Buying An Investment Property: The Complete Guide
Have you ever thought about buying an investment property? Real estate is a pretty common investment – and for good reason. Managing and renting out a property can bring in considerable and consistent cash flow for you when done right. Getting started can feel like a monumental task, however, and your investments shouldn’t be made lightly – so how do you get into investing?
Let’s go over what an investment property is, some of the different types and how you can start making well-researched and lucrative investment decisions yourself.
What Is An Investment Property?
An investment property can be defined as a real estate purchase made with the intention of earning a return through rental income or resale. This can include anything from flipping and reselling a house to renting out a condo.
Before investing in any sort of property, consider your intentions for the real estate you’re looking at ahead of time. Are you looking to make fast, short-term gains or are you willing to stick it out for a long-term endeavor? Real estate investments do not come without risk, so it’s important to do your research and consider all your options.
Investment Property Types
If you’re just getting started investing in real estate, you may be unsure where to begin. There are many different ways you can start investing your capital in real estate, and the method you choose will ultimately depend on your goals and budget.
Let’s go over each of these property types and what you need to know about investing in them.
Residential Real Estate
Residential real estate refers to properties that are zoned for private living or dwelling. This category includes single-family homes, apartments, duplexes, condos, townhouses and more. If you invest in residential real estate, you’ll most likely be taking on the role of a landlord. That means you’ll be renting out your investment property to tenants and handling the upkeep of the building and people who will live in it.
If fixing maintenance issues and screening potential tenants sounds like a headache to you, you can hire a property manger to take care of these issues for you. Keep in mind that will be another cost you will have to shoulder. If you only own one or two investment properties, you may want to handle the duties of a landlord yourself to assure you’re still making a decent return for yourself.
Commercial Real Estate
Commercial real estate is any property used for retail or office space. This category includes everything from offices to shopping malls. Investing in commercial property is similar to investing in residential property in some ways. You’ll still be renting out a space to tenants, but in this case, you’ll be sharing your space with businesses rather than individuals looking for a place to live. Commercial properties tend to provide more income than residential properties, but also carry more risk.
This is because your success is directly linked to the success of your tenant. If their business is failing, your investment will suffer, too. Lease terms tend to be longer with commercial real estate as well – sometimes upward of 5 years at a time – which means you’ll have to choose your tenants very carefully.
Commercial real estate requires a great deal of market knowledge, so it isn’t recommended to first-time investors, though first-time commercial real estate investor success is still possible with proper research and advice.
Industrial Real Estate
Industrial real estate refers to properties such as warehouses, manufacturing buildings, fulfillment centers and industrial parks. Even more so than commercial properties, industrial real estate is something geared more toward experienced investors.
Industrial properties attract high-profile tenants but are a higher cost to purchase and maintain than commercial or residential properties. Industrial properties can support the economy on a global, national or regional scale, so they aren’t as easy to get into as a beginner investor.
Land Real Estate
Beyond investing in buildings, you can invest your money in land to resell, rent or develop . Raw land is commonly leased to farmers, flipped and sold to developers or developed by the land investor themself as a larger and more long-term commitment.
Land tends to be a riskier investment than developed property because it may not appreciate in value over time and might not bring you considerable income. Before investing in land, it’s important to consider the location of the property as well as what type of land it is. Raw land in a growing area can be a great investment if you are able to resell it to interested developers. Land in an area where it is not in short supply, however, might end up costing you more than it’s worth. Landlocked property can present its own challenges with surrounding landowners as well.
How To Buy Investment Property
Now that you know a few of the main investment property types, how can you get started buying one? There are a few things you need to consider when financing your first piece of investment real estate, so let’s go over those now.
Secure Financing And An Investment Property Loan
One of the first steps to investing in property is securing financing to purchase it. Depending on the type of property you choose to invest in, the way you go about doing this might look a little different. If you’re investing in residential real estate, you might simply get preapproved by a lender for a mortgage loan. Whereas, if you’re looking to invest in a piece of industrial real estate, crowdfunding the property with a group of investors might make more sense.
Lenders are taking on additional risk when they lend to investors rather than borrowers financing a primary residence. Higher risk means higher interest rates and down payment requirements, which is important to keep in mind when considering your budget for an investment.
Choose Your Location On Where To Invest In Property
Regardless of the investment type, location is an extremely important factor to consider when making a real estate investment. If your property is located in a place where it will be in high demand, you’re more likely to make additional profit on your investment. A commercial property in a prime location will attract businesses, and a residential property in a popular area will attract tenants.
If you’re struggling to choose a location, enlisting the help of a real estate agent might be useful. Real estate agents tend to be very knowledgeable about the areas they work in and can likely provide good advice on high-demand locations.
Work With Real Estate Professionals
In addition to helping you choose a good location to invest in, real estate professionals can also help you with many other steps of the investment process. Investment property-friendly real estate agents and other pros such as real estate attorneys, contractors, inspectors and property managers can help you with a variety of investment related tasks. These include locating potentially profitable properties, advising you on investment choices and offering advice on investor-specific tax benefits that you might qualify for.
Calculate Cash Back And ROI
Before you buy an investment property, it’s a good idea to consider what the property’s return on investment (ROI) or profitability will be. Calculating the potential ROI can help you assess whether it would be wise to invest in a specific property . The formula for ROI is as follows:
ROI = (gain on investment – cost of investment) / (cost of investment)
So, as an example, if you spend $80,000 on a fixer upper home and think you can sell it post-flip for $135,000, the formula would look like this:
ROI = ($135,000 - $80,000) / ($80,000)
In this case, the ROI would be approximately 0.69, or 69%. ROI can be tricky with rental properties, however, since there are many variables and costs associated with the upkeep of the property that aren’t accounted for in the ROI formula. As an alternative, you might also calculate the cash back or cash on cash return that you can expect from your real estate investment.
Cash on cash return measures how much of your investment you’ll earn back annually. Where ROI measures your total return on investment, cash back simply measures returns based on what you spent out of pocket on the investment. The formula for a cash return calculation is as follows:
Cash back = ( (annual income – annual expenses) / (initial cash investment) x 100% )
So, if your income is $200,000, all your annual expenses totaled $155,000 and your initial cash investment on a property totaled around $175,000, the formula would look like this:
Cash back = ( ($200,000 - $155,000) / ($175,000) x 100% )
Your cash back percentage in this case would be approximately .26 or a 26% return. What constitutes a “good” return percentage is relative to the investor. It all depends on your personal financial goals and what you expect to make back.
Pros And Cons Of Buying An Investment Property
Buying and selling or renting out property can be a potentially lucrative investment if done right. But like any investment, there are still pros and cons. Before sinking potentially thousands of dollars into real estate, let’s consider some of the benefits and drawbacks of becoming a real estate investor.
Investment Property Advantages
- You can take advantage of tax benefits. There are a number of real estate investor-specific tax benefits that you can take advantage of once you’ve purchased real estate. For example, you can deduct operational expenses like property insurance, mortgage interest and property management fees from your taxes.
- Real estate appreciates in value. Unlike other investments that could fluctuate wildly in value, real estate tends to increase in value as time goes on. That means that if you give it time, you can likely sell a property for a profit just by letting it appreciate with value, which makes it a fairly safe investment in that regard.
- You can earn consistent income on the side. If you’re renting your investment property out to tenants, you’ll make consistent income from their rent payments which will not only help you pay back your investment but can also become a solid source of cash flow for you.
Investment Property Disadvantages
- It’s a lot of work and it isn’t cheap. Investing in a property can be a huge financial burden and it also requires a lot of hands-on work. Whether you’re managing a residential property or renting out a commercial one, there will likely be maintenance and upkeep tasks that will fall to you unless you hire someone else to take care of them.
- You will have a responsibility to your tenants. If you’re renting out a property, you have a responsibility to the tenants that are paying you. It’s not enough to simply collect rent every month – you’ll also need to manage these relations according to state law and make sure your tenants’ needs are taken care of.
- There is considerable financial risk. While real estate might seem like a safe investment because it’s likely to increase in value over time, investing in property can still put you at risk of loss. If a development goes south or a tenant unexpectedly vacates a property, you could have a lot of problems on your hands that you may not be prepared to handle on short notice.
The Bottom Line: Learn The Steps On How To Invest In Property Before Getting Started
Investing in real estate is a great way to diversify your portfolio and potentially make a substantial amount of additional income for yourself. It isn’t risk-free, however, and comes with a lot of work and responsibilities that you must be prepared to tackle if you want to invest.
Like any investment, you should consider your financial goals and future before sinking any money into it. Doing proper research can help you make a more informed investment that will better benefit you.
For more tips on getting started investing and getting into homeownership, read our guide to the steps to buying a house.