With the real estate market on the upswing and properties moving for the first time in a few years, the present seems like the perfect time to dip your feet into the market. Turn to HGTV and you’ll see an endless stream of shows narrating the trials, tribulations, and benefits of property investment. But before you dive head-first into flipping houses, make sure you understand the risks, rewards, ins and outs of real estate investing.
What is an investment property?
An investment property in its most general form is just what it sounds like: any form of real estate that is purchased with the aim of generating income, rather than simply using it as a residence. The means by which you can generate income vary, but are usually by either renting or re-selling the property. There are two types of properties: residential and commercial.
- Residential properties: A residential property is what most first-time investors will pivot to just based on familiarity and accessibility. Residential properties tend to be more manageable investments that can yield consistent income. People tend to be more comfortable renting to individuals than businesses. Residential properties can be turned over or “flipped” much quicker than their big brother the commercial property, which means investors can quickly profit and move onto their next investment.
- Commercial properties: This type of property is suited for a well-seasoned investor. Most first-time investors are advised to steer clear of commercial properties due to high up-front costs and the complexity of commercial real estate. However, the downturn in 2008 has left quite a number of low priced commercial properties on the market. For an investor willing to put in the time and money, a commercial investment property has the potential to yield a higher return than a residential one.
What makes a property worth it?
Calculating the amount of money you can expect to garner out of an investment property is not always as simple as a difference between money in and money out. While keeping a record of total buying costs, renovation costs, time for turnover, monthly mortgage payments, and staff overhead is essential to reaching an idea of which investment property will get you the most profit, there are a number of other more subtle considerations to keep in mind.
Net operating income
The calculation of a net operating income for a property is essentially the income coming in minus the operating costs for holding onto and managing the property. If this number ends up being negative it is called a net operating loss, a clear signal of a poor investment property.
Tax shelter
One way that your investment property can add to your income flow is by saving you some money come tax day. Real estate investments are full of instances where your investments are completely tax-deductible. From property taxes, to interest on loans, to even the amount of money you save from refinancing; all of these costs can be filed as deductible expenses. Another way that real estate provides a tax shelter is through depreciation of your property. While your land will never depreciate, you can progressively depreciate a home and write off a fraction of that property cost at a steady rate each year until it is fully depreciated.
Capital appreciation
Capital appreciation entails a rise in the market value price of your property over time. Whatever the reason, whether the neighborhood that your property is in becomes more desirable, or if the public schools in the area improve, a rise in market price is a good thing for when you decide to sell. Capital appreciation is a figure that property flippers pay close attention to in particular since the guiding principle behind flipping a home is buying a property at rock bottom and putting just enough money in to get to it market value for the most profit.
How to finance your income property
Real estate investments have been touted for some time as a great place to accrue side income. But unless you have a few hundred thousand lurking in a savings account, you’ll have to do some financing before buying your first property.
Put down as much as you can
Being able to pay a sizable down payment is a great step in ensuring a low interest rate. With most residential properties, you can get away with putting 20% down or less; commercial properties can run as much as 45% down.
Live in your property
Buy an investment property that you live in and rent out to access “owner-occupant loans” that have minimal down payment requirements. You’re not stuck living on the property for as long as the loan exists either. After 12 months you can move out, retaining the terms of the original loan, and move onto your next investment.
Shop around
Before settling for a big bank, think about meeting with credit unions, mortgage brokers, and even online lenders before settling with one. Shopping around will give you an idea of all of your options. As a bonus, you’ll also be able to gather financial advice and insight from a variety of reliable sources with different perspectives on the market and your investment.
What are the risks of real estate investing?
Every investment you make comes with a set of risks. The real estate market, as the past few years have demonstrated, is volatile; your money can be tied up in a property for a long while. Due to this inherent risk in the market, it is not advisable to engage in risky lending processes, which can lead you down a red path in the case that your investment of financial security sours. Even if you secure proper financing, there are a few common pitfalls that you should try to avoid.
Buying blind. Doing your homework on your first property is a long and arduous process, but it is a critical and unavoidable step if you plan on making money off of your investment.
Buying without a calculator. Miscalculating your net operating income can stick you with a property that makes you lose not gain capital. Connect with reliable contractors and professionals to get accurate estimates on rehabilitation costs, and factor in “rainy day” funds for those unforeseeable costs that are bound to turn up in the process.
Being too ambitious. While the professionals make renovations look painfully effortless on TV, if you’ve ever been involved in a renovation at your own place, you know how these things can take a sharp turn downwards. Picking a complete fixer upper as your first project with minimal experience can tie up your time and money for a long time while you get your property market ready.
Not being ambitious enough. Buying a turn-key property may not be the best route for maximizing your profit margin. While many renovations do end up being sinkholes for money, a number of smart projects on the other hand can drastically increase the market price and rental price of your property.
At the end of the day, the most important part of property investment is this: Be prepared. If you have your priorities and finances in order, the process will be far less of an uphill battle. Use what you’ve learned so far as a jumping point for more independent research before reaching for the keys to your new investment property.
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