What Is Real Estate Investing?
Real estate investing involves purchasing an investment property to generate profit. An investment property is real estate that isn't a primary or secondary residence. It's a piece of property that will not be occupied by the owner. Instead, the property is purchased in order to generate a profit, either through rental income, a future sale, or both. A home buyer may be interested in investing in real estate due to potential tax benefits or the opportunity to build up an investment portfolio.
An investment property can be a long-term commitment or a short-term endeavor, such as "house flipping", where a home is purchased, renovated, and then sold at a profit. Regardless of the specifics, the needs of real estate investors are different from the needs of a typical home buyer, so working with a lender who understands your goals is beneficial.
Why Get an Investment Property Loan?
Whether a borrower plans to purchase a single-family home, townhouse, condominium, or multi-family dwelling, there are different requirements to secure a loan on an investment property versus obtaining a mortgage for residential purposes. Since investment properties inherently carry more risk, the financing guidelines are different from traditional loans - they also offer additional benefits:
- Rental opportunity: Renting out your property to tenants creates additional cash flow. Consider purchasing properties near downtown areas, vacation spots or college campuses as these are popular among renters.
- Increased cash flow: Your investment property can provide income to offset your expenses. You may even profit from your rental property!
- Potential tax benefits: There can be many tax advantages to owning rental properties, such as deductions for mortgage interest, property and real estate taxes. Be sure to consult a tax adviser.
- Build your investment portfolio: You can diversify your portfolio by owning an investment property.
Real Estate Investing: Types of Properties
If you’re considering real estate investing and an investment property loan, here are a few different property types and the pros and cons for purchasing and maintaining them:
Vacation Investment Property
Pros:
- Beach or ski rentals can yield the equivalent of a month’s long-term rent in a week.
- Vacation rental services can supplement and even a few nights a month can add up to the mortgage being covered
- You can use when you wish
Cons:
- Popular areas can be very expensive
- Frequent turnover means you need to be an active landlord
- More tenants heighten risk for damage
- May sit vacant off season
College Investment Property
Pros
- Almost always a demand
- High rents because college-owned competition charges top dollar
- Rental market is calculated with each individual tenant’s share compared against dorm or college-owned apartment rates (as opposed to one rate for entire property)
- The area markets itself
- You can have property do double duty if you buy where your children plan to attend school
- Rent short term during summer or off season for orientation, summer school, sports competitions, etc.
Cons
- Frequent turnover; 8 – 9-month leases standard
- Risk of damage, noise complaints, repairs, tenant conflicts
- “Off season” may cause vacancies, but high rents during year should compensate
Long-term Investment Property
Pros
- Steady tenants, sometimes for years, allow you to know and trust who is caring for your home and build equity
- Low turnover can help you anticipate repairs (tenants have proven they won’t damage property, but regular upkeep will still be necessary)
- It can be a “passive investment.” If management company is utilized, it can handle all leasing, tenant interactions and repairs.
- Track market and sell when it’s most advantageous
Cons
- Monthly rents won’t be as high as vacation or college rentals
- It’s a recommended business practice that rents for long-term tenants should cover your mortgage, repairs, and other expenses including HOA. A landlord who doesn’t maintain property or raises rents at every opportunity will get a bad reputation in the region.
Real Estate Investing & Taxes
With multiple streams of income and properties, your taxes can become much more complicated. Here are some of the tax implications you can expect when pursuing real estate investing.
Note: Capital Gains Tax and Short Term Capital Gains Tax are applicable when rental properties are sold. Borrowers should always refer to a financial advisor or accountant for tax advice.
Capital Gains Tax: You’ll be forced to pay capital gains on your investment property if you’ve owned it for at least one year. You can deduct the money paid in real estate commission fees, but the income you gain from selling your property is still taxed depending on the tax bracket you are in for the rest of your income
Short-Term Capital Gains Tax: If you haven’t owned your property for at least a year, you will still be assessed short-term capital gains taxes. These taxes are at least easier to compute—your profits from your investment property are simply considered part of your yearly income.
Taxes on Rental Property Income: Income made from a rental property need to be disclosed in your tax return. At the same time, you can deduct certain expenses such as repairs and maintenance (though not improvements) when you own the property.
It’s still a great time to get into the real estate investing realm. The returns can be significant and the experience, rewarding.
Tips on Investment Property Loans
Ready to take that step and borrow towards real estate investing? Here is some advice:
Have money for a large down payment—you will need at least 15% to put down to obtain traditional financing on such a property, and mortgage insurance does not apply. With 25% down, you may even qualify for an even better interest rate.
Check your credit score—you could end up paying more for the same interest rate if your score is under 740 or having to accept a higher interest rate. Lenders will also want to see that you have at least six months of personal and investment-related expenses available.
You have options—Consider a bank like New American Funding to get financing for your investment property loan rather than a big bank if you don’t have as big of a down payment as you’d like. Mortgage banks like New American Funding may have access to a wider range of loan products.
Get creative—ready to pull the trigger on an investment property with a high probability of making you a profit? Take advantage of other means of obtaining a down payment by way of a home equity line of credit, or life insurance policies.
Talk to us about a cash out refinance on your current home to buy an investment property.
