When considering an investment property, it is important to weigh the pros and cons
An investment property is a home or piece of land that you buy to generate a financial return. That financial return usually comes in the form of rental income or from appreciation.
While there are numerous benefits to buying an investment property, there are also risks. It’s important to be aware of these ahead of time.
Generating a solid financial return is achievable. You just need to know how to get started. In this article, we will outline how to profit from an investment property.
When done properly, purchasing an investment property - a form of real estate investing - can be incredibly lucrative. This can still be the case even if interest rates are significantly higher.
Getting an investment property can also help you diversify your existing investment portfolio. Eventually, you may be able to earn a stream of passive income.
In this section, let’s look at the different ways of getting an investment property.
REITs, or real estate investment trusts, enable you to invest in real estate without the physical home or property.
REITs are usually compared to mutual funds. They are companies that own commercial real estate like retail spaces, apartments, office buildings, and hotels.
REITs are a common investment in retirement, since they tend to pay high dividends.
While REITs have the potential to be a good investment, they are also complex and varied. Some are publicly traded while others are exchanged like stock. The level of risk you are taking on depends on the type of REIT you buy. Non-traded REITs, for instance, are more difficult to sell and therefore may be harder to value.
Use online real estate investing platform
Online real estate investing platforms are a good way to connect developers to investors looking to finance projects, either through equity or debt. In exchange for taking on the risk and paying a platform fee, investors want to receive quarterly or monthly distributions.
If you go this route, you will likely need some money to earn money. Most of these online real estate investing platforms are only open to accredited investors.
What does that mean? It is defined by the Securities and Exchange Commission (SEC) as anyone who has earned income higher than $200,000, or $300,000 with a spouse, in each of the previous two years. Otherwise, an accredited investor can be someone with a net worth of at least $1 million.
Invest in rental properties
Consider investing in rental properties. One great way to get a foothold is to purchase student-housing style. In this case, you could buy a condo with multiple rooms and rent out of the rooms for yourself. The setup could even earn you money each month.
Another strategy you could follow up with here is called hacking, which is an online resource for real estate investors. It means you are occupying your investment property. You can do this either by renting out rooms or by renting out units in a multi-unit building. This strategy allows you to purchase a property with up to four units in it and still qualify for a residential mortgage.
Flip investment properties
In this case, you can invest in an underpriced home and renovate it as cheaply as possible before reselling it for a profit.
While a good option, it is also more costly now than in the past. Not only are building materials more expensive, but interest rates are also higher. For this reason, most house flippers try to pay for the property in cash.
Since it requires a highly accurate estimate, it would be a good idea to find a partner who has experience house flipping. One risk to keep in mind is that the longer you have the home, the less money you will earn. Why? Because you will likely be on the hook for the mortgage without bringing any income in.
Rent out a room
This is perhaps the easiest way to try your hand at investing in property. Renting out a room in your home will help offset the cost of the property. It is also a good way for younger people to make up their mortgage payments.
The 2% rule for investment property states that the monthly rent for an investment home should be equal to or no less than 2% of the purchase price. For instance: an example of the 2% rule for a property with a purchase price of $150,000 (multiplied by 0.02) would be $3,000. If you use the 2% rule, in other words, you are looking at a mortgage that has a monthly payment of $3,000 or less.
Another popular rule for investment property is the 1% rule. This means you would pay half what you would pay in the 2% rule. For instance, for a property with a purchase price of $150,000, you would be charging $1,500.
When it comes to rental properties, mortgage lenders often have stricter guidelines. While you can purchase a primary property for as little as 3% down, most borrowers are required to put down anywhere from 15% to 20% to purchase a rental property.
After finding an investment property you want to buy, you must go through the application process to secure financing. Most of the time, mortgage lenders need a significant down payment and evidence that you have a solid financial history.
Typically, investment properties have a higher rate of foreclosure. That means most lenders are less likely to want to take a risk on you.
Plus, there are other costs to consider. For instance, if you want to rent a portion—or all—of the property, you will need landlord insurance. If, on the other hand, you want commercial property, you’ll need a special insurance policy. This is not even considering the cost of repairs and renovations which are highly common with an investment property.
Let’s break down some of the pros and cons of purchasing an investment property.
Investment property: the pros
- Diversifying investments: An investment property will provide your portfolio with diversification, therefore reducing investment risk. Tangible assets like homes usually act as a counterbalance to paper assets such as securities. This means they rise in value while others drop.
- Earn money: An investment property will likely provide you with strong returns. This is often in the form of monthly rent or long-term appreciation.
- Tax benefits: Owning an investment property comes with added tax benefits and deductions. These will help you pay for the costs of depreciation, among other expenses.
Investment property: the cons
- Illiquidity: Purchasing an investment property ties up a significant amount of money that will remain inaccessible until you sell the home. And compared to unloading stock shares and mutual funds, selling a home takes much longer.
- Extra costs: Some unforeseen costs can include remodels, replacements, repairs, and any other expense that the investment property might require.
- Ownership challenges: Managing and maintaining an investment property can be time consuming. While you can hire help, it will be an expense that eats into any profits.
When buying an investment property, consider the tax benefits.
Like any investment decision, the best investment properties serve you, the investor.
Before you decide to buy an investment property, consider how much time you have to devote to the project. Also think about how much you’re willing to spend. Do you want to be the one who deals with any household issues that arise? If your DIY skills are lacking, you may have options. Consider investing through a REIT or a crowdfunding platform.
To find out more about how to buy an investment property, get in touch with one of the mortgage professionals we highlight in our Best in Mortgage section. Here you will find the top-performing mortgage professionals across the USA.
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