:

Residential real estate

When people think of investing in real estate, residential properties like single-family homes and condos usually come to mind first. Residential real estate refers to properties that people make their homes, as opposed to commercial real estate, which typically involves properties used for business purposes.

The residential real estate sector is often more accessible for everyday investors, since homes are an asset class most people are already intimately familiar with from their lived experience.

You typically don't need as much industry-specific knowledge to grasp the fundamentals of operating a home rental business versus commercial spaces like office buildings or retail stores. There are also more opportunities to invest on a smaller scale in the residential space, like flipping or renting out a single property, without facing the huge upfront capital requirements that large commercial deals often demand.

Types of residential real estate investments

1. ADUs (accessory dwelling units)

Also known as in-law suites or granny flats, ADUs are self-contained smaller secondary housing units on the same grounds as a single-family home. For example, converting a basement, attic, or garage into a small apartment or building a tiny guest house in the backyard would count as an ADU.

ADUs can be a smart way to add rental income potential to your existing property without acquiring and financing another home. However, permit acquisition and construction costs for adding an ADU can pose challenges depending on your location's regulations.

Not all municipalities allow ADUs, and some have strict requirements around maximum unit size, parking, and entrance locations. But as housing costs continue rising, more local governments are easing ADU rules to spur this affordable infill housing supply.

2. Flipping

Flipping involves purchasing a distressed home, renovating it by fixing and upgrading features like flooring, kitchen appliances, bathrooms, paint, and landscaping, and reselling the improved property quickly for a profit.

Flipping requires hands-on work and a sharp eye for which value-added improvements will bring maximum return when it comes time to sell. It can be risky if you pay too much for the purchase price or run way over budget with renovations. Successful flipping relies on accurately estimating repair costs and making deals with contractors and materials needed.

3. Long-term rentals

This residential property strategy involves renting to tenants on longer-term leases, usually 1-year agreements. It's not like house flipping where you sell the house right away. Rental property gives you consistent monthly rental income, appreciation, and potential tax benefits.

But long-term rentals also mean you take on ongoing maintenance responsibilities and serve as the property manager for your tenants, handling issues like repairs and screening applicants. Tenant vetting and background checks are key to minimizing risks and vacancies. Detailed leases outlining rules and consequences for violations also help avoid conflicts in the future.

4. Micro-flipping

Micro-flipping is a strategy where you buy houses at below market rates and then flip them right away without doing any renovations. It's a higher-volume strategy that relies heavily on having access to discounted off-market property deals to make the slim margins work.

Successful micro-flippers often cultivate networks of motivated sellers like heirs unloading inherited properties or owners facing foreclosure. Extensive research helps identify below-value homes with untapped potential. Time and efficiency are also key — the faster you can rehab and resell each home, the more profit you retain.

5. Vacation rentals

Property owners rent residential properties as short-term accommodations for tourists, travelers, and temporary visitors rather than long-term tenant residents. Property owners in this space list their rentals on sites like Airbnb, VRBO, and Booking.com. With short-term rentals, you can earn higher nightly or weekly rental rates than long-term leases.

Vacation rentals also come with more overhead costs for amenities, frequent changeovers between guests, and ongoing marketing to attract bookings. To be a successful vacation rental investor, you'll need to pay close attention to local tourism market conditions, which amenities help you increase income, and the competitive market.

Pros

• It provides a more accessible entry point for you as a small-scale investor.
• It is an easier asset class for you to understand compared to commercial property.
• There is consistent demand for housing that you can benefit from.
• You can generate monthly cash flow from rental income.

Cons

• You will see lower profit margins than commercial real estate investing.
• You take on costly maintenance and tenant management responsibilities.
• You need highly localized market knowledge to be successful.
• It's not a passive source of income; you need to do hands-on work to be successful.

Commercial real estate

Commercial properties cater to business owners rather than individual residential renters or owner-occupants. Commercial real estate typically requires more upfront capital and industry expertise and comes with higher risks than residential real estate.

However, commercial properties offer you the potential for much bigger profits through higher rents, appreciation, and scale. The higher property values in commercial real estate can mean larger returns when deals go well. Commercial real estate is more capital intensive, though, because of the potential for longer vacancies when space sits empty, higher improvement costs, and challenges in getting financing.

Types of commercial real estate investments

1. Multifamily properties

Multifamily properties are residential rental buildings with more than one housing unit. These properties can range from small duplexes (two units) to large apartment complexes or high-rise buildings with hundreds of units. Properties that have more than four units are considered commercial real estate.

The solid return on investment and lower risk profile of the multifamily sector draw many investors to these investments. Owning a property with multiple units means you're collecting rent from several tenants, not just one. This can mean a more consistent and often higher income than you might get from a single-family home.

The beauty of multifamily properties is in the cost savings. When you're managing a building with numerous units, the costs of upkeep are spread out over many tenants, making it more cost-effective per unit. This efficiency can lead to better profitability and easier management.

Risk is also more distributed. If one unit is vacant, it's less of an issue because the other rented units continue to bring in income. This situation is far less impactful than having a vacant single-family rental, which would result in a total loss of rental income.

2. Office spaces

This real estate investment type can include an entire office building leased out to businesses for workspace or individual floors or suites within a property. Commercial office real estate can range from a single-tenant building leased to one major company to a massive Class A skyscraper housing dozens of tenants.

Having property near public transit hubs, highways, dining, and entertainment is key for attracting office tenants. Office property values rely heavily on surrounding infrastructure, amenities, and corporate neighbors to retain and attract tenants. To protect your investment, you'll need to stay competitive with the latest amenities, building systems, and other infrastructure.

3. Industrial

Industrial real estate investments include warehouses, distribution centers, storage facilities, and manufacturing plants catering to logistics, shipping, and production companies. Real estate investment property in this space needs to be close to major highways, railways, seaports, and airports to be successful.

4. Retail

Retail commercial real estate includes standalone storefronts or space leased to shops and restaurants within a larger shopping mall or center. Retail property performance relies on tenant sales, rent affordability, sufficient foot traffic, and customer accessibility.

Area demographics, traffic patterns, parking, and even walkability are key factors in the success of retail real estate investments.

Pros

• You can achieve higher rents and occupancy rates than residential real estate. 
• Commercial property types appreciate strongly in times of economic growth.
• You can gain tax advantages and leverage benefits.

Cons

• You need substantial capital and reserves for maintenance. 
• Properties in the commercial space are more susceptible to market downturns than residential real estate.
• You take on higher professional property management fees.

Raw land

Raw land refers to vacant, empty lots or parcels with no existing structures or improvements. Investing in undeveloped raw land is a longer-term real estate investment strategy that requires patience but can bring higher returns over long time horizons spanning decades.

The goal with raw land is to purchase it for holding over an extended timeframe as a passive investment. You can benefit from appreciation in value over many years as nearby areas get developed with residential subdivisions or commercial projects.

The longer time horizon also means raw land investments tend to be less accessible for average investors compared to other real estate asset classes. Additionally, land real estate investments require more upfront capital since investors have to wait patiently for growth and development.

Pros

• Your investment can appreciate over time as nearby areas get built up.
• If you buy land for agricultural use, there are potential tax benefits.
• You have lower maintenance costs than developed property.

Cons

• You'll need to wait a long time to see a return on your investment.
• Owning undeveloped raw land means it will not generate rental income immediately upon purchase.
• Raw land can be sensitive to changes in the agricultural and natural resource market.

Real estate investment trusts

Real estate investment trusts (REITs) operate as companies that oversee a portfolio of income-producing real estate assets. These properties range widely from apartments to malls to medical facilities.

Publicly traded REITs allow investors to gain exposure to real estate income potential by acquiring shares through stock exchanges. This provides a more accessible, liquid way to allocate towards real estate compared to the responsibilities required of direct property owners.

Regulations require REITs to pay at least 90% of taxable earnings back to shareholders annually in dividend distributions. And with the ability to buy/sell shares daily based on stock price movements, REIT investing avoids tying up your capital.

This opens up real estate industry participation for everyday investors seeking to benefit from certain property types or overall real estate markets without owning real estate and operational responsibilities themselves.

Pros

• It provides an easy, liquid way for you to access income-producing real estate without needing huge upfront capital to invest directly.
• You can benefit from the professional expertise of the operator.
• Through private REITs you can add real estate industry diversification to your investment portfolio.

Cons

• You have no direct property ownership or control.
• Your investment is vulnerable to general stock market volatility and pricing dips.

Real estate crowdfunding

Real estate crowdfunding platforms help groups of individual investors to combine their money to participate in larger real estate deals most would not be able to access on their own. By pooling your money with others, you can invest in large commercial projects like multifamily properties, hotels, industrial real estate, and mixed-use assets.

It's important to note that many real estate crowdfunding platforms and offerings are limited to accredited investors due to Securities and Exchange Commission (SEC) regulations. This accreditation designation requires participating investors to exceed certain income and net worth criteria before accessing online real estate platforms.

Common real estate crowdfunding structures

1. Equity-based

Investors gain fractional ownership equity in the physical property and receive returns tied to the deal's performance. This includes a share of operating profits and appreciation at sale. The equity-based structure is higher risk/return than non-equity crowdfunding.

2. Debt-based

Debt-based real estate crowdfunding structures resemble bank financing models. Investors lend capital to buy an investment property and receive fixed interest payments over time. Debt-based crowdfunding has lower risk than equity deals but limited upside potential.

3. Managed funds

Crowdfunding platforms form diversified funds of assets like single-family rentals or multifamily properties. Investors buy shares in these professionally-managed portfolios for steady dividends. This structure provides broader diversification than picking individual deals.

The funds have defined lifespans instead of ongoing trading like mutual funds or publicly traded REITs, but they offer simple access to returns from bundles of properties without requiring the specialized skills to operate rentals directly.

Pros

• You can invest with lower investment minimums, which opens up access to different types of real estate property.
• Passive real estate investments in crowdfunding allow you to build a diversified real estate portfolio.

Cons

• Platform fees can be higher than traditional investment channels.
• This is a newer and less historically tested investment model, so you can have greater risk through these platforms.
• You cannot easily convert your investment back into cash until the operator sells the property.

Active vs. passive real estate investing

There are two main approaches when it comes to investing in real estate: active investing and passive investing.

Active real estate investing

This approach involves direct, hands-on participation in finding, acquiring, and managing investment properties. Examples of active real estate investing include buying rentals and flipping houses.

With this real estate investing strategy, you can potentially see higher returns because you have direct control and decision-making power. The trade-off is that active real estate investments also require far more time, effort, and expertise.

Passive real estate investing

With this method, you gain exposure to real estate assets without being involved in the day-to-day management or operations. It's a hands-off approach that includes REITs, crowdfunding platforms, private real estate funds and real estate syndications.

As a passive investor, you'll rely on the management teams to operate the properties. Meanwhile, you can collect steady rental income or returns in a passive manner. This approach provides portfolio diversification and income with less time commitment.

The best approach for many real estate investors combines active and passive investing elements for the right balance of control, returns, and hands-on involvement.

Finding real estate investment properties

If you've decided you want to be an active investor and are ready to buy your first rental property, where do you start? Let's cover proven tactics that can help you find the best deals.

Off-market properties

Sourcing investment deals directly from motivated sellers before the property hits the open real estate market provides more control and often better purchase pricing for investors. Some common ways to find off-market properties include:

• Direct mail campaigns: Sending letters to distressed homeowners who are facing foreclosure, are behind on taxes, or absentee owners who don't live in the area.
• Driving for dollars: Physically driving through target neighborhoods and looking for vacant, rundown, or visibly ill-kept properties, then contacting the owners.
• Networking: This can include collaborating with local real estate agents, brokers, lenders, contractors, and attorneys to connect to potential deals before they officially list.
• Signs: Using roadside signage and bandit signs in specific areas to attract motivated sellers looking to offload properties.
• Referrals: Getting word-of-mouth referrals for deals from friends, family members, or contractors who may know of owners looking to sell.

MLS listings & FSBOs

The Multiple Listing Service (MLS) provides access to properties publicly listed for sale through real estate agents and brokers. You can use MLS research and alerts to find good deals as new listings appear.

FSBO (for sale by owner) properties are sold directly by homeowners without a real estate agent representing them. This provides an opportunity for you to negotiate directly with motivated sellers who often price properties lower to account for the broker fees they are saving.

Mastering real estate investing types

Real estate's endless options let investors choose their own adventure. Strategic investors should first understand their personal financial situation and skills, then match opportunities accordingly.

For simpler passive profits, diversified crowdfunding or REITs provide accessible ways to invest. If you want more direct control, look at residential property, but be ready to take on more hands-on duties from tenant screening to fixing leaky pipes.

Careful research is key to reducing overall real estate risks. By first taking an honest personal inventory, then looking at the market for well-timed prospects, investors can grow wealth for years through this dynamic asset class.

Types of real estate investing FAQs

Which type of real estate investment is best?

The best type of real estate investment depends on your goals, timeline, and risk tolerance. Long-term rental properties can provide steady income, while house flipping offers quicker profits but requires more hands-on work and risk.

Commercial properties like apartments and office spaces are more expensive but can yield higher returns over time.

What is the most profitable type of real estate to invest in?

The most profitable real estate investments tend to cater to business needs, like industrial real estate. Warehouses or flex office spaces located in growing metro areas are commercial assets that often gain value while also collecting relatively high rents per square foot.

What is the safest type of real estate investment?

The safest real estate investments are typically residential rentals in stable, affordable neighborhoods. While the returns may not be as high, there is reliable tenant demand and less volatility in value compared to riskier commercial plays.