Real estate investing involves the purchase, ownership, management, rental and sale of real estate for profit. Improvement of reality property as part of a real estate investment strategy is generally considered to be a sub-speciality of real estate investing called real estate development.
Real estate is an asset form with limited liquidity relative to other investments, it is also capital intensive although capital may be gained through mortgage leverage and is highly cash flow dependent. If these factors are not well understood and managed by the investor, real estate becomes a risky investment.
The primary cause of investment failure for real estate is that the investor goes into negative cash flow for a period of time that is not sustainable, often forcing them to resell the property at a loss or go into insolvency. A similar practice known as flipping is another reason for failure as the nature of the investment is often associated with short term profit with less effort.
Real estate markets in most countries are not as organized or efficient as markets for other, more liquid investment instruments. Individual properties are unique to themselves and not directly interchangeable, which presents a major challenge to an investor seeking to evaluate prices and investment opportunities. For this reason, locating properties in which to invest can involve substantial work and competition among investors to purchase individual properties may be highly variable depending on knowledge of availability.
Information asymmetries are commonplace in real estate markets. This increases transactional risk, but also provides many opportunities for investors to obtain properties at bargain prices. Real estate entrepreneurs typically use a variety of appraisal techniques to determine the value of properties prior to purchase.
Once an investment property has been located, and preliminary due diligence investigation and verification of the condition and status of the property completed, the investor will have to negotiate a sale price and sale terms with the seller, then execute a contract for sale. Most investors employ real estate agents and real estate attorneys to assist with the acquisition process, as it can be quite complex and improperly executed transactions can be very costly. During the acquisition of a property, an investor will typically make a formal offer to buy including payment of “earnest money” to the seller at the start of negotiation to reserve the investor’s rights to complete the transaction if price and terms can be satisfactorily negotiated.
This earnest money may or may not be refundable, and is considered to be a signal of the seriousness of the investor’s intent to purchase. The terms of the offer will also usually include a number of contingencies which allow the investor time to complete due diligence, inspect the property and obtain financing among other requirements prior to final purchase. Within the contingency period, the investor usually has the right to rescind the offer with no penalty and obtain a refund of earnest money deposits. Once contingencies have expired, rescinding the offer will usually require forfeiture of the earnest money deposits and may involve other penalties as well.
Flipping is buying an under priced property and then quickly reselling it at market value. Homes are typically sold below value by uninformed sellers or those in distress like job loss or foreclosure. Often a property is sold under market value because it is a “fixer upper”. Sometimes they require very little such as paint and carpet and other times they have mold, asbestos, or foundation issues. These inherently hold more risk and more work, and therefore often have substantial profits.