On the outside, buying an investment property might seem relatively similar to buying a home: find a good house in a good location, make an offer, and get the U-haul ready. Investment properties, though, aren’t quite that simple in reality. Here are five ways that buying an investment property is different from buying a home:
1. Taxes Aren’t the Same
The IRS has very different rules for what you owe — and what you can deduct — for a primary residence versus a second home or investment property. You won’t be eligible for any homeowner tax credits on this property, and you will likely be paying a different rate for property taxes than you do on your home. The good news, though, is that you can deduct things from your rental income taxes, like:
- Mortgage and/or mortgage interest
- Loss of income (if total expenses were more than your total rental income for the year)
- Advertising/marketing expenses
- Utilities that you pay for
- Property management fees
- Local and state property taxes
- Annual depreciation
This means that, if you play your cards right, you can reduce your taxable rental income significantly. It just takes a lot of work and attentive record-keeping.
2. Location is More Important
When buying your first home, location doesn’t matter nearly as much as it does with an investment property. For your primary residence, you need only make sure that it’s close to work and perhaps that it’s in a good school district. Outside of that, your location choices are largely based on your preferences.
Investment properties, on the other hand, often succeed or fail based on where they are. If you’re buying a commercial rental property, for example, you need to make sure it’s in a high-traffic area where businesses and consumers want to be — otherwise, your storefronts are likely to sit empty in perpetuity.
Residential investment properties, too, need to be in areas where renters want to live. Sometimes, the areas that are great for renters aren’t the same as the ones that are great for homeowners; it’s hard to find a family that wants to rent a house in an expensive suburb when they could buy the property just as easily.
Use a wholesaler like New Western to help you find desirable investment properties. Wholesales tend to know where renters typically want to live and where off-market properties are. If you buy a rental property in an area where few renters are looking, you may have more trouble filling it than you would a rental unit right next to your city’s business or nightlife district.
3. Local Economies Play a Big Role
When you buy a home for yourself, you don’t have to worry about the local economy (so long as you have a stable job or business). When you buy an investment property, the local economy is a major factor.
Buying a cheap single-family unit in a small town might seem like a great deal until you find out that the town’s largest employer — perhaps a factory — is shutting its doors. When the factory closes, the local economy suffers greatly and the number of people looking to rent in that town will be virtually zero.
In a booming economy, though, you can make a killing with a single or multi-family unit. When a company expands or opens a new location, hundreds and sometimes thousands of workers move to the area, and they all need a place to live.
This is one of the most important things to take under consideration when shopping for investment properties: will the local economy help you land tenants, or will it keep them away? This is a question nobody asks themselves when buying a home to live in, but real estate investors need to keep it at the front of their minds.
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4. Mortgages (and Mortgage Lenders) are Different
Getting a Mortgage for an Investment Property
Your credit score, when you buy a home, isn’t too big of an obstacle. You can generally secure a home loan with a credit score as low as 620. Investment properties, though, are riskier, and lenders want to see much higher credit scores — 700+- before they’ll agree to the loan.
Your debt-to-income ratio (DTI), which is a major consideration for lenders when buying a home, matters even more when buying an investment property. Because you already have a large DTI ratio from your primary residence, some lenders will be extra wary about giving you a new loan. Before you decide to buy, check with your preferred lender and get pre-approved for a loan so that you know what your investment property budget will be.
When buying a primary home, a 30-year fixed mortgage is almost always the way to go because it lowers your mortgage payments considerably. Investment properties, on the other hand, can sometimes be better served by a 10-20 year mortgage.
With a shorter mortgage term, you’ll pay more for the mortgage each month but the loan will be paid off much faster. That way, you remove the biggest monthly expense on your investment property as fast as possible and your net profit shoots up.
5. Housing Market Conditions are Crucial
Housing markets can be divided into two smaller categories: home buying markets and home renting markets. While they have a lot in common, they aren’t always the same. One of the worst things you could do is buy an investment property in an area where property values are a lot higher than the average rent. In that situation, a competitive rent charge won’t be enough to overcome your expenses.
Before you buy a property, do some extensive research into the average rent prices in that city. If you cannot charge a competitive price and still make a decent profit, look elsewhere. Failing to do this research can lead to you becoming stuck with an unfillable unit; don’t neglect it!
Finding an excellent investment property is a lot more labor-intensive than finding your first home. There are many issues you have to consider with investment properties — economies, locations, and more — that doesn’t really factor into buying a primary home. Before you settle on investment property, do lots of research and consult with realtors and other investors to make sure you’re making the right purchase. If you do your due diligence, though, you can make incredibly lucrative passive income from owning investment properties.