Buying an Investment Property

Buying an investment property is one way to potentially earn income off of real estate.

While investing in real estate is a popular avenue to take when trying to increase wealth, it’s important to understand how to buy an investment property and how to choose the right one based on your needs and goals.

In this guide, we’ll cover the basics of buying an investment property to rent, including the pros and cons of buying an investment property and how to invest in property.

• What Is an Investment Property?
• Pros and Cons of Buying an Investment Property
• How to Buy an Investment Property
• Final Notes

What Is an Investment Property?

An investment property is a piece of real estate purchased with the intent to generate income, whether that income comes from rent payments or appreciation. A primary residence, on the other hand, is a home that’s purchased with the intent of the purchaser living there. Both primary residences and investment properties can play an important role in financial planning.

There are different ways to buy an investment property. For example, you can buy an investment property to rent out to people, which means you can hire property management or be your own landlord. You can also invest in property and earn money through appreciation or by increasing a home’s value through renovations.

Why Buy an Investment Property?

As an investor, there are a handful of reasons you might consider buying an investment property. One of the main reasons is the fact that the value of property has the potential to appreciate significantly in a relatively short amount of time. 

For instance, between March 2012 and March 2022, the Case-Shiller U.S. National Home Price Index rose by nearly 115%. 

Investing in property is a common way to earn money investing, particularly for those looking for consistent cash flow. If you are thinking about investing in property, you may also want to consider the importance of diversifying your portfolio, so you’re not investing all of your money in one place.

If you have the capital to buy an investment property, you might consider adding real estate to your investment portfolio. However, that doesn’t mean real estate investing is right for everybody. As an investor, you may want to take your time to evaluate your situation to determine the best investments based on your money habits.

Pros and Cons of Buying an Investment Property

As is the case with any investment, there are both pros and cons to buying an investment property. 

Before you invest, you may want to consider your financial situation, including:

• How much you want to invest
• Your investment goals
• Your budget

In the next section, we’ll talk about some of the pros and cons of buying an investment property.

Pros of Buying an Investment Property

There are several potential pros of buying an investment property, whether you’re buying property to rent or trying to earn money through appreciation. 

That being said, keep in mind that your results may vary based on your market, the property you purchase, and other factors.

Value Tends to Increase

One of the benefits of buying an investment property is that real estate tends to increase in value over time. This means you could potentially earn money on your investment in the long run, even if you don’t rent your investment property out. 

Appreciation

This also means that there is the potential to earn money through appreciatio—increased value of the asset—on top of earning money by renting out your property. Keep in mind that interest rates and property values change, so there’s no guarantee you’ll earn money through appreciation.

Here’s an example of how appreciation can work. You purchased real estate for $100,000 in 2019 and today you see on Zillow the estimated value of the property is $150,000. The increase in value (appreciation) not realized (since you still own the property) is $50,000. If you sold the property—with no improvements—for $150,000 the realized gain is the appreciation of $50,000.

Ongoing Income

Another benefit of buying an investment property is the ability to generate a steady income each month. When you create a budget that includes your monthly income and expenses, you can include your investment property income if you’re renting that property out. 

If long-term investments that don’t offer a return for several years make you apprehensive, investing in a rental property may be an alternative strategy to consider.

Tax Advantages

Finally, investing in real estate could provide you with the opportunity to take advantage of tax deductions and other unique benefits that are afforded to rental properties. 

For example, you may be able to deduct the interest you pay on your mortgage payments, and there may be tax benefits and deductions available for things like solar power. If you decide to rent your investment property out, you may also be able to deduct operating costs that you spend on repairs.

Cons of Buying an Investment Property

While there are several potential benefits to buying an investment property, real estate investing isn’t a god fit for everyone. Considering your financial situation and your investment goals before you invest are important as an investor. 

Below are some of the potential downsides you should consider when it comes to buying an investment property.

Housing Market Crashes

The fact of the matter is that there’s no predicting changes in property values. While it’s true that real estate tends to appreciate more than several other types of investments, that doesn’t mean your investment property is going to increase in value. In fact, the potential for housing market crashes means real estate investing can be very volatile at times.

Property Management

If you plan on purchasing a rental property, it’s your responsibility to manage that property. You can either spend the money to hire a property management company to manage your rental property, or you can act as the landlord. Either way, you may end up investing significant time and money in searching for prospective tenants, hiring cleaners in between tenants, and making repairs when something needs to be fixed. You’ll also need to track your spending if you hope to write off repairs and other operating costs.

Liquidity

While a rental property can allow you to earn consistent cash flow each month, real estate as a whole is an illiquid asset. What this means is that you can’t quickly convert your investment property to cash if you suddenly need cash or want to move your money to another investment. 

This may not be a problem for some investors, but it could be a deal-breaker for investors who lack capital.

How to Buy an Investment Property

If real estate investing sounds like it could be right for you, you might be wondering how to invest in real estate. 

Here’s a breakdown of the general process of buying an investment property for beginners in real estate investing. 

Note this process may differ depending on your circumstances. 

Choose an Investment Strategy

The first thing you need to do is decide on an investment strategy. 

1. You can purchase a property, fix it up, and try to flip it for a profit. 
2. You can invest in a long-term rental property with the goal of earning consistent cash flow for the next several years. 
3. You also have the option of investing in a property that you can rent as a vacation rental, which makes your responsibilities a little different if you’re acting as the landlord.

Regardless of the investment strategy you choose, it’s important to consider all the pros and cons. You may even want to use an inflation calculator to see if your investment makes sense long term.

Find an Ideal Location

Once you know how you want to invest, it’s time to pick a location. Location is key when it comes to real estate, so understanding the real estate market is a key. Look for a location where real estate values are projected to rise in the coming years, that way you can earn money through appreciation. 

Even if you’re purchasing a long-term rental property, it could have the potential to earn more money over time. 

Higher market values may also lead to higher rent prices, which means you could make even more by choosing the right location. Consider taking your time to research real estate investing trends in the areas you’re looking to invest in. A real estate agent can also help you find the best place to buy.

Get Pre-Approved

Before you start seriously looking for an investment property to buy, you may want to get pre-approved by a lender. Pre-approval essentially gives you permission to secure a loan up to a certain amount to buy a home, which helps you get a better idea of your budget as an investor. 

Pre-approval can also make it easier to make an offer and purchase a home when you find an investment property you like.

Consider shopping around for a mortgage to find a loan that’s right for you as an investor. Keep in mind that different lenders may offer different terms, including varying interest rates, loan amounts, and more. Investors typically  look for a mortgage loan with a low interest rate to minimize the amount they’re paying in mortgage interest each month.

Final Notes

Whether you’re earning money through a vacation rental or through appreciation, there are several reasons you might consider adding an investment property to your investment portfolio. However, the final decision comes down to your priorities, your finances, and what you hope to gain from your investment.

If you’re considering investing in real estate, having the right tools at your fingertips can be helpful. Luckily, Mint can help with our savings calculator, tools that allow you to track your investments, and more. 

Whether you’re just getting started or you’re an experienced investor, you can use the Mint app to make tracking your investments and staying on top of your finances easier.

This is for informational purposes only and should not be construed as legal, investment, credit repair, debt management, or tax advice.  You should seek the assistance of a professional for tax and investment advice.

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