There are many ways to go about real estate investments. You may own it as a primary residence, a second home or choose to update and sell a fixer-upper. A third, popular way of owning real estate is by investing. To see if an investment property is right for you, we’ll cover what an investment property is, what it’s like to finance one and more.
What is an investment property?
An investment property is a piece of real estate you or a group of people own to profit. This might mean a monthly profit from renting out your property, or a profit down the line when you eventually sell.
It’s important to distinguish the difference between an investment property, renovating and selling a fixer-upper and a second home. Buying a fixer-upper, updating it and selling it is usually not the same as an investment property because it yields short-term gains.
The strategy behind an investment property is usually long term — you intend on holding onto this real estate for the long haul and it usually isn’t where you reside, like you would in a primary or secondary home.
The IRS differentiates tax benefits between a second home and an investment property. There are different qualifications and tax implications for both. If you live somewhere other than your primary residence for more than 14 days or 10 percent of the days you rent it out, it’s considered a second home. That is why an investment property is not usually somewhere you, the owner, would be living. Keep in mind, though, that real estate definitions may vary lender to lender.
Why consider an investment property
If you have funds to invest, real estate may be a good option for you. There’s no guarantee in any investment, but real estate often proves to be a steady rate of return and profit.
There can be tax benefits to owning a property and renting it out. As an investor, you may be able to treat your mortgage interest rate as an expense and deduct it from your rental profits. There’s also an opportunity for depreciation deductions against the price of your home and various home improvements. These depreciations are annual income tax deductions. You can visit the IRS to learn more about how your investment property might qualify, or contact your personal tax advisor.
Common mortgages for an investment property
It’s more common and usually more cost-efficient for people to finance a primary residence only. But if you’re in the position to invest, there are a few things you can do. Keep in mind, down payments are usually higher for investment properties than primary residences. You will typically see lenders ask for a 15 to 25 percent down payment. Lenders may provide a wider range of down payments for primary residences because there’s less risk.
Like any home, it’s helpful to get prequalified for a mortgage. To be sure you're getting the best deal, talk with multiple lenders and compare their mortgage interest rates and loan options.
With prequalification, the loan officer will ask for information about your income, job, monthly bills, amount you have available for a down payment and possibly some other information. They will then provide you with an estimate.
There are various loan programs to consider with a real estate investment. It’s important to remain cautious about your debt, but it’s good to know that there is help if you need it. Here are a few examples:
- Conventional loans from a bank, like what you’ve probably used for primary real estate.
- Home equity loans. Take advantage of the equity you’ve built in your primary or secondary residence to help fund an investment property. You may get up to 80 percent value of your home equity if you take out a home equity loan.
- Find investors. You may have friends, family or colleagues in your network who are interested in a real estate investment that’d be willing to help finance the property.
The safest option is always to save up money and avoid any debt, but there are cases where taking out a loan or asking for help might be worth it. Make sure to do your research before committing to a strategy.
How to find the right investment property
There are many things you should consider when finding the right investment property for you. Here are a few things to ask yourself:
- What does the market look like? It’s important to remain up to date with estate trends.
- Try to make sure you’re coming in at a time that is financially sound for you. Acting on emotion is not recommended, but remaining proactive and reactive to market trends is.
- Where do you want to buy?
- Where is it smart to buy?
- How much can you afford?
- Do you want to invest alone or as a group?
- How much could you charge as a rental?
- How much do other homes cost in the area?
- Does this area have a high rate of appreciation if you’re looking to sell?
- What kind of attractions and job opportunities are around?
- Is this a vacation destination? If so, how can you remain competitive with other rental properties nearby?
If you know someone who has invested in real estate, it might be helpful to pick their brain. Knowledge is power!
The pros and cons of an investment property
As you can see, there are pros and cons of buying an investment property, and many of them depend on your personal circumstances.
Potential pros of owning an investment property
- Potential tax benefits
- Opportunity for passive income
- Probability of long-term appreciation
- Could be a steady, dependable place to put a surplus of cash
Potential cons of owning an investment property
- Can be a challenge to finance
- Income might ebb and flow with rental trends
- Additional management and upkeep responsibilities
- Potential lack of liquidity and unforeseen costs
Investing in real estate could be a good option for you if you have the resources to do so. It can also be a bit of a headache before you see the fruits of your labor. Speak with your Home Lending Advisor to see if owning an investment property is the right move for you.