What is an investment property?
An investment property is a property, most commonly a home or apartment, purchased with the intention of making a profit. In other words, its primary function is not to be a place for the buyer to live, but to be a vehicle toward producing positive cash flow for the buyer, either immediately, almost immediately, or down the road.
An investment property could also, of course, be a commercial property that the buyer would rent out to a business. This type of endeavor can be very lucrative, but also carries with it more complicated situations such as what type of business the property is zoned for, and what to do with the property if the business struggles.
What types of investment properties are there?
On the residential side, there are different ways to make money from an investment property. Sometimes, buyers purchase homes with the intention of fixing them up, improving their value, and quickly re-selling them at a higher price, pocketing the difference. Others try to find buyers who are motivated or even forced to sell because of financial difficulties, such as unpaid taxes or foreclosures. Sometimes sellers in this situation are forced to accept a much lower offer than they otherwise might.
A very common real estate investment is the rental property. This can be a home, apartment, or condominium purchased strictly with the intention of renting out to someone else. If the rent payments meet or exceed the monthly mortgage payments and costs, the the investment property builds equity value over time using the renter’s payments. When considering this course of action, location and population density in the area of the property are very important considerations. A large house in a rural area may not attract much interest from potential renters, while a smaller apartment in an urban area will almost always have a market.
How do I get a loan for an investment property?
The first steps are to decide how much you’d like
to spend on an investment property and then seek pre-approval from a bank or a credit union.
The process might be similar to obtaining a residential mortgage in some ways, but also might have some key differences.
The bank will of course want to verify your existing assets, your income levels, and check your credit. The higher your credit rating and net worth, the bigger loan and lower rate you’ll qualify for. For investment properties, a larger down payment may be required. First-time home buyers who intend to live in the property they are purchasing may be able to get a loan with as little as 3-5% down. For investment properties, a down payment of 20-25% is often required.
An added consideration with an investment property loan is the income the property is expected to generate. A bank may consider at least a portion of that revenue as part of your loan qualification, but also may allow for months where the property is empty and does not generate income. For example, if the property is expected to generate $1,000 per month in rent revenue, the bank may average it down to $750 a month to allow for “empty months.”
What to know about tenants. At a minimum, it is recommended to perform credit checks on potential tenants. Some landlords may even perform criminal background checks on tenants. Leveraging a service such Experian can help make your investment property a safe long term investment. They provide detailed reports on credit risks and background red flags. Lastly, consider asking potential tenants for a list of references and previous landlords as this will not cost anything and provide another level of security for your investment property.
Also, it is important to familiarize yourself with tenants’ rights and with potential landlord-tenant disputes that are common with rental properties. This can help you anticipate what you need to prepare for.
Although a property management company may carry some extra cost, they are worth considering for new investment property buyers, as they can help with things like standard leases, maintenance, and property listings.
What can I expect to earn on an investment property?
On a basic level, you need to consider the property’s monthly income from tenants, minus the monthly costs of the mortgage, taxes, maintenance, and other considerations. It’s the “other considerations” piece that investors should really plan carefully for: costs such as listing fees, repairs, obtaining new tenants, cleaning, and more.
Then, of course, beyond the monthly profit and loss, is the appreciation in value of investment property over time. This has become harder to predict in recent years, and depends heavily on the area in which the property is purchased. Researching recent trends is highly recommended.
Types of Investments
What to Expect