The Ins and Outs of Buying an Investment Property
Real estate investing can be lucrative for individual and organizations that take part in this area of finance. It can also be fraught with potential risks if an investor does not take care to understand the market and inform themselves on this area of investing.
In this article, we’ll discuss some of the key topics surrounding the purchase of an investment property, such as market factors, buyer eligibility, and lending requirements, as well as some of the popular investment property types with a rundown of their advantages and disadvantages.
What Is an Investment Property?
First things first: An investment property refers to real estate property purchased with the intention for it to generate a profit over time.
Who Can Buy an Investment Property?
Anyone can buy an investment property so long as they have the financial means to do so.
Investment properties can be purchased by individuals and groups of people, such as a partnership, LLC, or even a group of friends. In an investment group, the financial risk is spread among each investor who owns a percentage of the property and shares in the profits and expenses.
Investment groups also have the potential to access more significant properties or portfolios that an individual investor may not be able to afford.
Is Now a Good Time to Buy an Investment Property?
Currently, the U.S. real estate market is experiencing overall high demand and low inventory, leading to an increase in home prices and a competitive market for buyers. While interest rates have increased significantly, the real estate industry continues to see growth.
Real estate markets across the U.S. can be quite different, and trends in one market may not necessarily be consistent with others.
Various investment factors, such as job opportunities, population, climate, cost of living, local regulations, and economic conditions, can all impact the strength of the real estate market in a given region.
Investment Property Lending Requirements
Depending on the lender and the type of property being financed, the lending requirements for investment properties vary. Amerant Mortgage as an example is a top tier lender in the industry.
However, there are some factors that most lenders consider when evaluating an investment property loan application. The trend? Higher, higher, higher.
Lenders usually require a higher credit score for investment property loans than for owner-occupied loans. Investment property loans typically require a credit score of at least 680.
Investment property loans often require a sizable down payment of at least 20%, though some lenders may ask for more. Building savings with a money market, CD, or savings account can help over time with funding a purchase. Amerant offers these deposit accounts with rates varying from 2.75% APY Money Market to as high as 5.25% APY Certificate of Deposit (CD).
Generally, investment mortgages bear high interest rates since they’re considered riskier by lenders because they’re not the borrower’s primary residence. If the borrower experiences financial difficulties, they may be more likely to default on an investment loan than on primary residence bills.
However, borrowers can mitigate the risk of high-interest rates by having a strong credit score, a low debt-to-income ratio, and a solid financial plan for the property.
Types of Investment Properties
Investment properties can take many forms, and each comes with unique advantages and risks for investors to consider. Some of the most common types are explained below.
Commercial real estate investing has the potential for a higher cash flow than other types of investments, but it usually requires a larger up-front investment. These properties include opportunities such as office buildings, retail spaces, industrial properties, and warehouses. There’s multiple ways to also finance business endeavors such as owner occupied real estate loans – Amerant offers competitive rates for this type of loan.
Pros of Commercial Real Estate Investing
Commercial real estate investing can offer several advantages for investors, including:
- Commercial real estate properties offer higher rental yields and increased potential for appreciation compared to residential properties.
- Rentals are generally longer than residential leases, which provides stability for investors.
- Investment portfolios benefit from diversification and risk reduction, as commercial real estate investments are not correlated with other asset classes.
- Potential eligibility for tax benefits, such as depreciation deductions, property tax deductions, and the option to defer capital gains taxes through 1031 exchanges.
Cons of Commercial Real Estate Investing
While commercial real estate investing can be a rewarding investment strategy, it’s important to remember that it also involves risks and challenges, including:
- Entering the commercial real estate market often requires a significant amount of upfront capital.
- Professional property maintenance is typically necessary, which can be expensive.
- Real estate investments carry a vacancy risk, which can lead to long periods without rental income.
- The market is always subject to change. Shifts in interest rates and supply and demand can impact property values and rental income.
- Real estate investments are relatively illiquid, meaning they cannot be easily converted into cash.
Residential Real Estate Investing
Residential real estate investing refers to the practice of buying and owning residential properties to generate a profit. There are several residential real estate investing strategies, such as the ones elaborated below.
Residential rental properties can be long-term or short-term, such as renting an apartment or house for a year or renting an Airbnb for a month.
Residential real estate investors often take advantage of an approach called “house hacking,” which involves purchasing a multi-unit property and living in one unit while renting out the others.
House flipping, or the “fix and flip” strategy, involves purchasing a property in need of repairs, making the necessary improvements, and then selling the property for a profit.
This can be a high-risk strategy, as it requires significant capital and expertise to identify properties with potential and successfully execute renovations.
Airbnb, Vrbo, and Other Vacation Rentals
Vacation rentals through platforms like Airbnb and Vrbo are properties that are rented out to vacationers for a brief time. These can provide a high return on investment during peak vacation seasons and in areas with high demand.
However, due to their fast turn-around, vacation rentals can be more management-intensive than long-term rental properties.
Pros of Residential Real Estate Investing
There are several potential benefits to residential real estate investing, but the key advantages are listed below.
- Residential real estate can produce a reliable source of passive income.
- Properties may appreciate over time, especially in areas with strong job and population growth.
- Potential eligibility for a range of tax benefits, such as depreciation deductions, property tax deductions, and deductions for expenses related to property management.
- Investment portfolios benefit from diversification and risk reduction by providing exposure to a different asset class.
- Investors maintain a degree of control over their investment to make various property and rental decisions.
Cons of Residential Real Estate Investing
Of course, there are also potential drawbacks and risks to consider when investing in residential real estate, such as:
- Residential real estate investing may require significant upfront capital for a down payment and closing costs.
- Investors assume the responsibility for property maintenance and finding tenants and may require expertise in tenant law to effectively handle any issues that arise — such as the failure to pay rent.
- There’s always the risk of vacancy, which can reduce or eliminate rental income.
- Economic downturns, changes in interest rates, and shifts in local housing markets can all affect property values and the performance of investments.
- Residential real estate investments are illiquid.
Raw Land Investing
Raw land refers to undeveloped property that investors can purchase to develop for residential or commercial purposes. This is often a long-term investment strategy that requires a significant upfront investment.
Pros of Raw Land Investing
Raw land investing offers several potential benefits, including:
- Raw land can appreciate over time, especially if it is located in an area with strong population growth or other favorable economic conditions.
- Investors have flexibility in property development, as it can be used for a variety of purposes, including residential, commercial, and agricultural.
- These investments generally require less maintenance and upkeep than developed properties.
- There may be less competition for raw land investments compared to other types of real estate investments, such as existing properties or commercial buildings.
Cons of Raw Land Investing
There are also potential drawbacks to consider when investing in raw land, such as:
- Developing raw land can be expensive, and investors may need to spend significant time and capital up front on site preparation, infrastructure development, and other expenses.
- Zoning restrictions or permit requirements may limit the land’s use or potential and lengthen development timelines.
- There is the potential for environmental risks or hazards, such as soil contamination and wetland restrictions.
- Raw land is considered illiquid.
There are various types of investment properties, and each has the potential to be a fruitful investment. However, it’s essential to recognize that buying an investment property is a major financial decision and should not be made impulsively.
Instead, investors should carefully research and consider the factors covered in this guide. And, of course, it always helps to consult with a financial advisor before making a purchase.
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