The Beginner’s Guide to Investing

How to invest in real estate

Twenty/20

If you want to diversify your portfolio, real estate is a great first step. But real estate investing can bring to mind visions of camera-ready designers buying run-down properties to flip for a hopefully tidy profit, thanks to shows like "Flip or Flop" and CNBC's "Cash Pad."

Property flipping is certainly one form of real estate investment, but if that seems too overwhelming, there are plenty of options that don't require nearly as much effort — or construction know-how — for a potentially better pay off.

Before you start investing in real estate, it's important to have a solid financial foundation. That means minimal or no debt, healthy retirement savings and an emergency fund with at least three to six months' worth of expenses stashed away.

Once you have those bases covered, real estate can be a way to grow your portfolio further, assuming you do your due diligence before making any major financial decisions. Here are some of your real estate investment options.

Invest in REITs

REITs, real estate investment trusts, are one entry point for beginner investors, George R. Gagliardi, a Massachusetts-based certified financial planner, tells CNBC Make It. Through these, individuals can invest directly in residential or commercial real estate and earn income from their shares. They are bought and sold like stocks and pay dividends.

Some REITs invest in properties (such as apartments, office buildings, warehouses or personal storage), others invest in mortgages and some invest in a hybrid of mortgages and property. Mortgage REITs are more complicated and "typically not for novice investors," says Gagliardi.

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"I would generally avoid recommending them to inexperienced investors because of their volatility and they are not as easy to understand as 'own buildings, collect rent,'" which applies to the other type of REIT, Gagliardi says.

He adds that part of the appeal of REITs is learning how to evaluate them and "put together a diversified portfolio of REITs with different asset classes." If that's too complicated, you can also invest in a REIT ETF or mutual fund.

These investments are "not nearly as interesting as researching the different REITs to discover the hidden gems of the business, but a simple way to diversify one's investments and get into the real estate investment game," says Gagliardi.

Real estate mutual funds and ETFs invest in REITs and other real estate stocks, and operate the same as other types of mutual funds. They are an "an easy way to buy a large number of REITs in different RE sectors," says Gagliardi, noting that Vanguard's Real Estate ETF (VNQ) holds over 180 different REITs with a management fee of 0.12%. You can invest in them through most brokerages.

Rent out a room

If you have extra space in your home or on your property, you can get a taste of the landlord lifestyle by renting out a room — or your entire house — using a platform such as Airbnb or VRBO.

Renting out a room for a short amount of time is a low-stakes way to see if making a bigger commitment to rental properties makes sense for you.

Here is a guide to turning your place into a successful Airbnb rental.

Use a real estate crowdsourcing app

There are now a variety of apps and platforms like CrowdStreet through which you can invest in real estate.

"These platforms let investors pool together assets in order to invest in commercial or residential properties," Ashley Foster, a certified financial planner and founder of Nxt:Gen Financial Planning, tells CNBC Make It. "They essentially act as REITs for the small time investor."

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Then there are other platforms, like Roofstock, that let you buy actual properties all over the country and manage them remotely. This could be a good option for if you reside in high-cost of living cities like New York or San Francisco but want to pursue real estate as a form of passive income in a more affordable city.

It's a popular tactic. Just over 11% of home sales in 2018 can be attributed to investors, the highest percentage in at least 20 years, according to Core Logic. "Smaller" investors just getting their start in real estate are driving the increase.

Still, it's good to exercise caution. Unlike a stock, you can't easily divest yourself from owning a property. And you want to be careful with apps that have not been around for very long.

"Since these platforms have never been tested in a recession, no one knows how they will perform if thousands of small time investors start fleeing for the exits," says Foster.

Buy a rental property

One of the most obvious ways to invest in real estate is to buy a property and rent it out to others.

The best way to do this is to keep the ability to rent in mind when buying the house you intend to live in, Shon P. Anderson, an Ohio-based certified financial planner, tells CNBC Make It. That way, you can qualify for residential loans. You can either live alone at first and rent out the entire property later on or buy a building with multiple possible units or rooms and live there simultaneously with your tenants.

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"If you live in the place first, you can put as little as 3.5% down," says Anderson. And "you will have a leg up marketing it when it comes time since you lived there a while."

When buying an investment property, look for one with low expenses so that you can charge reasonable rent in the area and still come out ahead. Keep in mind amenities that appeal to tenants, such as walkability, access to restaurants and other activities or proximity to good schools.

Prospective buyers should also make sure they are not over-extending their mortgages, Barbara Ginty, certified financial planner and host of the "Future Rich" podcast, tells CNBC Make It. Consider what would happen if you bought a property and couldn't find a tenant right away: Would you be able to afford the rent yourself? Remember, you'll also be responsible for taxes, maintenance, insurance and other expenses.

If you don't have the skills to fix up the place yourself, you'll also have to include the costs of hiring a property manager or superintendent in your calculations.

Karl Leonard Hicks, a California-based certified financial planner, suggests asking the following questions before buying any property:

  • What is your plan for the investment?
  • Is this a long-term investment?
  • Is this a short-term investment that you want to flip?
  • What is the funding mechanism and how secure is it?
  • What is the most you should pay and how do you plan to handle the monthly cost and cash flow?

"The answer to these questions will help shape the type of investment and the return they should expect as well as whether it's a good idea or not," he says.

Once you have all of those answers squared away, you can start looking for a place to rent out.

Don't miss: How to turn your place into an unforgettable (and potentially lucrative) Airbnb rental

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