Suppose you’re one of the lucky few who have substantial savings, built an emergency fund, and are well on your way to a healthy retirement portfolio. In that case, it may be time to think about diversifying your financial portfolio. An investment property may be a solid option to do that.
Real estate investing can help diversify your existing investment portfolio and bring an additional income stream. But before taking the plunge to invest in real estate, here’s what you need to know about investment properties and how to invest in this asset class.
What is an Investment Property?
An investment property is a piece of real estate purchased to earn a return on the investment through rental income or the property’s future resale.
Usually, an investment property differs from an investor’s primary residence or a second home. It can be more challenging for investors to secure financing for an investment property because lenders see it as riskier than a primary residence.
Investors often treat property as a long-term investment. Over a given period, investors can benefit from a stream of rental income and capital appreciation, where the value of a property increases over time.
Most investors get into real estate investing with this long-term time horizon, but some investors treat investing in property as a short-term trade. Investors do this by house flipping, which is when real estate is purchased, renovated, and sold for profit in a short amount of time.
Types of Investment Properties
Residential real estate is a type of property used for people to live in, like single-family homes, apartments, townhouses, and more. Most people think of residential real estate when investing in property.
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However, that is just one type of investment property. Other types of investment properties include:
• Commercial: Commercial real estate is a term used to describe a piece of land or property used for business purposes. Commercial real estate can include office buildings, warehouses, retail space, large apartment developments, etc. While less common for individual investors, commercial real estate may still be an attractive investment that offers higher rents than residential property, though with increased costs.
• Mixed-use: A mixed-use property can be used for both commercial and residential purposes. For instance, a building may have a retail storefront on the main floor, while the upper portion of the structure consists of residential apartments or condos.
Who Is an Investment Property Right For?
An investment property is usually a good fit for those interested in earning rental income or owning an appreciating asset. Investing in property can be a way to diversify a financial portfolio, combining it with a mix of stocks, bonds, and other assets.
Additionally, some people invest for the tax benefits associated with real estate investment, while others invest for the ability to build equity in a property.
No matter your reason for investing in real estate, it is vital to research and understand the risks and potential rewards associated with this type of investment.
Pros of Investing in Property
Here are some of the advantages of investing in property. However, these advantages are not guaranteed; investors must research properties and real estate markets to increase the odds of generating returns.
Potential for High Returns
If the real estate you own increases in value over time, you can sell it for a profit. However, this price appreciation isn’t guaranteed.
Passive Rental Income
Investing in real estate can be a way to generate relatively passive income. Whether you invest in residential or commercial real estate, you can rent out your space to tenants and receive regular rental income.
Hedge Against Inflation
Real estate investments may protect against inflation. When the prices of goods and services rise, home values and rents typically increase. Investment properties can therefore provide you with increasing monthly income and appreciation to help protect you when consumer prices are going up.
Potential Tax Advantages
Investing in real estate comes with tax benefits. You can deduct several expenses associated with owning an investment property from your taxes, including your property taxes, mortgage interest, and other expenses.
Cons of Investing in Property
Like any investment, there are potential downsides to investing in property.
High Upfront Costs
Directly investing in property generally requires higher upfront costs than primary residences. Lenders usually require higher down payments and interest rates for investment properties. This makes it difficult for some people who don’t have the initial capital to invest in a property.
High Maintenance Costs
Maintaining a property can be expensive and time-consuming, and it is essential to factor in these costs when considering an investment.
Illiquidity
Real estate isn’t a liquid asset. It could be complicated if you want to sell the property, and you may not be able to sell the property at the price you want.
Real Estate Market Risks
The real estate market can be volatile, and there is always the risk that your investment may not perform as well as you hoped. It’s important to do market research to make sure your investment property is in a location that may experience price increases.
How to Invest in Property
Rental Properties
Purchasing a residential investment property to rent out to tenants is a popular way to invest in property. This strategy allows investors to reap the benefits of generating rental income and price appreciation.
Before you directly invest in a property, it’s important to determine how much you have to spend on this property upfront. Also, it would be best if you have the time to take care of it or have the means to employ someone else to maintain the property.
It’s often beneficial to look in neighborhoods or areas you are familiar with to limit surprises down the line. You may also want to consider neighborhoods where experts think a property is likely to increase in value.
Real Estate Investment Trust (REIT)
Buying and selling the shares of real estate investment trusts (REITs) is one of the easier ways to invest in real estate. With a REIT, an investor buys into a piece of a real estate venture, not the whole thing. There’s less responsibility and pressure on the shareholder when compared to purchasing an investment property.
When a person invests in a REIT, they’re investing in a real estate company that owns and operates anything from malls, office complexes, warehouses, apartment buildings, mortgages, etc. It’s a way for someone to add a diverse mix of real estate investments to their portfolio without developing real estate.
In addition to diversification, earning consistent dividends can be a compelling reason for investors to get involved with REITs. REITs are required by law to pay at least 90% of their income in dividends. The REIT’s management can decide to pay out more than 90%, but they can’t drop below that percentage.
Many, but not all, REITs are registered with the SEC (Securities and Exchange Commission) and can be found on the stock market, where they’re publicly traded. Investors can also buy REITs registered with the SEC but are not publicly traded.
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Interest Rates on Investment Properties
Lenders treat investment property loans differently because people are more likely to default on an investment property loan than on a primary residence mortgage.
Typically, lenders will charge a higher interest rate on an investment property than on an owner-occupied property. So if the rate was at 5% for your primary home mortgage, you might have a 6% to 8% interest rate on your investment property mortgage.
Lenders often require at least a 20% down payment to purchase an investment property. This down payment minimum may be higher, depending on the borrower’s credit score and savings.
The Takeaway
Adding an investment property to your financial portfolio can be a good option to build wealth. However, real estate investments come with a lot of work, especially if you decide to invest directly in a property; not everyone is cut out to be a landlord.
Fortunately, investors don’t have to invest directly in real estate or resort to house flipping to get exposure to real estate. Investors can invest in various publicly-traded REITs to benefit from their potential share price appreciation and regular dividends. And with the SoFi Invest® online trading platform, investors can trade stocks and exchange-traded funds (ETFs) for as little as $5.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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