What to Know About Buying an Investment Property

An investment property can bring in income if you rent or resell it, but the buying process can be complicated.

Linda Bell
Bella Angelos
Chris Jennings
Updated

An investment property is real estate bought for the purpose of generating income. Yet, what at first seems like an easy money maker inevitably comes with challenges and costs. First off, buying an investment property involves more stringent financing requirements compared with mortgages on primary homes. Then, once you own the property, you’ll be responsible for ongoing homeownership expenses that can cut into your profits.

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What is an investment property?

Buying an investment property allows you to generate income through the renting or resale of a property that isn't your primary residence.

Investment properties can be residential, such as single-family homes, townhouses or condominiums, or commercial properties, which are zoned for businesses such as hotels, restaurants and retail shops.

Investors in residential properties try to make money by collecting rent from tenants or by renovating the property and quickly reselling it for a profit, known as house flipping. The property can also be held long enough to increase in value over time, then sold.

Getting an investment property mortgage

There are differences between obtaining a mortgage for an investment property and for a primary residence.

Here are some of the major ones that lenders consider.

Down payment minimum

The down payment you need depends on how many units the property has and whether you plan to live there:

  • One-unit property: Typically requires at least 15% down with a conventional loan. 

  • Two-to-four unit property where you do live in one of the units: You may be able to put as little as 5% down.

  • Two-to-four unit property where you do not live there: Typically 25% down.

🤓Nerdy Tip
Owner-occupied multifamily properties can be a good strategy for first-time investors. You can live in the property while using the rental income from the other units to offset your housing costs and build your investment portfolio.

Credit score

Getting approved for financing could also be a challenge if your credit needs work.

For a conventional investment property loan, 620 is generally the minimum credit score, but qualifying with a 620 may be more difficult. Lenders might prefer a higher score, sometimes up to 720.

Your credit score will also affect your interest rate and loan terms. Investment property loans are riskier for lenders because borrowers facing financial trouble are more likely to default on an investment property than on their primary home. That’s why the stronger your credit score is, the better your rate and terms may be, which can significantly reduce your monthly payment and improve your overall return on the property.

Extra cash requirements

While it depends on the lender, you may be required to have extensive cash reserves when buying an investment property.

Expect your lender to require that you have at least six months of cash reserves or savings available after closing on your property to ensure you can cover operational and unexpected costs.

Government-backed loan restrictions

In most cases, government-backed loan programs offered by the Federal Housing Administration or the Department of Veterans Affairs aren't an option because those loans are intended for a primary residence only.

However, you may be eligible for these loans if you purchase a multifamily property, as long as you occupy one of the units as your primary residence for at least one year. You could then rent out the remaining units. Here are a couple options:

  • FHA loan: Purchase a property with up to four units, live in one unit and put down as little as 3.5% if your credit score is 580 or higher.

  • VA loan: If you’re an eligible veteran, you may be able to purchase a multifamily property with little to no down payment.

Did you know...
Shop around at multiple lenders offering investment property loans to find the best rates and fees, just as you would when obtaining a mortgage for a home. Compare what each lender offers by reviewing the Loan Estimate.

» MORE: See NerdWallet's list of the best mortgage lenders for second homes

Factors to weigh before buying an investment property

Before giving into the siren song of investment property income, know that you’ll likely need to shell out a sizable chunk of cash before you start seeing any profit. Also be prepared for potential headaches.

Choosing an area with a steady stream of renters is critical when buying an investment property. Owners also need to be aware of rental laws that vary by state, as well as the potential for having to deal with delinquent tenants.

Here are other aspects of owning an investment property to be aware of:

  • Maintenance: Maintenance is a significant cost to consider when buying an investment property. You can either hire someone to take care of the property, or you can handle things like rent collection, repairs and snow removal yourself. In general, you should expect to spend between 1% and 4% of the property’s value each year on maintenance, but that will vary depending on factors like how many units it has, when it was built and the condition of major systems like plumbing and electrical.

  • Property taxes and insurance: Like any property owner, you’ll need to pay taxes and homeowners insurance for as long as you own the investment property. 

  • Utilities: With utilities, you can either include some or all of them as part of the rent, charge them to the tenant each month or require the tenant to set up the utilities in their name and pay the providers directly.

Pros and cons of buying an investment property

Challenges aside, buying an investment property can be a lucrative move. Here’s how the pros and cons stack up:

PROS

  • The value of your property may rise enough for you to sell and make a profit.

  • You can benefit from tax deductions on your rental property, such as mortgage interest, property taxes and expenses like advertising, repairs and insurance.

  • You can gain consistent income from long-term rentals.

  • You can pay down your mortgage with rental income and build equity in the property.

CONS

  • You could lose money trying to flip or rent the property.

  • Mortgage requirements may include higher down payments and interest rates than you would see for a primary residence.

  • Real estate isn't a liquid asset. If you needed cash, selling the property could be time-consuming and complicated.

  • You have to hire a property manager or manage the property yourself.

What makes a good investment property?

Determining what makes a good investment property depends on some rules of thumb, but also individual goals.

For instance, consistent monthly profit and cash flow is likely a top priority for many who buy an investment property.

When evaluating the profit potential of an investment property, you should consider a number of factors, starting with how much the property could reasonably rent for. One formula, called the 2% rule, indicates that the total monthly rent should equal at least 2% of the total purchase price plus needed repairs.

Look for four factors

Before buying an investment property, look for a combination of four key elements:

  • Affordability

  • Appreciation

  • Local job growth

  • Population growth

Property values are more likely to increase over time in areas with a solid and expanding infrastructure. Score a few investment properties in a growing market and you have a healthy cash flow from renting them out, you may be able to fund your retirement.

That said, even in a hot market, not all properties are created equal. One house could be in great shape, while the house next store could have problems, such as lack of a view, or worse, previous flood damage. So make sure to inspect every investment property from top to bottom to ensure you don’t get hit with hidden expenses.

Frequently Asked Questions
What are the different types of investment properties?
Investment properties can be residential, commercial or industrial. Residential investment properties include single-family homes, multifamily homes, condos and townhouses. Commercial real estate properties are office buildings, strip malls or restaurants. Industrial real estate properties consist of warehouses, manufacturing buildings and factories.
What do I need to buy an investment property?
You will need a sizable down payment, good credit score and some cash reserves to buy an investment property. You’ll typically need to put at least 15% down for a one-unit property. If you choose to live in a two-to-four unit investment property you may be able to put as little as 5% down. If you choose not to live in the unit, you’ll typically put 25% down. Depending on the lender, you may also need a credit score of 620 or above to qualify for an investment property loan.
What are the tax implications of renting an investment property?
If you generate rental income from an investment property, you must report it on your tax return. Rental property owners can benefit from tax deductions including mortgage interest, depreciation, property taxes and repairs. Other expenses like transportation costs associated with maintaining your property, utilities and advertising may also be deductible.
Can I still invest in real estate without buying an investment property?
If you aren’t ready to commit to purchasing a property, one option to get some skin in the real estate game is investing in a real estate investment trust (REIT). REITs are companies that own — and often operate — income-generating real estate, raising money from investors to manage portfolios containing assets like apartment buildings, data centers and offices. REITs are publicly traded on stock exchanges, which means you can purchase shares of a REIT and participate in the gains (and losses).