Buying an Investment Property: Everything You Need To Know
Investing in real estate has lead to many people who have some money grow it into massive fortunes. Many investor professionals often suggest real estate as a sound investment because it’s fairly stable and in the right situations, can earn you a lot of money.
With any investment, it’s wise to first research it thoroughly and make sure it’s right both for you and your portfolio. Depending on what you purchase, and how you plan on making money off of it, there’s a chance it can lead to extra responsibilities or not getting your money back in the timeline you were expecting.
Table of Contents
- 1 How to Buy An Investment Property
Second Home vs. Investment Property
It’s important to know that there are differences between purchasing a second or vacation home and buying an investment property. Especially if you are looking to take out a loan to fund your investment property, you need to understand how they differ and how it impacts you financially.
Typically, buying a second or vacation home doesn’t require living there a specific amount of time, but with an investment property, you usually are not allowed to live there in any capacity. Other people can, whether you are renting out your investment to vacationers or tenets, but you yourself typically cannot. Investment properties are designed to make money for their owner and come with their own mortgage types, taxes, and extra responsibilities.
Mortgage Rates for Second Homes vs Investment Property
Gaining a second or vacation home mortgage loan often comes with slightly higher interest rates, larger down payments, higher requirements for a credit score than a first home mortgage, and being able to show you won’t go over the debt to income ratio. Receiving a second home mortgage also requires being able to show the lender you can pay the monthly costs without additional income generated by the home itself.
Investment property loans have higher rates than first and second home mortgages. That includes requiring a much larger down payment, higher interest rates, and many lenders want a business plan on how the property will be making money. Investment properties also have additional taxes to deal with, alongside property taxes.
How to Buy An Investment Property
To find success in buying investment properties, you need to make a plan. That includes where you’ll buy property, how you plan on turning the investment into more money, and what kind of timeline this will all happen in. You should also never buy investment properties in your own name, but instead create a Limited Liability Company, or LLC. An LLC can protect you in case of a lawsuit, as you won’t be able to be sued more than what you’ve personally invested into buying a home.
There are many different forms of investment property. You could buy a home to rent out to others, buy up an apartment complex, purchase a commercial or retail complex to rent out to business, or even flipping a home to resell later. Anytime you buy a piece of real estate with the purpose to earning more money from it, it becomes an investment property. Rentals are the most common type of investment property, but you need to be sure you pick what is best for your scenario and portfolio. Consider meeting with an investment professional to pick out the right path for you.
Know What to Look For in an Investment Property
Once you’ve chosen what kind of investment you want to make, you need to do research on what you want when buying it. Your requirements for a vacation rental home will be very different from a home you want to flip.
Before starting to shop around with a real estate agent, make a list of requirements and desires that will help you get the most out of your investment. This could include location of the property, how large it is, how new it is, extra features or benefits, and most importantly: cost.
Know Your Budget to Purchase An Investment Property
You don’t need to purchase an investment property completely debt-free, but you do need to have a good handle on your finances. Especially if you are just starting getting into real estate investing, it’s quite likely you’ll need to take out a loan for the first time.
When it comes to buying the investment property, you need to budget out the loan you’ll be taking out, or pulling from your own finances, to make sure you don’t ruin yourself. Make sure you have a high credit score, plenty of backup money, and shop around for the right lender.
Know Your Budget to Own Investment Property
After buying the property, there are still costs to account for. If you plan on renting it out long term, you need to account for bills you’ll cover versus what tenants will pay, year-to-year taxes, and paying for repairs. If you are flipping a home, you need to pay for all of the house bills, and the cost to get the home fixed up and sellable.
Be sure to create a budget and know how much extra financial burden you can handle, especially if your investment will take time to pay out. Take into account taxes, bills, paying for employees to help manage it, and expenses like repairs or renovations that might be needed. You should also budget out for when your investment does start paying off and that the money can cover either the costs of maintaining the property or paying off its debt.
Understand What Returns You’ll Need
The point of buying an investment property is to eventually start making money off of it. Just like most businesses, there will be a time you don’t make money, as you’ll be investing your money into the project. Have a plan wherein eventually, the investment starts paying out, and determine how much of that will go towards: your personal wealth, future investment plans, and continued maintenance of the property if necessary.
Prepare a Down Payment
Once have chosen a piece of real estate you want to invest in, and have done all the necessary budgeting, you need to prepare a down payment if you plan on taking out a loan. Typically, lenders require a 20 percent down payment for an investment property loan. Unlike mortgages for an owner-occupied property, investment properties generally don’t qualify for mortgage insurance, so having the full down payment is non-negotiable. Get your finances in order, save up money, or get an investment from somebody else to help meet that down payment requirement.
Understand Interest and Tax Rates
Be sure to shop around to find the best interest rates you can for a loan. The type of investment you are doing can impact the interest rates you’ll receive.
Similarly, be sure you understand all of the additional taxes and expenses you will have to pay. Property taxes, HOA fees, and insurances are all things you might have to pay for alongside the loan.
Research the Market
There is always risk when investing your money, and you need to make sure that someday, it will pay out. Whether that comes in small chunks over time, or in one massive payout, you need to understand the current and future market, so you can make your money back. Research and understand the business market you are joining, and who your competitors will be.
For example, if you plan on buying a luxury apartment complex, you need to compare your projected costs and rent to those around you. Are other apartment complexes in the area offering similar luxuries at a lower cost? Is there a high demand for luxury apartments in that area? Be sure you know what’s happening currently and look for trends predicting the future.
If you take the time to do lots of research, budget everything out, and have the right plans in place, you can make a lot of money through investing in real estate. Doing it the wrong way can result in money pits that never pay out, or even lead to bankruptcy. Take your time, make wise plans, and be sure of what you are doing before buying an investment property.
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Ben Allen is a freelance content creator and digital marketer who believes in helping small businesses succeed. He spends his free time bragging about his two daughters, eating stuffed crust pizza, and playing video games.
This post was updated November 13, 2018. It was originally published October 23, 2018.