Making a Buck on Real Estate

Question of the week:My money is primarily in the stock market right now, but I'm interested in diversifying by trying my hand at real estate investing. What's your take on that? --MM

Dear MM,

While making money in real estate is easy if you believe the late-night TV hucksters touting instant profits with no money down, the reality is quite different. Yes, it certainly is very possible to get better returns in real estate than in the stock market. But it requires a lot more work and a bit of luck.

When we recently asked members of the Armchair Millionaire community about investing in real estate, we heard about some good and not so good experiences:

"I first opted to try investing in real estate several years ago when moving out of state for new employment. Instead of selling my house, I contracted with a local property management company to rent it out and take care of it for me. This was one of the best moves I've ever made. This property has not only appreciated to near double what I owe on it, it also generates some monthly passive income. Since then, I have acquired other properties and am using the income they generate to purchase more." --Kevin

"My parents invested in a commercial real estate deal to build student apartments in a small town a few miles from a state university, but they lost money on it. It did sound like a project with good potential, but the person in charge went bankrupt during the building phase and all the investors lost their money." --Simplicity Key

When considering the pros and cons of investing in real estate versus the stock market, consider these fundamental differences between the two:

When you invest in stocks--especially if you do so through an index fund--you can build a hugely diversified portfolio of stocks from around the country and the world. But when you invest directly in real estate, you're usually restricting yourself to one property (or type of property) in one geographic location. This leaves you vulnerable to shifts in that market.

On the upside, real estate prices in general over the years have tended to be much more stable when contrasted with the volatility of the stock market.

If you're determined to dabble in real estate, my checklist will get you started in the right direction.

The Armchair Millionaire Checklist for Investing in Real Estate

• Understand what it takes. You'll have to devote a nice chunk of your time to your new enterprise. Also, be advised that you could expose yourself to financial and legal difficulties, and may have to deal with tenant and maintenance issues--all with no guarantee of a profit. If you don't have the right temperament for all this, stick with stocks.

• Choose your specialty. Your could buy property with the intention of selling and turning a quick profit within days, or purchase a property, rent it out, and then wait years for it to increase in value. You might invest in single family homes, apartment buildings or commercial property. You could focus on run-down neighborhoods or glitzy shopping malls. Each of these is a very different game, so understand the advantages and disadvantages of each and then pick one to excel in.

• Start slow. Don't take on too much too soon. Deal with one property and then, if it works out, go on to another. The learning curve is steep, so don't over commit your money while you're learning the ins and outs.

• Get professional help. Positively have an attorney and CPA on your side, preferably ones who specialize in real estate transactions.

• Consider REITs. Real Estate Investment Trusts (REITs) invest in publicly traded real estate companies but you buy and sell them like a mutual fund. With REITs you get diversification into real estate without the headaches of being a landlord.

THE BOTTOM LINE: As with all investments, when you're looking for higher returns in real estate you'll have to take on higher risks. Before you make the leap, closely scrutinize whether it's the best course for you, and then create a clear strategy for making it work.