Investment properties offer an excellent way to add extra income through real estate. While it may look lucrative, buying an investment property comes with many challenges that every aspiring investor needs to know before committing.
Like any other form of business, investment properties have industry perks and obstacles that can make an investor succeed or fail in the venture. Lack of knowledge is among the reasons most real estate businesses fail a few years after starting.
Thus, an investor’s success depends more on the depth of their knowledge in the venture than the number of resources they’re willing to dedicate. Before starting, here are a few things every investor needs to know before buying an investment property.
What is an Investment Property?
An investment property is any secondary home an investor purchases to make money. Investment properties fall into three categories, residential, commercial, and industrial.
Residential investment properties are homes investors buy to resell or rent out for residential purposes. These can be anything from single-family units to condos or townhouses. On the other hand, commercial property owners aim at renting or starting businesses. They include properties for hotels, retail shops, office suites, or restaurants.
Similarly, an investor may decide to purchase a new property for industrial purposes. These properties house manufacturing companies, warehouses, or food processing firms.
There are three major ways of investing in properties. In most cases, the investor can resort to buying a property, renovating it, and renting it out to families and businesses. It’s the most common type of property investment.
Apart from that, the investor can also decide to buy, renovate and quickly sell the property at a profit. This type of property investment is often referred to as house flipping. Unlike rentals, house flipping requires a deep understanding of the market trends and taking advantage of the available gap to make money.
Before Buying an Investment Property, What Should You Consider?
Investing in properties comes with several responsibilities, as this may not be the first property the investor is buying. But, investment properties have different conditions that don’t apply to primary homes. For instance, most mortgage lenders consider property investment to be risky.
Since they feel the buyer may default, most lenders have strict terms and higher interest rates for property investment homes. Also, most loan types and advantages available for primary homes aren’t available for property investments- here are some things to consider:
Most lenders offer mortgages at higher interest rates than primary homes. Also, the down payment for most investment homes is typically costlier than for primary homes.
To purchase a primary home, buyers can part with down payments of 10% or less. However, buying an investment home typically costs at least 15% down payment, with others demanding high minimums of 25-30%.
Similarly, buying an investment home places the purchaser in charge of everything: maintenance costs, insurance, higher mortgage rates, inspections, and closing costs. Again, insured mortgages, including Department of Veterans Affairs and Federal Housing Administration loans, aren’t available for investment home purchases.
Apart from the maintenance costs, investors will also need to factor in the cost of advertisements and credit checks to land the best tenants. As a result, every buyer should focus on having sufficient finances to cover the costs.
Buying an investment property comes with responsibilities and time commitments that may be hectic for investors with other businesses or jobs. First, the investor will need to spare time for advertisements, perform timely maintenance, run background checks on potential tenants to know they can pay rent on time, and attend to emergency calls when necessary.
One of the most common legal lawsuits that most landlords face is failure to attend to emergency repairs timely. As a result, ensuring enough time to commit to the requirements is inevitable. If there’s no time, the investor should set aside a budget for hiring an available property manager to run the errands.
Partnership or Sole Purchasing – Which is Better?
Both sides have their perks and challenges. Buying an investment property as a person will mean pocketing all the profits, but that also means taking care of all the expenses, from mortgage payments, maintenance costs, and other additional costs relating to the purchase.
On the other hand, a partnership will mean shared costs. The partners will also share the profits and any risks involved. If the partners manage the property themselves and a tenant sues one of them for not taking action on a required repair or maintenance, all the partners will be liable for the subsequent legal proceedings.
Is The Return on Investment Worth the Commitment?
Before buying an investment property, it’s essential to calculate the return on investment (ROI) and ensure it’s worth the commitment. ROI is the total amount of annual rental, minus expenses, divided by the total cost of the property.
For instance, if an investor purchases a property worth $150,000, rents it out at $1,000 per month, and estimates the annual cost of operation to be $5,000, the ROI will be:
Yearly rental amount= $1000 × 12 months= $12,000
Net yearly income= $12,000 – $5,000= $7,000
ROI= $7,000 ÷ $150,000= 0.05
In that case, the ROI for the property will be 5%. This can be a lucrative investment property, especially if its location is perfect and there’s a possibility of getting long-term tenants. The ROI doesn’t make the investment worth it, especially if the property may remain unoccupied for the better part of the year.
What to Check on Before Buying an Investment Property
Time commitments, financial situation, and market availability aren’t the only things to consider when buying an investment property. Apart from these factors, there are several issues that an investment property buyer needs to consider, including:
- The market trends
- Property tax deductions
- Legal Requirements
Buying an Investment Property: Final Words
Buying an investment property differs from purchasing a primary house. Before committing, it’s important that every investor learns everything about the investment process. This article sheds light on the requirements of every investor. But, walking with a reliable real estate expert will make the process easier. AIME Group is an excellent resource for all real estate needs.